Khanduja believes the Federal Reserve has "lowered the bar on data." He emphasizes that the Fed is aware the economy is running slightly hotter. However, the Central Bank has "maintained" confidence in their plan for rate cuts. He notes the headwinds of this approach could result in a weaker dollar and inflated risk assets.
Of course, inflation has remained sticky to start 2024, causing Fed officials to raise their core PCE inflation outlook for the year to 2.6% from 2.4%. Here's what Fed Chair Jay Powell had to say about the path towards lowering inflation at Wednesday's presser.
And so I think we're making projections that do show that happening, and we're committed to that outcome. And we will bring it about.
Satyam, I'll begin with you. As we think about what we heard from the Fed just yesterday and Fed Chair Jay Powell in that presser, I mean, how much of a significant move is this, given that we were all tracking the dot plot going into this meeting? We got a little bit more context about the rate and the pacing of cuts too here.
SATYAM PANDAY: Yeah, well, they did reveal their, you know, preference to be patient with inflation. So the dot plot by itself did not really show much of a move for this year, but it did move the 2025 rate cuts assessment that they have in their minds. It seems like at least 75 basis points for this year and another 75 basis points for next year, which means they moved-- they actually pared back some of their rate cuts for 2025 about 50 basis points or so.
So they will be patient with inflation. And you know, to be honest, they do have this optionality right now to wait it out and see, especially given the resilience in the economy.
- Vishal, when you take into account the reaction that we saw within the market yesterday-- we had the equity market rallying to record highs, we saw some pressure on yields here on the heels of this announcement and the presser that we got here from Jay Powell this morning-- does that market reaction-- does that make sense?
VISHAL KHANDUJA: Oh, very directly. Thanks again for having me on. Good morning. I heard your, you know, initial comments just prior to this segment very clearly. I think they've lowered the bar on data. What do I mean by that? They've acknowledged that the economy is running slightly hotter than what their expectations were as well coming into December, meaning growth is likely going to be higher, inflation is going to be higher. And even then, they've maintained their 75 basis points.
And not only that, but they've also probably had slightly more confidence, more dots, in that three cuts in 2024. And yes, as Satyam mentioned, slightly lower longer term neutral rates. So what does that do? It gets into steeper curves, dollar slightly being weaker, and risk assets again getting a bit back where the hesitancy of bid was there earlier this week as central banks dominated the flow this week.
- And Vishal, what does that do to the attractiveness of fixed income right now?
VISHAL KHANDUJA: Very attractive from our point of view. Again, we might be a little biased in our vantage point. We are active fixed income managers here. But our franchise flows and also the industry flows that we track very clearly-- we feel that, or we believe that November and December was just a glimpse of how a significant holding of cash or money markets that has gone on since 2022.
And when that starts moving out the curve as, you know, clients lock in some of those yields as the Federal Reserve gives them the confidence that we are down or our next move is going to be a down in interest rates rather than up in interest rates. So that definitely bodes really well for intermediate-- short and intermediate term fixed income instruments, even though the curve is slightly inverted, especially in the front end.
- Satyam, Jay Powell said what the markets really wanted to hear. Also from the economist's perspective too, just in terms of those expectations that the economy is going to hold up even better than the central bank initially thought. What, though, does that last mile, that last fight-- last mile fight to tame inflation, what is that going to look like, and why is it so difficult at this point?
SATYAM PANDAY: Well, I think it is going to be bumpy. And when you just look at the core goods, the core services, and the core core once you take out the shelter from the core services, just the combination of those three is what is going to make the path of inflation moving forward. We think that, just like, you know, Chair Powell said, the shelter component is going to reassert itself in the aggregate number.
It's the core core, once you take out the shelter, that actually goes more closely with the labor market strength. And that-- we have seen some wage numbers starting to become less of, you know, the strength that it showed last year. So I think that should show up in the data moving-- again, having said that, it is going to be tricky.
The timing is such that we may-- I think the risk may be that it may be delayed earlier than what we think right now. June, July is what everybody thinks. But it may be that it may have to be pushed back a little bit.
- How far?
SATYAM PANDAY: Well, I wouldn't say how far. But there is a risk that inflation may be a little bit more stickier than what many have been thinking right now. I mean, we've already seen, you know, January and February sort of surprise us. There may be more surprises, right? But still, fundamentally, we think that it is on its downward path towards 2%. But it's just, how fast is it going to get there to be comfortable for them to start cutting rates?
- What would that pertain for the balance sheet runoff as well then?
SATYAM PANDAY: Well, the balance sheet runoff, it's in a different channel right now. What Chairman Powell basically said, they are going to fairly soon come out with something. I think it may be May is when they will announce. And maybe perhaps the balance sheet runoff will be slowed down beginning in June.
So that is a net-net positive for financial conditions in general. But again, the idea here is to let the balance sheet runoff last longer. And maybe we will get to a point where the balance sheet itself of the Fed is actually smaller than what would have otherwise been and avoid some hiccups down the way. Like back in 2019, we did have a hiccup in September, which they really want to avoid that. So.
- Vishal, just lastly while we have you, certain corporate sector bonds here, you are also liking those. Which corporate sectors most notably should investors perhaps be considering for their portfolio?
VISHAL KHANDUJA: You know, financials in the investment grade corporate line, I think we've initiated-- we've issued about $500 billion of new issues in the first 2 and 1/2 months here of-- or in 2 and 1/2 months here of the year. Financials and especially the money center banks here in the US have pretty fantastic, fundamentally strong balance sheets.
And valuations there are still attractive whether you look at it from a fundamental basis and adjust it for the rating that those banks are in. Also looking at it from a longer term perspective where value lies within the fixed income market. So financials within especially the money center banks or the G-SIBs are a great spot to be in the investment grade corporate line.
- All right. Satyam and Vishal, thank you both so much for joining us here this morning to take a little bit of a deeper dive into what we heard from Fed Chair Jay Powell yesterday.