Fed’s hawkish stance risks 'overkill' on inflation, strategist says

Hugh Johnson, economist and CIO at Hugh Johnson Advisors, joins Yahoo Finance Live to discuss the outlook for Fed rate hikes and the odds of a hard landing for the U.S. economy.

Video Transcript

- Everyone, switching gears here, last week's inflation reports came in softer than expected, but we're still far above the Federal Reserve's 2% objective. Our next guest says that the Fed has plenty of runway beyond 2022 to rein in inflation. Hugh Johnson, who's the economist and chief investment officer over at Hugh Johnson Advisors, joins us now. Hugh, great to have you here with us today. Help us break down and add perspective to what you're seeing play through in the markets and what exactly the Fed pathway may be going forward from here that the markets will still have to digest over time.

HUGH JOHNSON: Well, what I think or hope that we'll see from the Federal Reserve is certainly not what we're hearing from members of the Open Market Committee or what they think lies ahead. You know, obviously, we got the good inflation numbers that we had for the month of July. I think you should keep in mind that the month of August are going to be equally good.

In other words, inflation numbers are going to be soft. And probably for the coming months, they're going to be soft. When we get to the end of 2022 we're going to be looking at, say, 6 and 1/2% to 7% year over year numbers.

And when we get into 2023, they're going to be materially lower than that. In addition to that, some of the signs we're getting from things like the leading indicators tell me that the economy is in the process of slowing. You're not going to see employment numbers that are as good or as strong as we saw for the month of June and July.

What you're going to see is the numbers are going to be coming down and coming down pretty swiftly. So we're going to have soft economic numbers. Now what I would like to see is that the Federal Reserve-- this gets reflected in Federal Reserve interest rate decisions.

But when you listen to what they're saying, members of the Open Market Committee are saying they're just as hawkish as they've ever been. And they're going to continue to raise interest rates continuously until they get that rate of inflation down to 2%, which I don't think they can do. But nevertheless, they're very intent on doing it. So the Federal Reserve is saying right now that they're going to be more hawkish than I think they should be. And when we get into 2023, when we start to see really soft economic and inflation numbers, we'll just see what they do.

- So here, you think this is just wishful thinking, this view that has become embedded in the market, of a dovish pivot by the Federal Reserve?

HUGH JOHNSON: Yeah, well, if you take seriously what they're saying, you certainly would say that's probably a pretty dovish view on my part or optimistic or too optimistic a view and that they're not going to pivot or they're not going to pause or they're not going to go a little bit easier on raising interest rates, particularly when we talk about September.

There's still people talking about 75 basis points. I think it'll be 50. And talking about 50 basis points in November, I think it'll be 25. December, 25.

They say they're going to be as tough as they've been. I don't think so. I think they're going to come off of that. Otherwise, they're risking the same mistake that we see so continuously in financial market history of-- you'll remember the word overkill. You might hear that word again.

- Well, and their mistake going into this was on the opposite side, right? That they were sort of too late to begin raising rates when we were starting to see signs of inflation. So what gives you the confidence that they're going to be-- that they've learned, I guess, from that mistake of not being responsive enough in the past?

HUGH JOHNSON: Julie, that's a great question. When you listen to what they're saying, it tells me that they're going to be just as hawkish or make some of the mistakes that they've made in the past. When they talk about the importance of a 2% inflation rate, look.

If inflation gets down to 2 and 1/2%-- and you remember the Open Market Committee. And you're seeing very soft economic numbers, very soft inflation numbers on a month to month basis. What are you going to do? You can either be humane, or you can stick to your guns and say it's got to be 2%.

If you stick to your guns-- and they've done this in the past over and over again. Stick to your guns. Then obviously, we're going to have a risk of very, very hard landing.

Keep in mind, Julie, index of leading economic indicators has been down five successive months and are telling us that we've got a real risk of a hard landing. The numbers we're looking at for the quarter to quarter numbers for the next third quarter, fourth quarter this year, first, second next year, we're looking at numbers like 0.9, 0.7, 0.6. That's pretty close to a hard landing. And you've got to be a little bit sort of flexible, shall we say, or responsive to the inflation and the economic numbers that we're going to see for the remainder of '22 and the early part of '23. They've got to be flexible because otherwise, they're going to make a mistake.

- Do you think that on the pathway to their inflation targets, they can maintain the employment situation that we've also seen?

HUGH JOHNSON: No, you're not going to see the employment numbers that we've seen, I don't believe. In other words, we're not going to see numbers that come down a little bit from the prior month but not a whole lot and they maintain real strength. Look at.

The employment numbers are going to come down, and I worry. Look, everybody forecasts these numbers, and everybody forecasts them differently. I see numbers that are pretty close to average monthly gains in the non-farm payroll employment of 100,000 per month and maybe even less when we get into 2023.

Those are not very good numbers. So I don't believe that in their pathway to 2% inflation that they're going to be able to, at the same time, maintain or keep employment numbers on a monthly basis up. We'd like to see them at 150 to 200,000 like they were before the pandemic.

I don't think they can do that based on what they're going to do right now. I don't mean, to be very negative, but I must admit I'm very concerned, and I'm obviously familiar with financial market history, and I've seen all the mistakes that they've made. And I see the rhetoric being very consistent with the mistakes they've made in the past.

- So just quickly, Hugh, what are the implications of all of this for stocks?

HUGH JOHNSON: You know, that's the interesting part is that if they do what I think they're going to do, if I think they're going to-- I don't want to use the word cave, but give in, I think in time, we're going to start to see numbers that say that the economic slowdown-- we'll call it a soft landing or hard landing recession-- is going to turn for the better, that things are going to start to improve. We're going to have a recovery. The stock market under those conditions will start to discount 2023, the earnings for '23, the earnings for '24, and the stock market will do better.

That's like a normal cycle. But what has to happen for that cycle to resurface is that we have to see the Federal Reserve be flexible or try to get the soft landing that they say they want to get. They have to be flexible. Otherwise, we're not going to get much from the stock market. If we do get that, we'll get something from the stock market and watch the consumer discretionary and technology stocks under those conditions.

- We'll be watching all of that. Hugh, it's great to get some time with you. Good to see you. Hugh Johnson, economist and chief investment officer at Hugh Johnson Advisors. Good to see you.