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Our equity team examines the Fed’s clues to forecast when tapering will begin.

Published September 3 2021
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Podcast Transcript
Linda Duessel: Hello, and welcome again to the Hear & Now podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist. Today I'm joined via phone by Phil Orlando, our Chief Equity Strategist, and Steve Chiavarone, Portfolio Manager and Equity Strategist. The Jackson Hole speech was widely anticipated as market participants look for clues as to when the Fed will begin tapering its 120 billion dollar monthly purchases of treasuries and mortgage backed securities. Both the bond and stock markets reacted positively to what they heard with the S&P making its 52nd new record high this year. We will explore the important data that the Fed and we at Federated Hermes will be watching as to when tapering and rate hikes will commence. There are some particularly important dates ahead, but first, Phil, what new news did you take away if any, from Powell's Jackson Hole speech?
Phil Orlando: I think Powell did a masterful job of threading the needle in terms of letting the investment community know that we had hurdled the inflation guidelines such that tapering was going to happen this year. But the eventual increase in interest rates was a separate decision that was still a ways off. And I think that very delicate balance was exactly what the investment community was looking for. And I think the market responded appropriately.
Linda: I like the way you refer to it. He's giving us breadcrumbs along the way. Just be nice and gentle. That's very, very full.
Phil: This has been a journey as much as anything, that the Fed started this process back in June.
Linda: Indeed they did. So now Steve, let's talk some dates. You are focused on September 3rd with the August jobs report for clues as to the first timing taper. Why the August report?
Steve Chiavarone: I think Powell dropped a lot of breadcrumbs. I thought it was telling that he addressed taper during the Jackson Hole speech. I think around that Jackson Hole speech, there's been a lot of Fed speak that's been quite hawkish and it's preparing the market for a taper decision sooner rather than later. And frankly, I think that separating tapering from rate hikes was an important first step towards moving to taper sooner. So it's my belief and I think we'll get into this a little deeper in discussion, that barring a big disappointment in the August jobs report to be delivered this Friday, September 3rd, that the Fed's on pace to taper at the September meeting, or announce the taper at the September meeting, which comes a little later this month on the 22nd. So the Street's looking for about 750,000 jobs in August, our internal model is right around that at around 713, at least its initial reading. And we think as long as it comes close, that probably clears the way for a taper decision later this month.
Linda: You have very interesting comment that you made that they're separating tapering from the rate hikes and they want to make sure that we know, we know, we know. And I guess given how massive these purchases have distorted the markets, just confounding those who just knew with a strong economy rates would go up, I suppose it does make sense that they would want to go slowly, slowly, slowly with the taper and not rock that bond market, makes some sense. What do you think Phil, is Steve correct?
Phil: I think Steve's sniffing in the right direction, but I think he's a month early. He's a little premature here. And the issue is that the August jobs report historically is very wonky for a number of reasons. And I'm not quite sure we're going to get a clean reading out of August. More importantly, is this Federal unemployment bonus of 300 dollars a week, which has been distorting the labor market in my view, is set to expire in half of the states, 24 states on September 6th. It's already expired in the other 26 states. And so the first time we're going to get a jobs report that does not have the bastardization, if you will, of this Federal unemployment bonus is going to be the September jobs report to be released on Friday, October 8th. And I think the Federal Reserve needs to see and wants to see that data before it makes the tapering decision, which I think is then going to come on November 2nd and 3rd, which is the next FOMC meeting after the one that Steve referenced.
Linda: I don't know, Steve. He makes a good point. You have a counterpoint?
Steve: No, he does. And I think that those are all very reasonable points to make. I think the fact that Powell did choose to talk directly about taper at Jackson Hole was a signal. I think also the other element here is you've got the dot plots that are going to be released in September. And I think that's a perfect opportunity for the Fed to continue this message of separating taper from rate hikes. Because at the same time they can announce a taper, which if they start earlier, they can do it more gently and slowly while also potentially pushing back the dots signaling a later start to rate hike.
Steve: So I think that there is certainly a balancing act that we're looking at here. And I think the back and forth that you're hearing from Phil and I is indicative of the kind of conversations that we're having on the macro committee. As we try to understand what the most likely path forward is and how markets are going to respond. And clearly it's not all set in stone at this point. There's a range of views to when this can start and what the timing is likely to be.
Linda: That's a very good point. And yet another important date, the FOMC meeting September 21st and 22nd and those dot plots. And what they're going to reveal. I understand that there are six to eight members of the committee who wants to move right now and get started on this thing. And also I think a very, very interesting about that October report and your very legitimate comment about the 300 dollar unemployment benefit falling off for about half the states. We sure do hope a lot of those help wanted signs can come off and ease some of those choke points. But I did read and you read all kinds of things which makes this all the more difficult doesn't it? That those states that refused the extra benefit didn't have that much different of an unemployment rate than the others with the tiny exception of the huge restaurant industry. But in any event that October report should give us a lot to chew on, shouldn't it?
Phil: Well, I would point out that the Wall Street Journal did a very interesting piece, maybe it was about a week or two ago, where they looked at the rate of unemployment in the states that have already expired the 300 dollar bonus versus those that didn't. And there was actually a pretty significant difference, maybe five or six percentage points in terms of the rate of unemployment. So we know that the JOLTS report in June that we've got a record, 10 million open jobs in this country, you can't walk down the street and not see a help wanted sign in every door, in every store in America. And I just think we need to get rid of this 300 dollar Federal bonus and see what happens. And I think to some degree, we don't know exactly what's going to happen. I think that's why the Fed would like to see a clean number in September, at the beginning of October, without that unemployment insurance bonus, to see what that does to the underlying fundamental labor market statistics.
Linda: Okay. Early October date. Sticking with you, Phil, and your comments that of course, hanging over all of this is the fact that Powell's term as Fed chair is due to expire at the end of next January, unless he is reappointed. And I'm wondering first, what is the important date here as that goes as to when we'll know, and a very recent Wall Street Journal article labeled Jackson Hole as a political speech. Is it possible that the timing of the first taper is personal for Powell?
Phil: I think we're playing a little inside baseball here, Linda. Now we're not talking about the labor market or the inflation statistics. We're talking about the fact that Jay Powell's term as the Federal Reserve chairman expires at the end of January. And we believe he would like to be renominated to a second term. Well, who has that power? Well it's President Biden, and President Biden would like to see the Fed be as accommodative as possible for as long as possible in order to get the economy rolling to enhance his party's chances in the midterm elections in calendar '22. So to some degree, you're playing a game of chicken here in terms of the timing. And to some degree that may determine the timing of the first taper decision.
Steve: The decision is made somewhere in the August through October timeline, and that may impact whether or not we're really looking at a September taper or a November taper. That's another consideration here. I thought that the endorsement of Chairman Powell from former chair, Yellen, who's the current Treasury Secretary. I thought that was important in telling. If that comes sooner, I think it certainly raises the odds of a September taper. If it comes later, maybe that does push them into November.
Linda: Not a date, but a range. Okay, good enough. Steve, sticking with you now, you're a fairly extensive work regarding the Fed's jobs mandate. As redefined under what some have called a new regime, seeking more inclusive, full employment, targeting particularly women and minorities. What does your work show regarding progress on these fronts?
Steve: So something very interesting. Women really took it on the chin from a labor market perspective during the pandemic. So female unemployment surged from 3.4% to 16.1% at its worst, which was 3 percentage points higher almost than male unemployment, which went from a similar 3.5% to about 13.5%. But women have made back more of what they've lost. So there's this perception in the marketplace that we need the schools to reopen. Well, the data suggests that women have found their way back in greater numbers already, whether that's through hybrid work, or being creative, or coming up with different childcare arrangements. Because women are only 1.8 percentage points away from their pre-pandemic low in unemployment, men are 2.1% away. So women have actually really closed that gap.
Steve: Certain minority groups though, there you still see a gap. So Black unemployment is 2.2% away from its peak versus 1.8% for white Americans, 2.3% for Hispanic and Latino, 2.9% for Asian-American. So we still see a demographic from an ethnic perspective and from a racial perspective gap. But the male-female gap is actually closed in favor of women, which is something that's occurred really under the radar.
Linda: And I also have to wonder if his new focus on these, the minority and the lower income areas of the economy, they do even better than getting back to the pre pandemic even better. And how long that might take, I wonder. But moving along now to Phil. Now, of course, Delta won't be pinned down by any dates. And surely is part of the Fed's decision making process for the taper. What clues does your extensive work give as to how this would likely play out?
Phil: So with regard to the Delta, the analysis our team has done has suggested that the Delta variant has actually peaked in about 18 states, about a third of the states and is rolled over here. And we also, as a nation, have been lagging the UK throughout this entire process over the last 18 months with the four different waves by about a month or two. So it could be that the Delta variant's peaking right here. We don't know. I think the Federal Reserve would love to take a little bit more time here, see if the rollover in those 18 states continues to see if we get an additional rollover in the two thirds of the states that haven't rolled yet. See, perhaps another variant steps forward, maybe the Lambda variant steps forward, are the vaccines continuing to be efficacious against Delta and whatever future variant? There's a lot of uncertainties. I've gotten many more questions that I've got answers here, Linda.
Phil: And I think the bottom line is I think the Fed would love to have an extra six weeks to evaluate the health care landscape before they make that next decision. That's why I think that November 3rd decision, as opposed to September 22nd, to me at least makes a lot more sense.
Linda: Pushing it off a bit. Yeah. Because boy, that sure that Delta sure is filled with unknowns. I'll stay with you, Phil. And as I know, you follow DC politics very closely, on September 27, Congress is going to vote on this bipartisan 1.2 trillion dollar, so-called hard infrastructure bill. Is September 27 an important date as goes Fed's monetary policy?
Phil: There are three major fiscal policy issues that are winding their way through Congress right now. The 1.2 trillion dollar hard infrastructure bill, they're also debating a 5.5 trillion dollar social spending program. You've also got the debt ceiling expired at the end of July, and that needs to be resolved. So that whole series of fiscal policy stuff is running at a comparable track with the monetary policy stuff. I think that if Powell and the Fed saw a series of adverse fiscal policy decisions being made, that might alter their monetary policy decisions as a means of trying to provide some additional support for the economy. We're guessing to some degree, but it's just another uncertainty in this variable.
Linda: I'd also have to think that maybe it's the social infrastructure bill and how that works its way through that is potentially even more important here.
Phil: The reason for it are the pay fors in terms of how much additional debt are we going to take on. Are we going to raise taxes on corporations and individuals? How high? Might there be fiscal drag? And to some degree, the Fed may decide that it needs to offset that fiscal drag with more accommodation on the monetary policy side for a longer period of time. And again, that's very uncertain right now.
Linda: That's right. And of course, that's not as hard a date as September 27 at all. It's a much bigger number. You got those pay for story above, but that's a lot of spending that I think some Democrats would really like to do next year in advance of their midterms. So there's a lot to keep our eye on over there in DC. All right, we've got a handle now on the key dates that are to watch for the first taper. But Steve, will the markets really react to tapering, or is the coast clear until interest rates are actually lifted? Or put another way, is there a difference between taper and rate hikes, or is it hard to separate the two?
Steve: There's a big difference between taper and rate hikes. I think rate hikes mark the end of the middle part of the cycle and beginning of the late part of the economic cycle, tapering does no such thing. I think if anything, tapering can have a calming effect on the markets because we know that it's coming. We know that we're entering that phase of the cycle, but we don't know the timing, we don't know the pace. And I think once that information is given that allows the market to kind of settle in now. Okay, we know what the pace is, we know how things are going to go. There should be less volatility around with that. I think, what ultimately will determine whether or not that pace is appropriate is the level of inflation. And we'll have to watch that over the coming weeks.
Linda: Yeah. Yeah. That's really very interesting. And of course, I know some people say it's the last rate hike that you need to be worried about if you're a bull on market. Much like it's the last place you look whenever you're looking at something you lost is where you find it. And so if that's the case, does seem like it's pretty early to be getting bearish. I like to now finally with Phil here, Powell continues to use these words, transitory and temporary when he's referring to the widespread noteworthy inflation in our economy. At Jackson Hole, he said, Time will tell whether we have reached 2 percent on a sustainable basis. At what level and for how long will persistent inflation have to go on before the market prices a Fed policy mistake?
Phil: Well, look, the reality is we're already sitting at 3.6% year on year inflation with the core personal consumption expenditure index, which is the Fed's preferred measure of inflation. We've averaged about 1.7% annually over the last 30 years. So we're running more than double that now. And Powell has been telling us that once the procedural base effect rolled off, the negative inflation from the bottom of the pandemic cycle, then everything was fine. Inflation would peak and would roll over. Well, guess what, those procedural base effects rolled off three months ago and inflation is still going higher. So I think the market at this point is making the assumption that the Biden administration, the Powell administration have misjudged this inflation thing. And we've got to get the show on the road. That's why Friday's Jackson Hole speech was so important because Powell acknowledged that inflation has run faster than the Fed thought and that it was appropriate for us to start tapering by the end of this year.
Phil: The interest rate liftoff decisions, probably not coming until 2023, but I think the market now has some confidence that the Fed recognizes that inflation is higher and more sustainable than they had originally thought. And we've got some policy action in the pipeline that's going to come later this year. Maybe it's September, maybe it's November, maybe we're just splitting hairs here, but it's going to happen before the end of the year.
Linda: Okay. So we're rooting for a taper. That's good because we're sure we're going to get it. Gosh, now there are so many things to consider here, and most of them are filled with uncertainties, as you made mention Steve. So I guess we too have to be data dependent. Okay then, September and indeed the rest of this year should be very interesting in keeping us on our toes. So thank you very much, Phil and Steve, and thank you to our listeners. We look forward to you joining us again on the Federated Hermes Hear & Now podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Hear & Now episode. Plus our other series, Amplified and Fundamentals for a global perspective on the issues, challenges, and trends shaping the investment landscape. I also encourage you to subscribe to Insights, updates from our website and follow us on LinkedIn and Twitter.
Disclosure: The S&P 500 index is an unmanaged capitalization weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Stocks are subject to risks and fluctuate in value. Views are as of August 30th, 2021, they're subject to change based on market conditions and other factors, these views should not be construed as a recommendation for any specific security or sector. Federated Advisory Services Company. 21-30381 (9/21)
Tags Markets/Economy . Interest Rates . Monetary Policy .

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Stocks are subject to risks and fluctuate in value.

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Federated Advisory Services Company