Undeniably hawkish

Linda Duessel: Hello, and welcome to the Hear and Now podcast from Federated Hermes, I'm Linda Duessel, senior equity strategist. Today's episode is a special recording of a roundtable discussion I led with Susan Hill, senior portfolio manager and head of the Government Liquidity Group, R.J. Gallo, senior portfolio manager, head of the Municipal Bond Group and the Duration Committee. And Phil Orlando, chief equity strategist and head of Client Portfolio Management. For those of you who are not as familiar with Federated Hermes, I'll give you a brief introduction to our company. Federated Hermes is a global leader in active responsible investing, with 668.9 billion dollars in assets under management as of the end of 2021. At Federated Hermes, responsibility is central to our client relationships, our long term perspective and our fiduciary mindset. It's part of our heritage and the foundation of our future. Our investment solutions spread equity, fixed income alternatives, private markets, multi-asset and liquidity management strategies. Now let's jump into our discussion. Sue, in light of the March FOMC meeting at Sherpao, subsequent remarks. Can you please set the table and frame where Federated Hermes thinks things are? With regard to monetary policy at present.

Susan Hill: Thank you, Linda. I would be happy to. So, I've been around the block a couple of times in my money market career but really have never experienced the shifting sentiment that we've seen over the past few weeks and months at the front end. I thought last week's FOMC meeting was really going to be the story that after so much uncertainty and long lead up it would be the thing that would set the stage for how the Fed would be responding. It was I think, undeniably hawkish. It's no secret that the increase in the target rate was obviously welcomed by money market fund managers who have been struggling with fee waivers for quite some time. But the rest of the meeting, the rest of the news was really attention-grabbing for sure. There were upward revisions to inflation. There were downward revisions to GDP, and then the dot plot revealed projections for future hikes, but really exceeded even the market's expectations at that time. So we came away knowing that the Fed was serious about inflation, strongly focused on the price stability aspect of the school mandate. Again, I thought that was the story until yesterday. Yesterday, in his speech in front of the National Association of Business Economists, J. Powell doubled down on his inflation messaging. He said the Fed will do whatever it needs to do to get inflation under control up to and including 50 basis point rate hikes as soon as the March 4th FOMC meeting. I think we got Powell's view yesterday rather than the collective views of the FOMC. And I think that was noteworthy from my perspective. So expectations in the market as reflected in the futures contracts, they've shifted yet again, words that I think have said almost every week since the fourth quarter of last year, and they now reflect well over seven hikes, almost eight hikes remaining over the course of this year, inclusive of the one just tailoring the additional one just taken. That implies effect funds target rate of over 2% at the end of the year and a greater than 50% chance of a 50 basis point move is price to those contracts were both the May and June FOMC meetings.

Linda Duessel: Does our Fed now sound more hawkish than any other central bank? Susan Hill: I believe that they do. We watch closely what other countries are doing. I do believe that the Fed is leading the way in the inflation fight. We in the US, I believe are in a better economic position, which may allow the Fed a little more flexibility to embark upon this path, but there are other central banks moving in the same direction. But the Fed, I believe has perhaps the most hawkish from my perspective. So as money market managers, we try and go back in history to find clues that might be helpful as to what might happen going forward. And I think the Fed has this unprecedented set of stuff in front of them which is difficult waters to navigate. And I think is an enviable position. From our perspective we believe that the futures market is maybe pricing a little bit too aggressively, but that the best case for a 50-basis point move at either the May or June FOMC meeting. We also expect several additional hikes throughout the course of the year over the months ahead. I do think this aggressive action is almost destined or maybe even designed to result in the Fed overshooting its goal a little bit as monetary policy works with long and variable lag. It's something that you hear very often. And I think the Fed will want to actually see the progress being made, rather than just assume that their boost will take effect. So I'm a little bit uncertain about the rapid pace of rate hikes that we expect to see today, really spilling over into next year. With respect to the balance sheet, we think the Fed will spell out its plan at the May or actually in the minutes to the March FOMC meeting. We'll see those minutes in a couple of weeks and we'll get a pretty good idea of what to expect. We have that already. We think it'll look a lot like what happened the last time around, although the numbers will be bigger and the pace will be faster. But we are in uncharted waters and it does raise a lot of questions about things that could happen, where things could go wrong.

Linda Duessel: What a sober start to our discussion today. Unchartered waters. And I understand that Sue says the future's market is fairly aggressive in what they're expecting. Are we undergoing a hike tantrum at the moment as we speak? R.J. Gallo: I think we are. Looking over the last five days, which hardly makes a long period of time. The two-year treasuries has risen 31 basis points in five days. The 10 year, people like to watch that more closely, is up 23 basis points. The 30 year is only up 11. And by any stretch of the imagination, these types of moves are pretty comparable to the taper tantrum of 2013 with a couple important differences. Back then the Fed wasn't signaling they were going to hike. They were signaling that they were going to slow down their bond purchases. That's already happened. Now, this isn't a taper tantrum, it's a tightening tantrum. Back then the yield curve bear steepened. All yields up, steeper yield curve. So 30 year yields went up more than two-year yields. This time, it's the other way around. So on a year to day basis, just as a measure of how this tantrum is unfolding, the two-year Treasury yields up 143 basis points, the 10 year is up 86. We have a bear flattener because the market is incorporating the Feds very public projections, the dot plot, for significant tightening and flattening the curve as a result, even introducing in the minds of some, this very flat or potential inverted curve, which starts to bring forward the prospect of are they overdoing it? Are we going to end up tipping over into a recession outcome as they fight the highest inflation in 40 years? So yes, we're going through a tantrum. The bond market, the aggregate index, the Bloomberg aggregate index is down over 6% and it is not even March 31st. So tantrum for sure.

Linda Duessel: Yes. The bond market was supposed to be boring. That's what I understood all those years growing up in the equity side and Sue, you spoke a bit about the balance sheet and what you thought might happen in terms of a runoff, but is the market prepared or can it be prepared for maybe something that's more destabilizing in terms of balance sheet behavior and selling bonds? And if they did sell bonds, what bonds might they sell first?

Susan Hill: So, we do expect to get details about the balance sheet runoff, the balance sheet management plan from the Fed to hint into that in the minutes to the most recent FOMC meeting. I think they will discuss it out right in May. I think their approach will be very passive initially, very similar to how they started things off the last time around because the history is there, and the market understands how it works. That passive approach should be something that the market should be able to handle. That'll be very clear in terms of its CAP process, how that runoff will occur. And over the first 12 months of balance sheet reduction in that passive mode, that should still account for a trillion dollars in terms of runoff of security. So I think the passive versus active approach is the critical component, and will start from passive. They need more or faster policy accommodation removal, then they can move towards selling securities outright. I think that could be more of a problem for the curve to digest. And I don't expect that for some time.

Linda Duessel: Well, R.J. or Sue if you could chime in on this one and you said something I thought was kind of powerful. Just the runoff will be 1 trillion dollars. That's a significant amount of the size of their balance sheet. Should we fear some sort of economic reverberations at all?

Susan Hill: From my perspective, again, I'm not concerned. I think Powell even alluded or stated during the course of the press to the FOMC meeting that took place last week, that the concept of portfolio runoff, at least in the early stages is maybe akin to an additional tightening step from the Fed. I don't think that's why the Fed has been buying securities nor do I think it's why they're running off securities to mimic the tightening process. I think they need to reduce the presence in the marketplace. It's substantial and they need to do so in a responsible manner.

Linda Duessel: Okay. Great. Now I'd like to move over to you, Phil and still with inflation unfortunately, but changing the subject a bit here too. What is the at the top of all the discussions these days is the Russia Ukraine conflict. And what is your expectations as to how that particular conflict will impact inflation as we suffer it around the globe?

Phil Orlando: In a word, we think it's going to make it worse. Sue. I think they did a beautiful job of setting the table for us. You've got nominal CPI inflation right now sitting at 7.9% in February, essentially before any of the impact of Russia's unprovoked and unjustified invasion into Ukraine began to stabilize the energy market. So crude oil, WTI was sitting at about 90 dollars a barrel on its own merits before the invasion, spiked up to 130 dollars a barrel in short order and has come off and stabilized a little bit. But as we look at the impact of Russia, Ukraine, their situation, Russian aggression here has made them international pariahs. They're being sanctioned all over the world in terms of their energy output. Now they're one of the three largest energy producers in the world, right? Saudi Arabia, Russia, the United States. And they account for about 10 million barrels a day in production. They export about half of it. So, if they've created a situation which no one in the Western world will buy their oil, that means that the rest of us have to replace that 5 million barrels a day. And that supply, demand balance is suggesting that the cost of oil is going to remain high, and that's going to have an incrementally deleterious impact on inflation. So this is not just an eye blink, this creates a higher more sustainable level of inflation at least for the next several months. Linda Duessel: And doesn't this play right into the hands of Russia, as isn't that their business to sell oil?

Phil Orlando: Well I would argue that Russia is basically a giant gas station with an army. So this is their stock and trade. And to some degree, I think they anticipated what was going on here, but it's great for them because they're producing 10 million barrels a day, and the price has just gone up from 30 dollars a barrel 15 months ago to about 110 dollars a barrel. But even though the prices are up, do they have the ability to sell that oil to someone else? And what we're hearing, is that there are countries, normal customers that are reluctant to buy that crude from Russia because of the global sanctions, that even though Russia may be discounting that crude by 20 or 30 dollars a barrel, they're having trouble moving it. So does that sort of gum up the works as it relates to Russia's economy? Answer, yes. It also gums up the works in terms of the global economy, because again, you're taking 5 million barrels a day out of a relatively tight market in an economy that's still performing pretty well.

Linda Duessel: And of course, I think that we at Federated Hermes have suggested, even though no one could really read the future on a geopolitical event like this, that it might be a long slog, and that's the case. And with what we know now, can we call this kind of an uptick in inflation as related to the price of oil and the conflict transitory, can it be transitory Phil?

Phil Orlando: So from our perspective, no. I mean, this has been the tug of war the Federal Reserve was undergoing, I guess, at about this time last year, they were assuring us that the inflation trends were temporary, they were transitory, as soon as the procedural base effects rolled off in the middle of last year, inflation would roll off. And we didn't see that, in part because of energy pricing, food pricing, housing prices, and supply and demand in the labor market. And so we don't think that what's going on with Russia and energy is pointing to a transitory inflation picture. We think it's higher for longer here based upon what we think we know. Linda Duessel: And what do we have as our price outlook for barrel oil? What's our outlook? Phil Orlando: Well, 15 months ago we thought we could get to 90 dollars a barrel by the end of last year. And we think we can get to about 120 dollars a barrel by the end of this year. And directionally, those were decent calls. So I we're sticking our guns at this point.

Linda Duessel: It's a tough thing to hear when we know as Sue and R.J. had been speaking about the fact that the Fed is walking a tight rope here. We're all hoping fingers crossed to see inflation come off the boil. And this has not helped one little bit, something that I've read that I think is perhaps a bit comforting here in the United States, is that we used to use a lot more energy in the United States to create a dollar of GDP. The fifties are a lot more, the seventies, even the nineties much more, so that's one good thing. And I guess what we're now starting to see is we don't have time to talk today about the midterm election year that we're in. That in this midterm election year I think those that are up for reelection are trying to figure out some ways of helping the lower income cohort here in the United States deal with this right to your pocketbook problem. But now I'd like to move over to R.J. again, if I may. R.J., talk about that yield curve again. I've always thought that the bond market was a very good forecaster of economic cycles and you really don't want to be seeing an inverted yield curve. And we keep saying in the media every day, parts of the yield curve inverting and what that might be telling us. Do you see some trouble here as goes the yield curve and evidencing a recession on the horizon, R.J.?

R.J. Gallo: Sure. Historically the yield curve is a powerful predictor of recessions. Some even think that flattening or inverted yield curve actually causes a recession. I'm not a big fan of that theory, but that's a discussion for another day. And the yield curve that gets most attention in the marketplace is the slope in basis points between the two-year yield and the 10-year treasury yield. That is just 21 basis points right now, still upward sloping, but closing in on zero. It's flattened by 57 basis points on a year to day basis and just this month is flattened almost 19. Worrisome, yes, but I would suggest that the reason the curve flattens as you head into recessions is because the Fed is hiking short rates, causing short-term yields to rise and longer yields, which have clearly a longer horizon, say 10 years at the 10 year part of the curve, which are incorporating expectations for the economic performance and the rate environment over the entire 10 year period. So oftentimes, when the Fed has imparted so much restraint by tightening, short rates will go higher than long rates. You have an inverted curve, the market's signaling a recession is coming. They think ultimately the Fed will be forced to ease in years to come. Right now, we don't have that inversion. And I also think it's important to note that the most compelling yield curve for signaling the probability of recession is really the three month to the 10-year yield curve. The three-month bill to the 10-year yield curve. That slope is 184 basis points, and it's gone up 39 basis points year to date. Why the disconnect? Linda Duessel: That is powerful what you just said. We don't appreciate that enough out there. That's what we should be focusing on. What's that telling us?

R.J. Gallo: Well, the disconnect here is I think that the two-year yield and the 10-year yield are reacting to the dots. They're reacting to the fact that the highest inflation since Paul Volcker was the Fed chairman back in the early eighties, demands policymakers attention. And the Fed is paying hawkish attention to it. They're telling us they're going to tighten. They're going to tighten a lot. So the two-year yield incorporates expectations of the Fed funds rate over the next two years, but they've only hiked once. There's more coming as we said, probably 50 basis points sometime soon. But short rates of the three-month part of the curve are going to react to what the Fed actually does. So the bond market likes to focus on two tens because it incorporates expectations of the two year and a 10-part of the curve, but the most predictive curve for recessions is a three months to 10-year. Its what the Fed watches very closely. The Fed also watches slips of curves even within a year when they get to the point where they're thinking about ending their hiking process. They're nowhere near that just yet. So, I think right now it's reasonable to worry about the recession risk, lets face it. We've had a massive aggregate supply shock in the form of the highest inflation in 40 years, aggravated by the Ukraine and Russia situation and the Feds tightening. Other times in US history when the Fed is tightening and inflation is on the rise, a recession eventually follows. So the curves flattening makes sense, but they're not yet flashing yellow and red. And I think we should maybe calm down a little bit, because we don't have that inversion at this point in time. Linda Duessel: And R.J., before I leave you here, is there a Fed put on the horizon?

R.J. Gallo: I think the Fed put is way out of the money. I've been in the markets in one form or another since 1991. I used to work with the Federal Reserve Bank of New York. The Fed put used to be a sort of a pejorative term implying that the Fed had become slave to the marketplace. But what was interesting over most of my career is that inflation was relatively benign and actually going down for much of my career. So the Fed could afford to have a put, why not work with the market so the financial conditions support economic growth when inflation's so low. That's not the situation today. Inflation is so high. So the Fed put is much further out of the money. The Fed is not apt to completely do a 180 like Powell did in 2018 when the market protested. I think he's not apt to do that this time. The inflation situation is much different than the last 30 or 40 years. The Fed put is much further out of the money. They need to focus on inflation, not just the markets. Linda Duessel: All right, Phil. The Fed put is out of the money. Inflation is just too high and we have this conflict that only makes things worse. And my understanding is that the Fed being in their attempt to get things under control, they always go too far. They're the ones that throw us into recession. Do we see a recession on the horizon this year or next Phil?

Phil Orlando: In a word, the answer is no. And the reason for that is there's just so much stimulus in the pipeline, both fiscal and monetary that to take a step back from all of this near-term recession discussion, and really take a deep breath. Remember, the Fed cut interest rates down to zero and left them there for a couple of years and ramped up its balance sheet to 9 trillion dollars. Then between the CARES Act in 2020 and the ARP program in 2021, we added another 5 trillion dollars from fiscal policy stimulus into the pipeline. It's going to take a tremendous amount of time to ring all of that stimulus out. Even though savings rates, are back to normal at about six and half percent, we still have excess savings in peoples and businesses bank accounts of about 2 trillion dollars. So the reality is that it's probably not going to result in a recession in '22 or '23. But again, to bring this back to the Federal Reserve, it takes about six to nine months for one half of the effect of a rate change to start to filter through the economy. It takes about 12 to 18 months for the full effect to be felt. So listen to what Sue and R.J. have been talking about. If the Fed follows the path that we've laid out here, we've already seen a quarter point last week. Maybe we've got a couple of fifties coming up after that. Then a couple more quarters after that, that suggests as we get into that '24, '25 timeframe, that's the period of time given the risk of the fed overshooting, that legitimately we should be concerned about recession. And maybe the Fed goes a little faster and maybe that gets pulled forward a little bit, maybe into the end of calendar '23, but to suggest that we're looking at recession tomorrow or next month, next quarter, it's probably not in the cards at least based upon what we think we know now. Linda Duessel: Well, yeah, '24, '25, gosh, I could sleep very well at night if I felt that way. A lot of water could pass under the bridge between now and then. And of course we don't have to have a recession to have a weak market. What do we know about the ability of companies to push through the hikes, the inflation that they are suffering in the name of their profits and the stock market?

Phil Orlando: Well, what we've got is data on the fourth quarter of last year. And we know that wages are up substantially. We know that commodity costs are up substantially. We know that transportation costs are up substantially. Yet corporate earnings in the fourth quarter were expected to be up about 20% year on year. I think we were looking for 25%. They actually came in closer to 30% and the margins were very strong. So I think what that's suggesting is that companies have had plenty of pricing power, and maybe that was a function of the fact that we've all got so much savings. And we've so been so deprived based upon the Coronavirus situation over the last two years, we're willing pay anything to get that good to get that service. Now, as prices continue to go up and as savings contract, maybe that situation gets dicier throughout the balance of '22 and into calendar '23, but at least through the end of last year, companies were able to pass those price increases along and didn't have a lot of resistance from end clients. Linda Duessel: Okay, well, so far so good, it is true we rock the boat in a lot of ways and some of the ways ended up quite positive. We still have a lot of money and we've pent up demand and we're ready to go out there and savings are still abundance. So I guess that's good news for this year and next anyway, and no recession on the horizon. But Sue, coming back to you if you would, now R.J. reminds us that the yield curve is misbehaving, even though the Fed is only raised once. What sort of indicators are already reflecting the tightening and kind of doing the Feds work for them in a manner?

Susan Hill: Sure. So actually, I will add on to R.J. that I have full respect for yield curve signaling, but I agree wholeheartedly with him that the front end of the curve or the measures that include the front end of the curve are really the ones that matter. And I think we heard that from Powell yesterday as well. So we're far from signaling at this point. When we start to see how the Fed judge's success and whether financial market conditions are tightening or not, you can flat outlook at the increase in yield out on the yield curve, which have been substantial to know that there are certainly financial conditions that are tightening. And that's been taking place since the fourth quarter of last year. We look at the five-year forward, inflationary expectations built into the marketplace to see how that may be shifting, in fact, is shifting with respect to expected Fed action and the success of that action. And ever since the pandemic and the huge dislocations that we've seen in the marketplace, the traditional inflation measures. The CPI, PPI, PCE, Core PCE, the Feds preferred measures are really just the same as most economic indicators. Traditional economic indicators aren't necessarily up to the task to judge at any given moment what's being successful or not. So you look for market-based indicators, you look for financial conditions indices to see how they may be shifting and reflecting what at this point has just been for the most part, a lot of talk from the Fed, and once it gets implanted, how this is delivered. Linda Duessel: Okay, well, excellent. So R.J., inflation is not transitory and I guess we all have to agree to that now. And I have asked you many times in this last year or two, how do we have in and around a 2%, 10-year bond yield when inflation is at 8%, how does that happen? And you explained the importance of inflation expectations. Is that the most important thing here and for this tight rope the Fed's walking on?

R.J. Gallo: I think right now, it probably is the most important thing. I think that the inflation expectations are important in a variety of ways. Number one, in the market's pricing. If the market anticipates that inflation is going to follow a trajectory up or down, it's going to affect the relationship between long-term yields relative to short-term yields. Currently, the expectation is very different. Inflation is now likely to be peaking in the next three to six months. At one point, we thought it would've peaked maybe by now or by April or May, but the Russian invasion of Ukraine certainly changed that expectation. So if you look at inflation expectations, what are they telling us? Right now in the Treasury-Inflation Protected Securities market, you can see inflation break evens at the two-year part of the treasury market. The yield difference between a two-year tip and a two-year nominal treasury is an astronomical 4.79%. So that's telling you that the market believes abstracting away from some liquidity premiums that affect how TIPS price. The market believes that it's going to average about 4.9% over the next two years. You go out to five years, the inflation break even falls sharply to 365. Go out to 10 it's down below three at 295. The simple fact of the matter is that the market believes that inflation will not stay where it is, the 8% year over year number will in fact be fleeting or episodic. I don't want to use the transitory word. What causes it to correct a Fed that is tightening, that helps the market believe that the Fed is working to get that inflation down. What else helps inflation correct? Well, the economy's probably going to slow amid the aggregate supply shock. It's going to reduce aggregate demand and economic activity as much as it's going to inflame inflation. And, the supply chain debacle that took off in the wake of the pandemic reopening will eventually work its way out. There's too much profit there to be realized to let the supply chain be as kink as it is forever. The economies and governments people, see great profits in trying to deliver goods from point A to point Z, that will get better over time. So the market believes inflation expectations are going to come down. It's very key in keeping long-term yields from rising even further. If the market starts to believe the opposite, that inflation at 5%, 6%, 7%, 8% is not going to come down, then watch out below. Because bond prices have to fall a lot more and nominal bond yields would have to rise a lot more to compensate bond investors for the risks that they're taking. So fortunately, the Fed is helping to support the bond market prevent an even more stark sell-off by having a very clear hawkish path that they've communicated to the market thus far. Linda Duessel: And so inflation expectations can be 4% in two years and the market is swallowing, that's okay, it's coming down, even if that's two years out. I imagine then Powell and his team are very focused on these inflation expectations. Might that have something to do with his speeches?

R.J. Gallo: I think so. I think one other forum in which inflation expectations are fundamentally important, the academic, economic and policymaker forums. Your macroeconomics textbooks many years ago, focused on monetary aggregates and focused on other ways that monetary policy was transmitted to the real economy. More modern treatments of monetary policy give very high focus, a lot of attention to the role of expectations. Because they realize that inflation expectations can also impact the behavior of firms in pricing their products. It can impact the behavior of households and making their purchasing decisions for goods and services. So it goes well beyond just the sort of the corners of the bond market. It affects the way that households and firms behave as well. So if inflation expectations becoming unhinged, that outcome would be very dangerous for the Fed. It would end up resulting in the kind of wage price inflation spiral that we saw way, way back, 50 years ago, that the Fed very much does not want to repeat. Their tough talk, helps to keep those inflation expectations, hopefully from becoming unhinged. The problem will be if inflation doesn't come back down. If inflation doesn't come back down, I think it's going to be a rude awakening for financial assets broadly. Because the implications would be the Fed has to hike even more. So bond prices fall, yields rise. I think other financial assets might be challenged if yields rise excessively high.

Linda Duessel: Now you brought up something that I think I'd like to see if anybody else in the group would like to respond to. And that is, they really have to get these inflation expectations down. And the wage price inflation, the wage price spiral is something that I remember seeing it back in the seventies and those who would argue Well, the price of oil was always attached to the inflationary problem. Yes, but we're less reliant on energy and we had been historically, at least here, in the United States. But wages are under control and this is where I think it's a worry. And I also think that there are two whole younger generations that have never seen anything, but a 2% inflation. They haven't a clue on what might be coming ahead. When we started to see people up the skill level, getting really good wage hikes just from going down the street, maybe from one bank to the next, are we witnessing a wage price spiral now that is only exacerbated the fact that there are 3 million baby boomers who retired a bit earlier than when they thought they would before COVID. Anybody want to chime in on this wage price spiral?

Phil Orlando: I'll take a crack at it to start. And I'm sure Sue and R.J. will have some thoughts. So just looking at the latest set of data, we've talked about the fact that the nominal consumer price index is sitting at 7.9%, a 40-year high, but wages are pretty good. Last jobs report we saw the month of February wages, roughly 5.1%. That's pretty good. But what a lot of people don't recognize or understand is that this implies that there's a loss of purchasing power of 2.8%. And what that does is it forces employees to go to their employers and demand a raise, and they either get that raise or they leave and walk across the street and get a better job that pays more. And you've got the jolt report right now, the job opening and labor turnover survey, which has in round numbers about 11 million open jobs in this country. And the relationship is there is something like 1.7 open jobs for every one person who's actively looking for a job. So if you're a skilled worker, the ability to walk across the street and get a better job that pays more is certainly a high probability. And then we had talked about the concept before, okay, if an employer is paying higher wages in order to get their workers to come back into the market, to come back into the company, to be able to conduct business, companies are simply passing those higher labor costs on in order to maintain their profit margins. And so this is the virtuous cycle that we're looking at, the inflation leads to higher demand for more wages and then companies simply pass that on and the cycle continues. This is the conundrum that Volcker needed to break 40 years ago by taking interest rates up high, intentionally invoking a recession I guess in order to break those expectations and sort of reset. I don't think speaking personally that the situation is anywhere near as draconian now, and that Powell is going to need to do anything as extreme as Volcker did, but that's the risk. That's a concern that this wage price spiral gets out of control, the power of the Fed jaw bone doesn't work. And that's going to require more active policy in terms of either quantitative tightening or raising of interest rates above and beyond what the markets they're pricing in. Linda Duessel: Okay, Phil from your lips, that this doesn't get much worse, and we don't have to suffer why poor Powell would want that job anyway, but we wish him God speed. And consumers haven't been so miserable in quite a long time, which is so inconvenient for the midterm elections that are coming right down the pike. And even if the average person out there doesn't see a recession on the horizon, they might want to go to the voting booth and vote out the current leadership there in terms of the midterm elections. So do you think Phil, that Biden where we know that the midterm elections are referendum on the president, do you think that he might try to seek a fiscal stimulus and resurrect some part of that build back better as a midterm, so called hail Mary?

Phil Orlando: So, there's no question that the president's poll numbers have taken a hit here in recent months in light of the inflation spike and the rise in energy prices, et cetera. Certainly there are certain cohorts within the US economy that could benefit from lower gas prices, or maybe a holiday state and local or federal gas taxes, or things of that nature, or perhaps some other fiscal policy stimulus to counter that. But given the fact that we're sitting here with 7.9% inflation in February and likely going higher in coming months, the appetite, I think in Congress to pass something like this, that the average voter might view as being irresponsible with regard to inflation, I think is a problem. From a logistical standpoint, the calendar is pretty tight right now. We're now towards the end of March. Once you get into about the end of July, the Congress goes home, they go back in district. They begin their reelection campaigns over the course of the months of August. And the first half of September. They come back to Washington for some procedural stuff. But if you don't get a fiscal policy program passed now in between the end of March into the end of July, you simply don't have enough time to get it done. And there are two other major enchiladas that the Congress has got to focus on. One is getting a new Supreme Court justice approved, and the other is filling out the board of governors of the Federal Reserve. Both of those things are going to suck some of the air out of the Congress as well. So Congress has got a lot of stuff to work on right now. And not a lot of time to do it. Linda Duessel: Yeah, the clock is ticking. I think I'd like to move back to you now, Sue, as I noticed the Google search terms kind of fun to watch what people really search for. And I started watching this more closely at the beginning of the pandemic when we were all looking up, what does social distancing mean? Of course, now it's baked into our heads. It's amazing what a couple of years will do. And then I remember that when stimulus money started to come out and lots of people were like, How do I get money showing up in my bank accountant? They did a lot of Google searches on inflation, which again had been dormant for 40 years, but now they're spiking in terms of stagflation. And of course, I suffered stagflation back in the 1970s. Are we having a stagflation now, how do we even define that these days? What do we want to tell those people that are searching?

Susan Hill: It's a great question. And I'm embarrassed to admit that I did my own Google searching for the true definition of stagflation and how it's being used today. And in almost all cases you get the idea that inflationary pressures are there. The prices are higher and the growth is slower, but one component seems to be a persistently high unemployment rate, which clearly is not the circumstance we have today. We have an unprecedentedly tight labor market, and a lot of room to go with Federal Reserve action and policy accommodation removal. So tightening before that labor market is hit and even begins to approach an unemployment rate that can be included in the stagflation definition. The Feds very clearly focused on inflation. And they have said many times that they think that the labor market is enough to withstand the types of rate hikes that are being discussed, but is not a guarantee. And frankly, if inflation is not under control I would not expect the Feds to maybe go a little bit farther than anticipated, simply to accomplish that goal. So the labor market might take a hit, but I don't think to the extent that you have an unemployment rate that meets that Google definition of stagflation in the next year or two. Linda Duessel: The next year, that's all we're going to ask for right now. No stagflation, you need high unemployment. We're in a booming employment situation, perhaps the best in our lifetimes. So now coming back to you, R.J., again, I just remind myself that interest rates have been coming down. You make money when interest rates decline, if you're in the bond market, they've been low, you have a ton of people retiring, maybe retiring early up over 60. And we thought that we should invest more for income, more for safety. We always went to the government bond for that. And even today with inflation, as high as what you all have been describing, the 10-year bond yield has a handle on it. And what I found very interesting is that since the housing bubble burst of 2009, monies continued to flow into bond, mutual funds and ETFs as it left equities. And so now with interest rates low but rising, we in the equity side of things like to speak of TINA, there is no alternative as a good bond steward. Is there no alternative to bond? Should we even be thinking about buying bonds, even the highest quality treasury bonds of the United States?

R.J. Gallo: Well, I think that just like within the equity market, there's a variety of stocks. There's small cap, there's large cap, there's value, there's growth, there's different sectors. In the bond market oftentimes people view it unfairly in a monolithic way. So right now, the treasury index and investment grade corporates, high quality bonds are producing losses of five, six, 7%. Meanwhile, if you were in floating rate bank loans, you're down a little more than a percent. If you diversify into TIPS, you actually have a small positive return, depending upon how long the TIPS are that you own. And right now there's not a lot of absolute positives in bonds. Here's why. We just came out of a hundred-year pandemic during which the Federal Reserve cut interest rates to zero and grew its balance sheet to nine plus trillion dollars. When they started to reverse those factors, eventually shrinking the balance sheet and telling the market they were going to raise interest rates, yields had to go from near record lows, higher, causing bond prices to go down. Right now, we're in a difficult adjustment period. It's hard to argue that we should just go out and buy treasury bonds and think everything's going to be okay. Treasure bonds don't default, but they can lose four or five or 6% as yields rise. And that's the situation we currently face. Being overweight stocks and underweight bonds has made sense now for quite some time as we've come out of the pandemic, I still think it makes sense. There's room for caution however, because of the array of shocks that we've discussed in this conversation to the economy and the inflation situation. Right now, bonds still make some sense in an underweighted position. I wouldn't abandon all your bonds. If Putin is crazy enough and he might be to carry the Ukraine conflict beyond Ukraine's borders, extending the conflict to potentially NATO territory, you're going to want to own some high quality bonds. Because some of the market's response to that kind of development will be very painful. And as I think the last three years have taught people over and over, be careful with investing with too much confidence in the sense that you know exactly what's going to happen. We don't know exactly what's going to happen. Inflation's a problem. We think it'll come down. We think that the fight in Ukraine will stay in Ukraine. In that outcome, high quality bonds, underweight them, but don't abandon them. Because you can't really see the future and you don't want to put all your eggs in one risky basket thinking you know what's going to happen. Linda Duessel: Yeah. Well, thank you for that R.J.. When I do my talks across the country and I speak about our relative underweight, I always hasten to say, we would never suggest anybody be completely out of the United States government bond, which is the safe haven for the world. And that's something that we really can remind ourselves, particularly when geopolitical risks come front and center as what it has done. But Phil on the equity side and I guess R.J. made reference to this as to what Federated Hermes stand is general terms of overweights and underweights. Do you have any comments that you'd like to make, particularly for those looking for income out there?

Phil Orlando: Yeah, I think R.J. made some excellent comments and I would echo them. We sort of reflect the same sort of thought process on the equity side that we're looking at this market that was down 14, 15% into sort of the end of February. And then as the FOMC was doing its thing last week raising interest rates and sort of laying out the process and whatever, stocks inexplicably are up about seven or 8% here in the last seven days, which does doesn't make any sense to us. Stocks appear to be over bought. There are resistance levels all over the place, and we're still concerned about what's going on with Russia and inflation and monetary policy and what the impact is on the economy, as it relates to a prospect of recession across the proverbial valley. So, what we did just yesterday is made some adjustments in our model. We reduced our exposure to international, small and midcap and international developed are actually added a tick to domestic large cap value, and added another tick to cash. So we are still 3% overweight equities, 3% underweight bonds. But within that equity allocation, we are very focused upon economically sensitive categories in the value space that are cheaper, that have lower betas, that have lower risk profiles and have well above average dividend yield support. Stocks that are yielding three, four, 5% as opposed to the S&P average, which is around one and a quarter, one and a half percent. So we're playing defense here as we try to figure out exactly what's going on with all of these areas of concern. We think we'll get through this over the course of the year. We think we've got some favorable midterm election results coming up later in the year, but this is a very perilous part of the cycle right now. And I think being cautious, being prudent, playing defense is probably the right way to sort of navigate these difficult times. Linda Duessel: Yeah. I think when we had our year-end outlook webcast and you all spoke about the volatility that was to come, I think you hit the nail right on the head. We certainly are experiencing volatility. I'd like to say to the group, we have been weaving in questions from the group throughout the discussion today. And if anyone has any questions that they want to just chime in now. I do have a question for Phil though that's come in here towards the end of our time together. And it looks at the what's the appropriate price earnings ratio to pay for stocks. And we know that in January, the stock market got hit hard. I think by two multiple points, as we concerned ourselves with the Fed, this is even before as we know, before Russia, Ukraine became a thing and the price of oil did a quick bounce up. We got hit for a few price earnings multiples. We suggested inflation will come down, but still stay rather high. Should we still expect lower price earnings ratio more punishment that way, as we try to figure out how our year's going to end here with the S&P 500 level?

Phil Orlando: So, were not in a Goldilocks environment now for the reason stated that we have had this spike in inflation and typically price earnings ratios, and levels of inflation, nominal inflation are inverse, which would suggest that if inflation goes higher, P should contract. At the same time, interest rates are still relatively benign. That's another key element in our evaluation model, the so-called Fed model that Alan Greenspan had created when he was the chairman of the Federal Reserve back in the eighties. Low interest rates, when we're sitting here with benchmark tens with a two handle, suggest that PE should be relatively high. So you sort of put those two disciplines together, and our PE assumptions over the last couple of years is that PEs very comfortably could be in the low twenties. And that's exactly where they've been. Now that we've seen the spike in inflation, and we've seen interest rates start to move up based upon the Federal Reserves withdrawal of policy accommodations, we're thinking that PE should contract. We're not going to go to zero or some single digit number, but taking an average PE from 21 or 22 and bringing it down to 18 or 19 or 20, until we can get our hands as to what this cycle looks like is probably a prudent approach to valuation. Linda Duessel: Yeah. And probably still can make sense when interest rates are still so very low, right? Phil Orlando: Exactly.

Linda Duessel: Still, quite low. And so R.J., just as we come towards the end here, did you want to hazard to guess as to whether or not we'll see a 3% tenure during this year? R.J. Gallo: I don't know if it'll be this year, certainly could be. I think 3% is exerting some gravitational pull on the tenure. I don't know whether we get there in count 2022 or not. The Fed told us in the summary of the economic projections, the median dot for the terminal Fed funds rate in this cycle was a 275. You do a chart historically, the 10 year does seem to converge on the terminal Fed funds rate in every Fed tightening cycle. The jury is out whether or not that happens this calendar year. If you go back to 2018, the 10 year peak to three and a quarter. You go back to the end of the taper tantrum 2013, early 2014, 10 year peaked out right around 3%. So history suggests we may be getting there, current inflation levels which are very high relative to recent decades can't persist. They have to roll over. If they don't, the 10 year treasury will probably get to three and even higher. So all eyes on inflation and hopefully enough economic strength behind the US economy to power through all the shocks while allowing inflation to at least level back out to more tolerable degree.

Linda Duessel: Thank you, Sue, R.J. and Phil, for your insights. And thank you to our listeners. We look forward to you joining us again on the Federated Hermes Hear and Now podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Hear and 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 our Insights email updates for the latest market commentary from the many great minds at Federated Hermes and follow us on LinkedIn and Twitter. Disclosures: Views are as of 3/22/2022 and are subject to change based on market conditions and other factors. This should not be construed as a recommendation for any specific security or sector. 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. Yield curve is a graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities. The Fed put refers a monetary policy response in which the Federal Reserve would step in and implement policies to limit the stock market's decline beyond a certain threshold. The Bloomberg Aggregate Bond Index is a broad-based, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States frequently used to measure the performance of the US bond market. FOMC is the Federal Open Market Committee. ETF is Exchange Traded Fund. Beta analyzes the market risk of an investment by showing how responsive the investment is to the market. The beta of the market is 1.00. Accordingly, an investment with a 1.10 beta is expected to perform 10% better than the market in up markets and 10% worse in down markets. Usually the higher betas represent riskier investments. 22-10036 (3/22) Federated Investment Management Company