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As the U.S. Federal Reserve signals more interest rate hikes are coming, MoneyTalk’s Greg Bonnell discusses what it means for the economy with Chris Whelan, Senior Canada Rates Strategist at TD Securities.
Transcript
Greg Bonnell: It was a hawkish tone from the US Federal Reserve as they raised rates to the highest level in 15 years, and they signaled that more hikes are ahead. Joining us now for his reaction, Chris Whelan, senior Canada rates strategist at TD Securities. Chris, great to have you with us. Let’s talk about what we got out of the Fed. It seems like it was getting ready to say goodbye to 2022. You got the Central Bank sort of singing that song they’ve been singing for a while.
Chris Whelan: Yeah, I think we’re all tired of the broken record now that we have going on this year. Tight labor market, persistent inflation. We need to bring rates higher. I think yesterday’s bond market reaction, and I think the stock market reaction we’re seeing, is telling us that these rate hikes are going to be tough for the economy to absorb. I think we definitely have a highly indebted world, and I think we’re quite sensitive to interest rates. So, I think the markets are bracing for what’s probably not going to be a wonderful 2023 economically. And on our side, we think that the Federal Reserve could still raise rates another 1% from here on the Fed effective rate. So still more pain ahead, I guess we’ll call it, until things can resolve themselves and we can see those inflation numbers come down and the job– and the labor market ease a little more. What’s been sort of surprising me about all this is that the message that we got yesterday isn’t far off the message that, really– if you go back to Jackson Hole, when Jerome Powell seemed to want to say, listen, we’re pretty serious about this fight against inflation. You’ve got to listen to what we’re saying. But in between those events, you get the markets sort of saying, oh, yeah, they’re probably close to being done. And that optimism sort of creeps in. I mean, what’s the dynamic here, where the market keeps thinking, maybe we don’t believe you until we hear from you again, and then we believe you again?
Chris Whelan: So, I think the market is actually starting to get a good idea of where terminal rates are going to be. I think they’re comfortable with them getting to somewhere in the 4.75% to 5%, or we think a little bit higher than that. But I think the market is starting to get a more narrow band on where they see the terminal rate path ending up. I think that that’s providing some clarity for the bond market, and I think that that’s actually giving some stability to the bond market further out of the curve. So, I think you make a good point, where we’ve been kind of going in and out on, are they going to pause? Is there going to be a pause? Is there going to be a pivot? And we kind of go back and forth. So now I think that the market is kind of re-gearing up for that pivot and pause, but not here. It’s a pause away now. So, there’s a bit of a change in tone, where we used to think they were going to pause imminently or there’s going to be a pivot imminently. Now we’re thinking about a pause at least 50 beeps, at least half a percent higher than where we are currently on the overnight rate. So, I think we’re in a bit of a different regime. And I think that the market is acting like that, like we have some clarity and kind of consensus on where we end up on the overnight rate. I think we know that we can’t go to 10%. I don’t think we’re going to make it through that. So, I think we’re starting to be comfortable with this 5-ish area on the effective rate in the US.
Greg Bonnell: What about this idea– and we got new economic projections as well. And the Fed seems to be assured that even though they’re going to continue raising rates to try to tamp down inflation and slow the economy, they’re not going to throw the economy over a cliff, that they’re just going to find this perfect place where they can bring consumer costs and inflation into line without doing too much economic damage, really even too much damage to the labor market. Is that possible?
Chris Whelan: I think there’s definitely an argument to be made that we can do it because the data– the economic– there’s components of the economic data that have been holding up well. And so it kind of depends on how the job market evolves. We’ve seen some job turnover and dynamics turning up in the technology sector. We’ll see how that pours over, and we’ll see how the 2023 realizes. I think we all know there’s a delayed effect on the higher interest rates, so it depends. It really depends how that realizes. And I think no one is really comfortable with what they know. I think on our side, we think that a soft landing becomes very difficult as you move through the year next year. But at the moment, the data may just unfortunately hold up just a bit too long to get them to hike a bit too far to then give us a bit more pain than we would have liked. We’ll see how that evolves. But I mean, the soft-landing scenario is so difficult when we’re hiking to the magnitude, we are with the debt levels that we have today. So I think that engineering the soft landing is a lower probability than not.
Greg Bonnell: Do you think the banks are operating right now with an extra dose of humility? I mean, if we back up a year ago, you have the Central Banks– OK, we know the consumer prices are getting out of where we want them to be, but don’t worry. It’s all transitory. Once we can work through this disruption and this disruption, everything is going to be fine. At some point, they had to admit, everything’s not going to be fine. Is there more humility in their work right now?
Chris Whelan: I think there’s some humility in their work. But then, I think we are– I’m surprised that we’re not acknowledging downside risks as much as we are. So, we’ve kind of shifted from, it’s transitory, it’s transitory, which got us behind the ball. So, we should have been hiking earlier in the year at a stronger rate than we are now. Now we’re in catch up. And then, now, we’re sustaining these at least 50 beep hikes each time, which is still a notable pace. And then so as we move forward, I’m surprised we don’t have humility to the downside risk that this poses and that we’re becoming so confident that we need to keep going and that that’s the way forward. So, I’m not sure the humility is there. I think we’ve almost shuffled from, it’s transitory, to, this is going to keep going, to, OK, maybe this isn’t going to keep going. So, I’m not sure the humility is totally there, but I think, definitely, there’s some humility there because that transitory call wasn’t the best call.
Greg Bonnell: Could that be one of the reasons why the markets don’t seem to fully believe, in between inflation reports and in between Fed announcements and other Central Bank announcements, what they’re being told? I mean, they seem to believe it today, in the aftermath of the Fed. But sometimes, do market participants step back and say, listen, you got it wrong a year ago? You got it wrong a couple of times. Why should we trust you this time?
Chris Whelan: Right. I think, right now, the bond market is saying– I think part of the bond market reaction with the yields moving lower out the curve or at least flattening is– you can argue that that’s one part the market not believing them. Or you could– on the flip side, the market believing them and knowing that that’s going to cause pain. But I think either way, the market’s telling you that long-term interest rates are not where we’re going to end up this cycle. I think we’ve said it. I think we talked about this before. This is more of an adjustment. This is, we overshoot here, we take the wind out of the sail, and we bring this back into check. And then we see what we can do to manage damage when we’re back there. But at least we’re not fighting an inflation problem. I think it’s kind of a broken record. It’s just fighting inflation at the expense of all else, and that seems to be the motivation and the overarching framework here.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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