Fed: Further market volatility expected ‘until we see this rate plateau,’ strategist says

Arbor Financial Group President Jeff Small and U.S. Bank Wealth Management Senior Investment Strategist Rob Haworth join Yahoo Finance Live to discuss the latest inflation data, Fed rate hikes, and retail earnings.

Video Transcript


- There you have it, your closing bell from Monday the 14th of November. A tough day, as we saw the major indices were sort of rattling and oscillating between positive and negative territory. But losses accelerating into the close. We see the Dow there down more than 200 points, ending the day 0.6% down. The S&P 500 losing almost a percent as well, down 35 points. And the tech-heavy NASDAQ there losing more than 1% on the day.

But let's take a closer look at the broader markets. Let's bring in Arbor Financial Group President Jeff Small and US Bank Wealth Management Senior Investment Strategist Rob Haworth. Good to have you both on the show. So Rob, what do you think the markets were digesting as we see the sell off that happened into that last hour?

ROB HAWORTH: Yeah. The markets last week really priced in an expectation that we were done with inflation, that inflation was starting to come down. And today, we got both speakers Waller and Lael Brainard talking about how high they're going to have to maintain interest rates.

So investors may have taken too much of their expectation out for the terminal Fed funds rate taking the 2-year Treasury down to 4.4 when it looks like the Fed's probably going to get to 5%. So I think markets are having a tough time adjusting to where we think the terminal Fed funds rate is going and what that's going to mean for the economy and for earnings as we roll into next year.

- Jeff, what's your assessment just of the action that we've seen, the excitement that we saw in the market last week following that inflation print and then, of course, what we could expect as we head into the end of the year?

JEFF SMALL: Well, it's kind of the same thing that we've had the entire year when we have these false rallies. Dollar weakness and yields drop, meaning the market go up. And so with a lot more pressure on the upside, with rates probably peaking in March or April, just like Rob said, we expect more volatility coming into the fold here. This is just going to be a normal state of where dollar drops, yields drop, market goes up, and then vice versa, market corrects until we see this rate plateau and we really see some good areas of where inflation can be.

- Yeah. That's interesting. And Rob, I just want to follow up quickly on the comments from Waller. And maybe I'm a little over obsessed with them. But he did say we're looking at moving in paces of potentially 50 points the next meeting or the next meeting after that. Is a 50 point hike on the table at the next two meetings?

ROB HAWORTH: Well, I think that's very possible that the market has to contemplate that, particularly if we don't see some faltering in the labor market and we don't see wage growth come down. But our base case would be to take them at what they said in their September dot plot, which is 50 basis points in December, probably another 25 in the February meeting. But there's certainly room to think. And they're certainly looking to make sure that financial conditions don't ease as they try and battle inflation here in the near term.

- And Jeff, we did hear from Brainerd really talking about having the medicine from the Fed really take effect and paying more attention to perhaps what they're seeing with that lagging data versus the real economy. But with the potential for a recession on deck then, how should people be viewing this? What lens do you view your investment strategy through right now?

JEFF SMALL: That's a really good question. I think the lens needs to be we know stocks are probably going to be cheaper here and a little bit of a longer term than they are in the short term, so why not hold the Treasury paying 4%? I mean, it's just stupid. The writing is on the wall. If you want to be long in the market right now, I'd call that the turd trade at this stage of the rate cycle.

And let's not pull any punches. Every time rates go up in this type of an environment, the greatest rate increases in history, all 11 rate hiking cycles have ended up in what? The big R. The big recession. And that's going to happen again, no doubt.

- How deep of a recession, Jeff, are you expecting?

JEFF SMALL: I wish I had the answer to that. But based on the way they're raising rates, I look for a very significant pullback in the economy. We are seeing things like real estate, mortgage applications, and those areas getting crushed right now. A lot of activity is dropping. Finance is dropping. It depends on how many layoffs we see or what happens to earnings.

But we do in this type of environment with the 5% 10-year note, it's going to be very challenging headwinds. But it's going to be a longer dated cycle than normal to recover from. This 12 to 24 month process from here, even though we're almost, what 10, 11 months into the correction here. This is going to be a little bit longer than normal.

- Rob, Jeff mentions the labor market, as did you did in your comments about the Fed. And we got news from "New York Times." About 10,000 job cuts at Amazon. Mark Zuckerberg laying off 11,000 at Meta. Is this the beginning of the cracking of the labor market, technically what the Fed wanted to see?

ROB HAWORTH: Well, it certainly could be. We're not yet seeing that data pull through into the jobless claims data. We're not yet seeing that pull through into the broader, which is very lagging, economic data. So we'll have to see how this plays out. But what we've been seeing in the data has been a lot of demand in leisure and hospitality.

We'll have to see if that continues because, certainly, as we look at consumer spending, and retail sales Wednesday will be very important, as will Target and Walmart earnings this week, to tell us where is the consumer actually putting their demand and, therefore, where might we see demand for jobs, even though we are seeing some layoffs coming in the technology sector, which, however, is still a very modest part of the overall labor market. Still about 2% of the overall labor market. So, certainly, very sad to see 20-plus thousand people lose jobs. But it's not yet a harbinger of that really broad labor market trend.

- And Jeff, as Rob was saying there, you have a number of big box retailers reporting earnings this week, your Home Depot, Walmart, Target. What are you watching for in those earnings reports in terms of what that's going to tell you about how the consumer is actually faring?

JEFF SMALL: Well, I think it's the difference between discretionary and non-discretionary. And we know in recessive environments what happens there is that people start to pull back. But a large part of the problem still is we still have a lot of COVID pent up demand. And that's why consumers are still spending. It's the big ticket items that require higher rates of interest and higher monthly payments that we see are getting shellacked. And that's going to take some time to work its way through.

- Rob, we got Jeff's perspective on what he thinks investors should be doing right now. What do you like in this environment that we're currently in?

ROB HAWORTH: Yeah. We're still defensive, kind of like Jeff is. We're staying underweight US stocks and foreign stocks. We're looking on the fixed income side to actually be a little shorter on the maturity spectrum rather than longer because the challenge with rising rates is it really hits those longer maturity bonds much harder. And you're getting most of the yield in those shorter maturity bonds.

And then we're still looking towards real assets. We think global infrastructure has some room to run here. We're looking at, certainly, utilities can be a steady state. They've had a rough month here or so. But we think that they continue to provide you some cash flow and sensitivity to that, to rising inflation. And then also, we'd look towards energy infrastructure because we think you're getting paid to wait there.

- All right. Good stuff. Rob Haworth, Jeff Small, appreciate you both being here.