SCHQ - With U.S. Inflation Showing Signs Of Cooling Will The Fed Hold Rates In September?

2023-08-14 21:36:00 ET

Summary

• More signs that U.S. inflation is easing.
• Federal Reserve likely to hold on rates in September.
• Pockets of weakness appearing in economy.

U.S. consumer prices ticked higher in July, but by less than analysts expected. MoneyTalk’s Greg Bonnell discusses what it means for interest rates with Chris Whelan, Senior Canada Rates Strategist with TD Securities.

Greg Bonnell: While US consumer prices did tick a little higher in July, the increase was less than Wall Street was expecting. So what does it all mean for the Federal Reserve? Are they going to hold on rates going forward? Joining us now to discuss, Chris Whelan, Senior Canada Rate Strategist and Head of Portfolio and ESG Strategy at TD Securities.

Chris, great to have you back on the show.

Chris Whelan: Yeah, thanks for having me.

Greg Bonnell: So it was an interesting print, right? I mean, you did get that tick up. But the Street was fully anticipating that tick up, and they seem to be taking it in stride.

Chris Whelan: I think this is business as usual, keep calm and carry on kind of print today. Yeah, the bond market's not reacting too much to it. It makes sense. It was fairly in line. So there's really nothing to take away there. I think it's -- we've talked about this in the past, that we're kind of in wait-and-see mode. And we're kind of data dependent.

But now we're in a global manufacturing recession right now. And we're waiting for services to tip over. We're leaning towards that they do. That still has to materialize. So I think that's the more important thing as we go forward in the coming months.

We don't have additional hikes expected in Canada or the US right now. And I think we feel comfortable with that for over the next month or two, with holding that view. And then I think we'd have to have some surprise data -- basically, a revitalization in the economy into the fall, winter, for us to kind of change our stance on that, that they're not done, that they could hike more. So I think that's what we're waiting to see. But manufacturing is certainly not doing well.

Greg Bonnell: All right, so you said manufacturing recession. You said you're waiting for services to roll over.

Chris Whelan: Yes.

Greg Bonnell: The central banks have said, once they get to where they want to be with rates, then they're going to hold them there for a very long time. But if we start seeing this kind of weakness in manufacturing, and if it falls through to services, how long can they stay at these restrictive levels?

Chris Whelan: I think-- you can't speak for them, but I think, when they say they want to hold them there for a long time, I think they're trying to be careful of not sending a message that this is -- that they're going to relax interest rates too soon and then drive consumer behavior. If they say, hey, we're going to go back to low rates next year, don't worry--

Greg Bonnell: Spend accordingly.

Chris Whelan: Spend away. I think what they're trying to do is take a tough stance on inflation. And it's really just a tough stance. But I think, in the end of the day, you have a bond market that has refused to not price in cuts shortly after. It's a 2024 story. We'll see.

This has been -- cycle has been constantly pricing cuts. And then time goes by. And then we move out the cuts, and then we move out the cuts, and then we move out the cuts. This time, I would say that our conviction is that it's getting a little stickier now, that this is probably the top in rates. We're getting more confident in that story.

There's still a risk there. We're more biased to hikes being done in North America than we are to further hikes coming. But you can't be-- it's basically impossible to be fully confident that it's truly over. But we're getting more and more confident that we're closer to the end.

Greg Bonnell: So we are going to hear from the Fed in terms of an actual rate decision next month, in September. But of course, we're going to get Jackson Hole in the coming weeks. I only think about-- Jackson Hole, to me, used to be like-- we would talk about it in financial journalism. And it would sort of come and go. And you're like, yeah, they all met. They talked.

But last year, I mean, Jerome Powell coming down, he really laid it down. It was sort of a short speech. It was very stern, and the markets didn't like what he had to say. He used a lot of tough talk. Are you watching for anything of that degree at Jackson Hole this year?

Chris Whelan: Last year, you had just started rate hikes. And rate hikes take time. There's a lag effect. So Jackson Hole required a tough message. This year, they're completely in the middle. Generally, as a rough rule of thumb, you can have 18 months until the impact of rate hikes really transpire into the market.

So we're kind of month 9, month 10 or 11 now. So we're not quite there in terms of the lags having enough time to come into play. So, I think Jackson Hole is very hard for them, for how they deal with the messaging. And I think this Jackson Hole, we're settling into a bit more of a neutral setup.

However, if there is a surprise at Jackson Hole, that probably is market moving, because we're probably-- the market is probably going to get set up for less, anticipating less of a surprise reaction, so not ready for that. So time will tell. But I think that we won't have seen enough data come through for them to have confidence on a cutting narrative or anything, so small risk to additional hike rhetoric.

Greg Bonnell: On top of this inflation print from today -- as you said, sort of a stay the course kind of thing, nothing to get too excited about -- we have been getting jobs figures out of the States as well. I think I might have been away. But I try to keep it on top of the headlines. They added jobs, but they're a bit softer than was expected. Wasn't that the case?

Chris Whelan: There's a bit of softening on the job front. In Canada, we had a bit more softening as well. I think, in the end of the day, when you look at the headlines, we are seeing layoffs. We're seeing large companies announce layoffs. And then it's just a matter of time before that shows up in the data.

We do not see companies announcing large hiring plans. We're seeing equilibrium. We're converging towards equilibrium on demand and supply in the wage market. And we're getting there. So I think, in the end of the day, there's a phenomenon going on right now in corporate earnings. Revenue growth is strong, but earnings growth is fairly mediocre.

What does that tell you? It tells you that companies-- even though it kind of feels like companies are just passing on price increases, just hoping that we'll accept them, they actually aren't fully passing on the true increase of their expense base. So in the end of the day, when you can't grow earnings, but you're growing revenue, that shows you that you have an expense issue. So that is a wage -- that's layoff pressure. That is a job pressure.

So then there's a lag to that. So then you have the layoffs. And then you have the wage inflation pressure down. So that's another lagged effect. So we're waiting that out.

But I think the job data is not strengthening. And the headlines are layoff tilted. And the revenue versus earnings, that gap, the revenue growth is much higher than the earnings growth. That gap is not a good fundamental for wages on a go-forward basis, which just comes back to the lagged argument, that pain and softness will come from the rate hikes.

And just, we're in that middle zone. We're in that middle zone. We're getting closer to the -- we're now past the midpoint. So we're getting mid to late now in terms of the lag. And so now this is -- we're getting closer to, let's say, game time of cuts becoming a discussion. And so time will tell. And I think the risk to that is a rejuvenation of the economy into the fall. That would be a surprise right now. But that's the risk.

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