Stoltzfus states that the CPI print solidifies the notion that if the Fed were to implement rate cuts, "we wouldn't see anything until June." He emphasizes that bringing inflation down is a "process," saying everything "requires some patience." However, he adds that the print "looks good for the market and the economy" and demonstrates that the Fed is "on track" to bringing inflation down to its target.
Donald highlights that "the big problem" with the CPI print data is hawkishness. She cautions that if the Fed were to cut rates prematurely, they could "unwind the progress they've made so far." Donald suggests that the Fed's focus should shift from the inflation target to the economy's overall resilience. However, she notes that as investors anticipate a soft landing, a shallow recession might be "preferable."
That gives a more stable environment. It is a ratcheting down. It's a process of bringing inflation down. I got into this business in 1983, as you know. So I've lived through many Fed funds hike cycles, and also liquidity cycles. Everything takes some time. Requires some patience. But this looks good, we think, for the market, and for the economy.
The Fed is on track to do what it needs to do. It's a read that says, things are really where they should be at this point.
Now, we've talked a lot about inflation in the past year. But now, I think the focus is going to turn slightly away to inflation towards how resilient is the economy. Because if we're heading towards 2%, but the economy is not breaking, I think we're going to have to push those rate cut expectations out further.
Meanwhile, on the other hand, if this inflation number continues to come down as it has, but we start to see the employment side or retail sales later this week begin to break, June seems like a very reasonable time to expect the first cut.
BRAD SMITH: And there have been increasing conversations, chatter, at least, that what if the Fed doesn't cut this year, Frances? And it sounds like you're now looking at that possibility as well.
FRANCES DONALD: Well, it's certainly a risk scenario. Now, we still believe there are higher than price chances of a recession this year. That the soft landing-- well, it's already priced. And there are evidence that we may actually see this deterioration.
But one of the things I say to clients is don't necessarily hope for a soft landing, because while it sounds good on the surface, what it will mean is we'll probably get no rate cuts this year. And I think that will be more challenging for markets to digest, especially, because even in a soft landing, you'll see lower growth.
So a short recession, one that is shallow over with quickly and comes with a nice solid easing cycle, for most investors, and most asset classes, that's preferable even though, of course, we never wish for a recession from an investment standpoint. Be careful what you wish for.
SEANA SMITH: What do you think, John? Do you agree that a soft landing is it necessarily good news here for investors?
JOHN STOLTZFUS: I'd have to say when considering this, Seana, is that you've got this situation where we look at is our expectations have been that the Fed would likely raise more likely in the second half of the year. It could be as late as the fourth quarter. We expect in terms of cutting-- I'm sorry. In terms of cutting rates, you're looking at maybe once or twice this year and maybe none.
And we think that, essentially, what really counts is this resilience that we're seeing in consumer and business and in terms of the jobs numbers. And a Federal Reserve that has been incredibly sensitive in practicing its mandate to provide an economy with sustainable growth and full employment that's defined somewhere between 3% to 4% unemployment in terms of transitional moves within the labor force.
So we look at it. We think this is very much navigable by the markets and the economy. We have said, oh, over the course of the last two years that we thought that we thought that the Fed, once it got away from being behind the curve, it had a good opportunity to deal with inflation. We thought it made good progress. And thus far, no recession two years into this with what-- was it 11 hikes and five pauses or something like that. No recession.
We think they're on track to perhaps a soft, if not maybe somewhat bumpy landing, but we'll say-- we agree with Frances in the sense that nothing is clearly defined here. But we would have to say, beware of darkness. We think this looks like good opportunity for both the economy and investors here.
BRAD SMITH: What is the likelihood, John, that inflation, once again, rears its head if the Fed does go in June or just too early, in general?
JOHN STOLTZFUS: I think the biggest problem, Brad, is that if they were to go too early, they don't want in any way look like Arthur Burns, the unfortunate predecessor to Paul Volcker years ago, who just couldn't deal with inflation, cutting too soon, going back and forth. It wasn't the right way to do it.
So I think it's a steady as it goes. And the Fed will carry us through on this. What you've got is Jerome Powell does not want his legacy to be one remembered as Arthur Burns, nor does he want to have to be one who has to do draconian measures to reel inflation back in.
So we think we're looking at the Bernanke legacy Fed. Gentle as it goes and sensitive. And we'll get through this.
SEANA SMITH: Frances, when you take a look under the surface at this report sheltering gas costs right now accounting for about 60% of the monthly increase that we saw for the index here. I'm curious, is this something that the Fed should ignore to a certain degree? Or how should the Fed be looking at the fact that it's gas and housing that accounts for 60% of that increase?
FRANCES DONALD: Well, we know that housing is lagged. And also housing is a much smaller component of the Fed's preferred measure, which, of course, is PCE. So they're going to look through that.
That's why Powell always talks about the super core measure, which is services ex-housing. That's going to be what he's focused on. And so I'm going to agree with John that I think the story is really going to move away from the inflation we've seen from the past two, three years towards what is the real economy doing.
And for the Fed, the reason that's really important is because for inflation in services to move downwards and continue this downward trend, and prevent an Arthur Burns type scenario, like John is describing, they need the economy to soften.
So retail sales, employment, those are going to become important inputs into their outlook into inflation. And that's why a year ago, we would have been dissecting this report for days. I think the focus is going to move very quickly towards the real economy, because that's the key to the Fed moving forward.
BRAD SMITH: And in the shelter component there, as well, we've got to think about the number of homes that aren't even built to actually add more capacity and perhaps bring some of the pricing down. It's a chicken and egg thing to a certain extent.
But if we think about where the housing market now needs to see more supply come in so that we eventually do see some of these prices come down. How is the Fed going to adequately read through the continued home equivalent rent and what people are paying on mortgage, as well, in order to make sure that they're not necessarily keeping a housing market back from potentially seeing some new home buyers, first time homebuyers? Answer them, Frances.
FRANCES DONALD: Oh, man. We need a whole segment to dive into the substance of that question. There is a lot going on in housing. Just to clarify, the OER, the owner's equivalent rent measure within CPI, it is lagged. And we know from private data that we will see these numbers decline.
But what you're cluing into is actually one of the biggest problems for central banks globally, which is what do central banks do when their inflation measures are increasingly driven by supply side problems? The Fed cannot build housing. And their interest rate policy doesn't necessarily fuel how much housing is being built.
So they're a little bit at the hands of things that are not traditionally drivers of inflation. That's why they're going to have to focus on where is the economy. And I'll just highlight this just to leave you off here, the average time between the first hike and the impact of the economy is two years.
So the idea that we haven't seen the impact yet, therefore, it won't happen. Well, historically, it wouldn't have hit yet. The two-year anniversary of the first Fed rate hike is next week. Now, if we are going to see the impact to the economy, we're going to start seeing it in the next three to six months. Or this is a new economy and resilience this time is different. I'm just not quite in that boat.
SEANA SMITH: John, before we let you go, what do you make of the market's reaction here? We're moving higher on this hotter than inflation print as much of this, obviously, already been priced in. And then what does that therefore tell us about some of the short-term moves that we could see?
JOHN STOLTZFUS: Well. I think what it shows, it shows me for-- looking at the market is the market has told us usually going ahead into these numbers that you see some profit taking, some pullback, as we saw over the course of the last few days. And then the market gets back to where it is. Recognizes the fact, it's a process, moves forward.
The market is saying, this looks good. It's not too hot, not too cold, not a Goldilocks thing. You're dealing with inflation. It's an insidious thing. And it's problematic to an economy. You needed at a lower rate of where we are now, ideally.
And, essentially, there's a moment where there's acceptance that comes in one of this process. People buy homes, believe it or not, with 7% or 8% mortgages. My first mortgage is with 10%. My bosses was, I believe, 16. His boss was 22. We've run into meetings where we find people who had 18% mortgages. Guess what? We all survived.
But we're not there. We're in a much better situation. Things are getting better. And I think even as things remain uncertain, things are actually the overweight tends to be on the better developments for now. And we hope that continues.
SEANA SMITH: John Stoltzfus, always great to have you. Oppenheimer's chief investment strategist. And, of course, our thanks to Frances Donald, Manulife Investment Management's global chief economist and strategist. Thanks, guys.