Darius sat down with Mike Ippolito last week on the On The Margin podcast to discuss the FOMC, interest rates, inflation, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. We Believe The Projections From The September FOMC Meeting Are Wishful Thinking
In the September FOMC meeting, the FED hiked its 2024 and 2025 median dot plot estimates by 50 basis points.
- The Fed raised its median Real GDP estimates by more than double for 2023 to 2.1% and by 40bps for 2024 to 1.5%.
- The Fed lowered its median unemployment rate estimate by -30bps to 3.8% for 2023, -40bps to 4.1% for 2024-25, and sees unemployment at 4.0% in 2026.
Despite these hawkish revisions to its growth and labor market estimates, the Fed still sees Core PCE decelerating by 3.7% by year-end, 2.6% by 2024, 2.3% by 2025, and 2.0% by 2026.
We disagree with the Fed’s projections and believe they will need to engineer a recession to bring down inflation to below-trend levels.
2. The Fed Will Likely Need to Cut Rates More Than What The Market Is Currently Pricing
The current Fed Funds futures pricing shows the expectation that the Fed will begin cutting rates mid-2024 – we believe this current pricing is misguided.
Our research shows that a recession is the modal outcome, so we believe the Fed will need to cut by more than what is currently priced.
The 10-year three-month treasury yield curve, an indicator that has successfully predicted a recession eight out of the nine times it has inverted since its inception – and eight of the last eight – continues to be deeply inverted and supports our view.
3. Inflation Will Likely Trend Higher In The Coming Months
Our research shows that the median Core PCE delta in the year leading up to a recession is +5 bps, suggesting Core PCE is generally ‘flat to up’ in the year preceding a recession.
Additionally, the three-month annualized rates of the different indicators of the inflation basket have halted their downward trend. Although the headline YoY numbers may continue to decelerate, we are seeing increases in specific indicators like:
- Energy inflation increased to 25.4% on a three-month annualized basis after spending approximately one year compounding negatively.
- Core PPI Less Food Energy and Trade Services increased to 3.3% on a three-month annualized rate in August.
We believe that many of the indicators that make up the inflation basket will trend higher in the next few months and will not decline to below-trend levels until we go through a recession.
That’s a wrap!
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