The Federal Open Market Committee meets on Sept.19-20. It is expected to hold interest rates in a range of 5.25% to 5.50%. The market will be watching for clues about future moves. Join us live on Sept. 21 at noon, Eastern time, as Jeff Timlin, managing partner at Sage Advisory, discusses the FOMC meeting, Fed Chair Powell's press conference, the new Summary of Economic Projections, and what it means for monetary policy.
Transcription:
Gary Siegel (00:10):
Hi, and welcome to another Bond Buyer Leaders Forum event. I'm your host Bond Buyer Managing Editor Gary Siegel. My guest is Jeff Timlin, managing partner at Sage Advisory. Today we're going to discuss monetary policy including yesterday's Federal Open Market Committee meeting. Jeff, welcome and thank you for joining us.
Jeff Timlin (00:35):
Thank you, Gary. Thank you for having me. Welcome everybody. I look forward to having a little discussion with you today about what's going on in the markets.
Gary Siegel (00:44):
So was there anything in the FOMC statement, the summary of economic projections or Chair Jerome Powell's press conference that surprised you or grabbed your attention?
Jeff Timlin (00:57):
I think surprised probably not. I mean, I think he's been kind of pretty transparent the whole time since they began the tightening cycle. I guess from a attention-grabbing perspective, they still remain hawkish. Obviously they're concerned about inflationary pressures and are really trying to rein in the economy here. Obviously economic growth has been above expectation, I think, not only by the Fed but by most market participants. So again, the language itself was basically stating that they're going to remain in a tightening policy or a bias towards a tightening policy, and that kind of solidifies their desire to accomplish their dual mandates in terms of price stability and full employment. Again, they're at this point, they've been doing a fairly decent job of that, but they continue to see that there's more room to go.
Gary Siegel (01:54):
Well, the Fed wouldn't commit to being done raising rates depending on data. Of course, the SEP suggested another rate hike this year. Many analysts think the Fed is done. Do you agree or do you see the one more rate hike coming?
Jeff Timlin (02:12):
Yeah, I'd say we're more on the side of where other analysts are in terms of that they're done. Again, it's another 25 basis points. So even if they do go another 25, it's kind of a rounding error at this point from where we're at and is not extremely detrimental. But I think they need to keep that language in there so that the market doesn't get the perception that they're pausing, which then could potentially lead to an easing cycle. So I think they're keeping, again, like I said previously, they're still in this hawkish type of mode and looking to basically give confidence to the market that they're still fighting some of these factors that continue to be a little bit of a challenge to the consumer and the overall economy and really are trying to rein in those factors that are continuing to pressure, put pressure on inflation and at the end of the day will poorly affect the consumer.
(03:09)
So when we're looking at what the language is versus what most people perceiving, I think people in the know realize that they have to keep the proverbial language again, hawkish so that people will not perceive a different turnaround. Again, the Fed doesn't want volatility of rates, and although rates are heading higher today, they want to keep that the curve, particularly on the long end at higher rates so that it will continue to do their job. Obviously, the front end rates are significantly higher, which again, this still an inverted yield curve that will deter from their efforts if long end rates continue or do shift and head lower, which they would if the market, if they signal something of an easing cycle or a pause in the market.
Gary Siegel (04:00):
So the panel voted unanimously to hold rates, but based on recent speeches, it seems like there's some division on the FOMC that some panel members feel that more rate hikes are needed, one, two, or even three, and others believe that they should be done. Do you see the division in the speakers and is this a compromise that they're holding or is this really a consensus?
Jeff Timlin (04:41):
Yeah, I think the markets need and want different points of view, and that's kind of why there's multiple members, they're discussing their points of view and how they see the market and the remedies to take to get the economy back to where they want it, get the data where they need it. So again, I don't think that dissension is necessarily a bad thing. We don't really focus too much on the dissension between the voters. I mean, we do pay attention to it because obviously it can lead directionally in a different manner, but it's more of the economic data, how we perceive it, and generally the language within the text that gives us the best insight from that. But dissension obviously is something that we have on our own investment committee obviously it creates healthy discussions and brings up points of view that maybe somebody hasn't thought of, and I think that happens there. So for me, I actually like it more often when they're not unanimous because you don't want groupthink at the same time. So for us, you kind of hear what each one is saying in their perspective of why they think they should be accelerating or continuing along the rate hike policy or not. So it does give a little insight into the entire committee's view, but at the same time too, that's not something that I think as a driver of making ultimate decisions.
Gary Siegel (06:02):
Do you think that Chair Powell has rallied the committee to these unanimous decisions, or do you think that the ones who feel there are more hikes coming can feel that they can be patient about it?
Jeff Timlin (06:21):
I think that's a combination of multiple things, right? I mean, I think they all understand what their responsibility is and how to accomplish that. Obviously when you're talking about the actual policy implementation and what they want to do, that can be obviously a difference of opinion there. But again, we're talking about on the margin here. So whether we stay here at the current level and remain unchanged or go up 25 basis points, like I stated earlier, it's kind of a rounding error. And from those things, again, I think even within the dissenting vote, they still are concerned about some of the numbers that they're seeing most or particular inflationary factors and those, they seem to be all on the same page on that. Now, the remedy to that is obviously in dispute here amongst several of them at times. Again, they're all unanimous at this point in time, but when it comes to the data going forward, that's going to probably, if inflation starts to ramp up again and you start to see some of the other members pull for higher rates, you can understand that point of view. But at the end of the day, I don't think they're heading in the same direction in terms of what they're trying to accomplish. Just again, like I said, the policy tools that they're utilizing are I guess the ones that they're debating the most, but on the margin.
Gary Siegel (07:52):
Projections for disinflation in the June SEP were based on slower growth. But since then, GDP has come in stronger than expected. The employment slow down is not as quick as the Fed has expected and inflation remains higher than the Fed wants. And that led to the Fed changing its SEP or changing its projections. How do the Fed's expectations compare to yours in terms of inflation GDP, unemployment?
Jeff Timlin (08:28):
Sure, absolutely. I mean, I think everybody expected stronger and stronger than expected GDP was something that was a surprise to most market participants. I think at this point in terms of the magnitude of the rate hikes and how quickly they did it, I think a lot of people felt that the economy or inflation would be ratcheted in quicker. Economic growth would slow down. You'd see the effects on employment or higher unemployment. But again, those factors have been very resilient and again, different than most other markets that we've seen in the past. But again, remember there's also, if you look back, that's looking just kind of down kind of a narrow window. If you look back at really what's been going on over the past decade or so, you've seen a significant change in monetary policy. Their balance sheet is ginormous now relative to where it was 10, 15 years ago.
(09:23)
So there's also lingering effects of excess liquidity in the market that was generated over multiple years, if not over a decade. So those are still kind of working their way out of the market. And also we're seeing a pretty significant rise or elevated amount of fiscal spending, which again, wasn't there during 2010 to 2018 ish. So when the Fed was easing, they didn't have the fiscal component of it. Now we do, and they're kind of spending very similar to what we were in COVID period, which is a little bit concerning from a budget deficit standpoint. So you're seeing kind of these outside factors that are outside the Fed's purview, or at least in terms of their immediate ability to affect the economy, that I think are still having the effects on GDP. Again, like I said, the government spending, that's obviously elevating the GDP numbers, consumer spending, indirectly, the money's flowing back into the consumer sector.
(10:22)
And then when it comes to the lingering effects of monetary policy over time, there's still a lot of money still out there to invest. And again, they're reining it in slowly and they're doing a good job of not collapsing the economy, but at some of these exogenous factors out there that I think are supportive of the market, again, they'll work their way out I think over time, but at this point I think that that's kind of one of the things that what's different from this market that we haven't quite fully appreciated until kind of now.
Gary Siegel (10:59):
So it sounds to me, Jeff, like you think the full impact of the recent rate hikes for the past year and a half have yet to work completely through the economy, is that correct?
Jeff Timlin (11:13):
Yeah, I would say, I mean even the Fed stated in their statement that it's a lagging type of effect, but it's cumulative in nature. So the longer this goes on, obviously the higher rates put a constraint on multiple areas of the economy, just simply put, look at the housing market, it's remained relatively stable, but at the same time too, it's much lower than where it was in the past in terms of the amount of turnover in new purchases. Why is that? Because the prices have not come down substantially or enough relative to the increase in interest rates, which again, most people focus on the monthly payment, not so much the principal value. I mean you kind of should and you do in a roundabout way or an indirect way, but really it comes down to monthly payments. So those monthly payments have significantly increased because interest rates have pretty much doubled.
(12:03)
And then also too, that creates, and again, this is just more of an example standpoint is why have we not seen so much of a challenge in the housing market at this point is because most people are the labor market's doing well, so people are still able to mostly afford their houses. One area that could be a crack obviously is the rental market that kind of picked up substantially. We're seeing a higher percentage of homes that are for rent sitting on the market and not being rented. But on the primary residential side, the job market is good. So people probably aren't worried so much about their monthly payment and they're not willing to go to the next home because they like sitting on their two, three, maybe 4% mortgage rate and not readjust into that five, six, 7%, which again, as a small kind of example or example that kind of brings it home.
(12:53)
The same things are going on in corporate land, right? They're sitting there and also making the same judgments as well. Banks are doing the same thing in terms of their profitability. So obviously higher rates, curtail spending, curtail lending, and those things do take time because debt that's out there that was issued 2, 3, 4 years ago needs to take time to roll off before it gets reinvested. And then new projects that are obviously coming to market into the future will now be affected and continue to be affected. So that's one area that again, is a cumulative type of thing. So as months go by, those type of projects continue to be pushed off and again, slowing the overall growth of the economy,
Gary Siegel (13:41):
The Fed uses backwards looking data. CPI is not current, it's a month old GDP is for the past quarter. Is this a problem? Is there something else they should be looking at to see where the economy is going rather than where it's been?
Jeff Timlin (14:01):
Yeah, I mean obviously looking in the rear view mirror and trying to drive is very difficult if not impossible, you're going to crash into something at some point. Same with them in some respect. I do think they do pay attention or have something in their metrics that obviously is forward-looking and kind of understands where things are headed. But again, it's one of those things that they do rely heavily on past data. And again, there's some utility to that and obviously everybody looks at past data and trends to make forecasts into the future. But again, in terms of that data does, depending on the data, some lags more than others, but one obviously that lags is typically in hindsight 2020, okay, no, I should have seen that coming, is the labor market, is the consumer spending portion of it, and those just don't show up until the numbers come out.
(14:54)
But again, looking at leading indicators there, obviously that came in under expectations. So that is a deterrent. So the market does look at that and price that in, and then those adjustments can be corrected throughout the remainder of the curve. Obviously the highest influence of the Fed is in the front end and then the back end of the curve is really dictated more by the market. And I think the market is obviously still pricing in a soft landing and because again, equities, even though they're kind of selling off today, have done quite well year to date. And just kind of looking at risk on risk off measures, risk on being an equity type of market or high yield in terms of fixed income as of yesterday, I think both the equity markets and high yield year to date had a 13% return, and at least in the high yield component of triple-C names, that's pretty substantial and would kind of dictate from a number standpoint that we're in a soft landing during a tightening cycle.
(15:49)
And then on the fixed income side, obviously rates are in some cases negative because rates have been rising so significantly, which means that people aren't concerned that the economy's rolling over and people then want to receive real rates, right? Real rates have continue to roll higher in addition to nominal rates. So I think that there's, even though the Fed is maybe more focused on past data, the combination of the markets kind of sets the tone for the entire yield curve and then gives us kind of a good forward-looking perspective. But remember that the Fed is also trying to deal with, again, trying to accomplish their dual mandate, and one of the parts of the mandate is inflation, and that's the number they have to get in line and one that they're going to highly focus on. And that really comes with hindsight.
Gary Siegel (16:38):
So the June SEP projections were revised this week. Do you see more revisions in December? What do you see changing? Will inflation projection go up or down GDP go up or down rate projections go up or down?
Jeff Timlin (16:57):
I think going into the year and so fourth quarter until the end of the year, I think it's pretty much status quo with a bias towards slower growth at the moment. Again, the effects of monetary policy and where rates are now are still taking hold and will continue to influence economic data going forward, albeit at a modest or slow pace. But I think once you get into 2024, things will accelerate a little bit. I think you'll probably start to see some cracks in the proverbial economic armor that are out there. And where those cracks will come is I think anybody's best guess. Obviously I spoke about the rental market. That's one area that will continue to, I think put downward pressure, because if people aren't renting, then they're using their own discretionary income to pay for those mortgages. I'm sure a lot of them not owned outright.
(17:48)
They're levered and have a mortgage attached to them. In addition, student loans are coming up October 1st, I believe, is when they start again. So that's going to be another detractor of the economy. And then again, just speaking about general where rates are at and where expected growth is, if you're talking about say 3% GDP and your borrowing rate is five, 6%, why would you borrow, right? There's really no incentive to go out there and take, if your return on investment or return on equity, depending on which metric you're looking at is below the growth rate is below our expectations are below the borrowing cost, then obviously that's going to stop them from that entity or that person from borrowing to invest into roll debt forward. So I think next year is really where we're going to see some of the challenges Right now, I think we're definitely in a soft landing type of environment, but I think that that's very hard to navigate in terms of, think of it, navigating a soft landing is trying to land, I think a aircraft, a naval plane on an aircraft area.
(18:54)
There's a lot of things that go wrong and you have to do everything right to land it. In that regard, I think the Fed is doing what they can and they're on approach to that soft landing, but they haven't landed quite yet. But I think Sage has a view that going forward we're going to start to see some of the negative effects of higher rates infiltrate the economic data point and then curtail, curtail both inflation and economic activity come next year. How that kind of plays out again is a little bit challenging to kind of put your finger on, but that's kind of the expectation we have. It's not so much what's the problem, but that there is going to be a problem.
Gary Siegel (19:37):
Yeah. It's never easy to predict the future. The yield curve has been inverted for over a year and still is inverted, and many believe that signals recession is coming. LEI, which came out this morning has been down for nearly a year and a half as well, also suggesting recession. Why does the economy continue to surprise forecasters and defy the doomsayers and what happened to the recession? Where is it?
Jeff Timlin (20:11):
Right? The million dollar question and you're getting leading indicators, you're right, and it's been sustained and leading indicators are saying, hey markets, we're heading in an economic, let's not say recession, but we're heading in a slowdown. We should be slowing down. Things are telling us that things aren't as rosy as the current or past data has indicated, and it's kind of befuddled the markets in some ways has kind of confused us. We have been making moves. We do believe that it's not the if but when kind of scenario. So Sage has been actually taking steps to position ourselves for an economic slowdown, maybe not an outright recession, but definitely taking some chips off the table in terms of the outperformance that we've seen from some of the high beta names. But again, you're seeing a kind of bifurcation between the leading indicators and what forget even the other economic data that are backward looking, but the markets themselves, the market's kind of an indicator of the sentiment of what investors are thinking.
(21:13)
And again, like I said, equities are doing quite well. Fixed income, bonds, at least I should say the rate market, and that'd be Treasuries, continues to increase above expectations. Yet on the risk side of the fixed income market, that being the IG and the high yield market, those spreads are towards their lows. So it's indicating that people are still willing to take on credit risk in a market that is slowing and having some challenges, at least in terms of the leading indicators. So I kind of go back to the old saying, markets don't repeat themselves, but they do rhyme. And in some ways we're seeing that rhyme going on now. It's the difference though. What's the difference from the past that we're trying to assess? And I think I kind of covered that a little bit earlier in terms of previous or decades monetary policy of extreme easing record easing, and not just domestically, but globally.
(22:05)
This isn't just a domestic problem, this is something that they're dealing with globally, and the policy was so accommodative for so long and so much liquidity was in the market that again, it is still being worked off. And at the same time too, this is a point where usually late cycle, the fiscal policy is typically not as generous to the markets and not in this much of a deficit spending, and they continue to obviously flood the market with additional fiscal liquidity. So those are things that I think are causing or kind of elevating the market or supporting the market. There are factors that weren't there, say back when rates were in a similar environment, the two year and 10 year, the last time we were hit these levels was back during 2005 to 2007 when we were at the peak of policy. Then we were coming out of a recessionary environment and heading into the new boom before the great recession.
(22:59)
So I think that this time when you're looking at the inverted yield curve, I still believe it's an accurate indicator of a recession at some point or an economic slowdown. We don't have to go as far as saying a recession, but a slowdown in the economy. And again, it just by the influence of what it is doing in terms of short rates being higher and long end being shorter, I mean banks have a hard time making money in that particular market. They want a normalized yield curve. So that's one area of the market that obviously you curtail lending and loan demand and loan supply, and this would be supply that is going to actually at some point create an environment that is not sustainable, at least in terms of a growing economy that we've seen. And again, we're seeing signals that things are slowing down and cracks in the armor.
(23:49)
I was just reading today something about, I forget the group, but I was talking about a restaurant, the high-end restaurants, people are curtailing their wine purchases . So you're seeing little things creep up. And again, those are cumulative too. So you kind read the tea leaves, and again, one of those big tea leaves is the inverted yield curve. And remember those cycles last anywhere, the average yield curve inversion is about 15 months. We're at 14 heading into 15, but the range is a little bit wide, six to 24, somewhere in there, six to 24 months. So again, we're kind of in that middle of that range, so we can go a little bit longer. We're not outside of normal ranges in terms of when we're going to enter an economic slowdown or recessionary period from an inverted yield curve standpoint. So I do think that this, at some point we are going to enter an economic slowdown. It's just the magnitude of that slowdown that's again, is yet to be seen.
Gary Siegel (24:43):
And what kind of severity do you think we will see? Is it going to be just a slowdown or recession? And if it's a recession, how bad and how long?
Jeff Timlin (24:53):
I would say in 2024, you're probably going to see a modest recessionary environment. There is a good chance you can get into negative GDP. It doesn't have to be huge. All has to be is negative, right? Negative 0.01 is still negative. You get two of those, you're technically in a recession. So I think currently we're sitting in an area that we could definitely see some periods of negative GDP. Again, some of the influence there. And then this is kind of the wildcard is what happens with government spending if they continue to pump the gas into the proverbial economic fire, that'll be challenging. Obviously the Fed is not doing it, right? The Fed's doing what they need to do to ratchet in inflation ratchet in economic growth. But again, it's one of those things that there's outside factors and we're dealing with, again, a global economy where the Fed has to be cognizant of what's going on globally.
(25:44)
Because again, if you start doing things vastly different than what other monetary entities are doing around the globe, then you affect your currency. And then currency challenges can obviously rear their ugly head, which people don't talk about a lot, but the currencies are the great equalizer. I mean, you can domestically try to get your house in order and do things that work for you, work best for you. But if you don't take it into context with this global economy, which we are, I mean I started my career back in the mid nineties and it was a fairly global economy then. It's only become more so with technology and instant trading and basically 24/7 trading. There's no part of the world that really shuts down. It's like the perennial New York City, it's 24/7. So I think when it comes to that, we do expect a modest recessionary environment going sometime into next year.
(26:33)
Again when first quarter, second quarter, again, it goes back to what we were talking of when something does finally crack and we think it will, that will the slowdown in economic growth and possibly cause some challenges in labor area as well. I mean we're seeing some of that rear its head now in terms of challenges with the strikes, the UAW and other areas challenging for higher wages. Again, there's a fine line that needs to be drawn there in terms of expecting getting your fair share and also wanting too much, which could obviously affect economic growth for those companies in terms of profitability. So we're seeing that those things pop up as well. So there are so many factors out there. And that's the thing is we've been in a economic growth cycle for so long, we've never really had a correction that got the marginal players out.
(27:33)
So there's so much competition out there still that from a competitive standpoint that I think sometimes they're eating each other in terms of what they're trying to sell and obviously the consumer they're going after. So we really not have had a market clearing like we did in the past. So those are things that I think could be healthy again if done in a managed way. And I think again, I think the Fed's doing their best to try to navigate that. But again, they're dealing with previous policies and different market expectations and how many areas are still levered up pretty substantially across the board that are now going to have to deal with the effects of higher rates. If they have to refinance, again, like I said, forget new money. They're probably not doing new projects at the moment, but if debt comes due and they need to roll that debt because they just can't pay it off and they need to roll it at best, they just have to deal with this higher interest rate cost, which lowers all things being equal lowers profitability because of that interest rate cost.
(28:29)
But again, depending on how they want to keep their profit margin stable. One area that we've seen in the past is that they cut employees. That hasn't been done yet, but that's one area that obviously could crack. And once that starts to accelerate, then again people can't pay their house, then that creates a chain effect. Oh, this domino effect that kind of ripples through the economy. Again, we're not there and that's why we've seen the relatively stable market. But I think something along those lines, and again, I'm just bringing up a few, there's a lot more on that. We could just have a whole discussion on this topic alone. As you can see, this is the one I spent the most time on that we could talk about this all day. But again, that's really not the point. The point at the end, I'll just sum it up is the point is that something I think is going to happen that will help the Fed in their endeavor. Again, no one's going to like it because no one likes to have a economic slowdown or economic challenges, but I think those things will come to fruition sometime in 2024. And again, for Sage, we've been kind of positioning well in advance of that.
Gary Siegel (29:37):
Many economists had expected a recession this year, some even early this year and some late in the year, but that hasn't occurred. Will this delay or lack of a recession have an impact on the rate of disinflation going forward?
Jeff Timlin (29:57):
Yeah, I guess history will tell, right? But again, we're in kind of that soft landing. I think that people did expect a recession to come a little bit sooner or an acceleration or a greater slowdown in economic data and the economic numbers that again, like I said, there's multiple factors that have been supportive that have led to this type of environment. I mean even Sage here, we are probably a little bit early to the party in terms of thinking along those lines as well. But again, we were seeing the writing on the wall, and again, we're looking at leading indicators too. So we have a bias more towards looking into the future than looking into the past. Obviously we consider backward looking and coincidental indicators as well in our assessment, but it's really what's going to happen tomorrow because that's how we can position the portfolio for our clients.
(30:52)
And I think a lot of people were erring on the fact that, okay, valuations across the board were relatively rich, we're at kind of peak cycle here coming off of COVID. Obviously we had a really robust economic environment for several years after COVID, supported along by what was happening from a fiscal standpoint. And then monetary policy during that time was not as restrictive. So you still had this environment that was very conducive to growth revenue receipts coming in on governmental level above expectations. I think corporations were doing well, but again, valuations were rich and pricing that in and pricing that to go on for probably a longer period than what was warranted. And now I think you're seeing a little bit of that, the numbers coming and maybe people being a little bit, sorry, the negative numbers coming and people being still a little skeptical fool me once, shame on you, fool me twice, shame on me.
(31:51)
So I think they're being a little bit more, I was going to say cavalier, that's probably not the right word. A little more cautious in terms of being overly defensive and then putting some money to work in certain areas. And hence why I say at least on the fixed income side, which kind of represents the risk off, treasury rates are higher, which kind of doesn't portend to a recessionary environment because people will throw money into fund flows, go into treasuries when people anticipate an economic slowdown and the Fed to start easing, which again is not showing up in the treasury side. And then on the risk side, and again, it's modest risk on the investment grade size spreads are towards the low. I think they're around 1.16 today is when we were talking this morning, which again is on the lower end and not overly attractive, at least from a historic standpoint.
(32:38)
And on the high yield side, we're somewhere in the 3.70 range. So again, people aren't overly concerned with defaults and the disruption in that particular market. So I think what we're seeing here is definitely that, a little bit of complacency on that front, but if you're looking at it just for the next quarter, I think that's okay. Looking into 2024, that's where the uncertainty begins a little bit more. And again, those cumulative effects of rate hikes, I think become more prevalent in the market. And then that's again why I said I think we'll see some challenges in '24.
Gary Siegel (33:16):
Core inflation is still higher than the 2% Fed target. And the SEP suggests the Fed is not going to wait until inflation is down to 2% to cut rates. Is this a strange thing in your opinion, that they want to target 2% yet they'll cut rates before they hit 2%?
Jeff Timlin (33:42):
I guess it depends how you kind of view it. And I mean if you look at it from just, okay, all things being equal today, that does seem like an odd statement. Absolutely. But again, if it's, it's accelerating towards 2% and you start to see those cracks that I was talking about, and then the equity markets have a huge sell off and unemployment starts to ratchet up significantly higher, again, all the effects that are part of higher interest rates and what they're actually trying to accomplish in the slowing down of the economy, if it does collapse and they can kind of foresee that things are heading, that 2% target and maybe even going through it again is more of a risk or a higher risk than being slightly above. Because remember, what was their challenge? Going back again, I go back into history a little bit.
(34:32)
What was their challenge? It was getting inflation above 2% and it took record and historic monetary policy to move that forward and really a global event, i.e., COVID to kind of help that along when basically the market was not just flooded with monetary policy and monetary easing or easy monetary policy, but also fiscal spending globally, global fiscal spending and deficit spending. So when you're looking at what they're saying, I think you've got to read between the lines a little bit and say, okay, if we're in a economic slowdown or a modest recessionary type of slowdown, that is again, what's normal. I guess that's anybody's best guess. But if it's tolerable meaning that things are happening on a measured pace, I think they'll probably be patient and get back to that 2% target and then reassess from there. But if it accelerates and you get again, a COVID-like selloff in the market and things which we're not anticipating, but if you get a COVID-like economic crash in the market where things are just falling, basically everything's falling off the cliff at the same time, then I think they would be more apt to be like, let's put that part of our mandate aside because we know it's heading in that direction anyways.
(35:53)
It's going to be dragged down by the significant economic slowdown that's presently hitting the market in that type of environment. So I think it's just understanding that, I think at the end of the day what they're trying to say is, listen, we're going to be nimble. We're going to give you as much information as possible. We're going to be transparent. We don't want anybody expecting things that we're not trying to portray or trying to deliver to the markets. And they've talked about this for some time being more transparent, and I think they've done a real good job of being transparent and basically giving the market what it needs to maintain. Again, price stability, which again is their other mandate without the market trying to also move against them because obviously once they signal that they're going to start easing or start doing that, the market's going to price that into the future and then backend rates come down lower again, which then offsets what they're trying to do. So I think they're trying to get the market to be on the same page as them as best they can and then have that work in tandem with managing a slowdown in inflationary pressures while keeping prices as stable as possible, even though there will be a disruption at some point.
Gary Siegel (37:11):
Okay. I'm going to take questions from the audience after this last question. We have a couple and we're running short on time. What are the biggest risks you see for the economy going forward?
Jeff Timlin (37:23):
Well, I guess again, known risks. There's two types of risks. There's the known risks, which is it can be big risks and I'll kind of detail that. And then the unknown risk, which is the largest risk because that are not priced in. But again, the biggest risk is that, again, we just talked about it, is the acceleration of a slowdown where then there's a significant layoffs in and unemployment heads higher at elevated or accelerated pace quicker than what the Fed or the government would want or really anybody would want. And again, those cause the ripple effects across the board in terms of reduced consumer spending. Obviously challenges with you don't have a job, you can't pay your bills. So then that ripples into the housing market, which then into the construction market. And again, we saw that play out. The biggest risk is a similar situation, maybe not the same factors per se or exactly as the great recession back in 2007, 2008, but having it be the magnitude of that being as powerful as it was back then, that's kind of the greatest known risk.
(38:22)
And again, the market's not pricing that in now, just to be clear. But then the biggest risk in my opinion is, and that's what keeps me up at night and keeps me thinking in terms of what do I do on a daily basis? And probably most other asset managers is looking through the data, not just looking at the headline risk and what is known, but what is unknown. And again, those are things that unfortunately can never be quite determined until after the fact. But where's the softness? What things are going on? And I talked about the rental market that's become such a huge thing that wasn't around back during the other great recession, but could again affect the overall housing market. So that's one area that we've been focusing in on. Other things are more recent in terms of cyber attacks that could infiltrate MGM and Caesars recently.
(39:10)
I mean it's one company, but again, what if we have some of these factors that haven't been considered or priced into the market come rear their ugly head. So even, let me throw some way out there, climate change and some of those things that people are concerned with. So there's numerous risk factors that are out there that seem to be prevalent in the market and causing some disruptions across the board. I mean, climate change is affecting the insurance industry like never before, right? They're not even insuring some areas of the country. What does that portend for? Again, the housing market. Forget even if we have a soft landing here and everybody is doing well, how do people insure themselves or their new home if they can't get insurance? Those are factors that we were trying to incorporate into our models in terms of forward looking, assessing the tail risk, because really that's what it is, it's tail risk.
(39:58)
But then when tail risk becomes an actual risk, then people, they're like, why don't you consider it? So those are things that I think's the unknown risk that I'm being priced in the market now that are the biggest challenges. But again, the way you manage that and the way that Sage is trying to manage that is just look at obviously valuations and credit fundamentals and then reposition the portfolio to avoid some of the areas that are not having as many challenges and have a better financial footing so that if something does come up that was unexpected, that they could handle it better than most others. And that's the way I think most people should look at across their whole asset allocation. Forget just fixed income and their whole asset allocation, whether they're dealing with equities or fixed income or any alternatives looking to take some of those chips off the table. If you do think that we're heading into an economic slowdown.
Gary Siegel (40:48):
So from the audience given higher mortgage rates, higher fuel prices, increasing food costs due to the cost of transporting to market, etcetera, increasing mortgage defaults due to inflation and increasing layoffs in banking tech sectors in particular, how are continued rate hikes good monetary policy?
Jeff Timlin (41:11):
Well, again, it's all those higher and larger and increasing. I mean, the only way for them or the primary tool to ratchet that in, to control that, and obviously the mortgage increases, that obviously is going to be a symptom of what they're trying to do in terms of ratcheting in fuel prices and food prices and things of that nature. But remember too, let me just step aside real quickly and bring it into it. I didn't talk about it earlier as a supply component. You can kind of fix some of these things by increasing supply and focusing on some of that. But again, there's been policies that have curtailed oil and energy and policies that in some ways that probably a less understood by the market that have constrained or some of the challenges in terms of climate change that I talked about earlier that have constrained the supply of food in certain areas.
(42:00)
I know there's some rice challenges going on and I'm kind of going a little bit all over the board, but what I'm trying to get at is good monetary policy is it depends on how you're looking at it. Good is yes, good from a standpoint that we're going to be ratcheting in and making it and helping curtail some of these inflationary pressures both on the discretionary and non-discretionary side, but bad in the fact that actually from a consumer in terms of how we utilize the markets, the debt markets, and what we're using it for. One being for a homeowner or somebody that wants to purchase a home, the mortgage rate that is not advantageous, particularly in the current price environment. Prices haven't come down substantially for, I guess current owners is good for, people who want to buy not so good. So it's really hard to determine good, I guess it comes down to it's good in one point of view and bad in another, but again, they're just trying to accomplish their mandate, their dual mandate.
(42:55)
Within that, you could define it as good, but from a consumer standpoint, you may still look at it as a good and bad. So it's both for a consumer good that they're bringing, it will bring down food prices and bring down energy costs hopefully, but from bad from the fact that credit cards and auto loans, and again, mortgage rates are higher, which obviously like I talked about earlier, affect your monthly payment, which is for you bad. So inflation is kind of different depending on the economic inflation versus consumer inflation. The percentages are a bit different in terms of where your spending goes.
Jeff Timlin (43:46):
Yeah, I was just saying, I hope I answered the question.
Gary Siegel (43:48):
Yes, you did. So what does all this mean for the bond market?
Jeff Timlin (43:54):
Yeah, I mean in a way it's actually a good thing for the bond market, at least for the individual you're talking about. Bad for the consumer in terms of rates are higher because when you're borrowing, but if you have money to invest, this is actually wonderful. Rates are as high as they've been for the two year, going back two year, five year and 10 year, just looking back today, somewhere in the oh five to oh seven range. So now you're actually being paid to own fixed income. Again, if you have investible income that needs to be put to work at those rates, it makes it very challenging to really want to put money elsewhere. I think you can actually get in a very safe asset class, obviously you're dealing with interest rate risk, but from credit risk you can just put your money to work in treasuries and get a pretty nice return for your money, particularly with how we're looking at the economic outlook for over the next, say 6, 12, 24 months.
(44:39)
It looks like risk assets are going to be under pressure valuations, I think by anybody's and I watch some of the pundits out there, even the people inequities are like, yeah, they're kind of rich here. So even they admit that the valuations are rich, at least from a price to earnings perspective. I think it's somewhere in the 20 times earnings. So again, even they are being a little bit hesitant in terms of how they're deploying. I think they're being reallocating the low beta type of names within that sector. But overall, I think that this is a really good time to be in the fixed income markets, particularly if you have new money to invest or you've been sitting in the short part of the curve. I think the treasury rates right now are a little bit overdone relative to X market expectations. I think that they're pricing in a little bit too much of a soft landing in a rosy environment.
(45:26)
But again, that's the benefit to that is that people can take their proceeds and reallocate into an asset class that probably will perform well in a slowdown. Not only are they going to get the higher income, which is part of being in fixed income, it's in the name itself. So they can actually enjoy the higher income, the highest income they've seen in almost two decades now. And then at the same time too, realize probably some significant price appreciation if the economy does enter an economic slowdown or recessionary environment, because at that point, at worst, the fed pauses and then at best it starts to ease rates, which again will then influence the price component of your bonds. As rates go lower, the price rises. So again, that would be a nice additive to your overall portfolio. And then at some point you can probably redeploy into risk assets once they reprice. So again, it looks much like that good bad policy, it's how you look at it, good from reinvesting in fixed income, bad from maybe a risk on standpoint, ie. Equities. But again, if you are able to rotate and do make those asset allocation decisions in advance, then you can actually take advantage of any market environment, whether that be bullish market or bearish.
Gary Siegel (46:37):
Well, we're out of time, but I want to thank my guest, Jeff Timlin, managing partner at Sage Advisory, and I'd like to thank all our listeners for joining us today. Have a good afternoon everyone.
Jeff Timlin (46:50):
Thank you everybody.
