Branstad: Hi, everyone. Thank you for joining us here at Thrivent Asset Management. I'm Jeff Branstad, portfolio manager.
Lowe: And I'm Steve Lowe, Chief Investment Strategist.
Branstad: Today, we're going to be talking through some of the issues that are going on in the economy. The big driving issue, of course, is inflation. We had a pretty high number come out in the last CPI report. That was a little bit higher than expectations. People were hoping to see it level off, but we're not there yet. What's the latest? What's going on with inflation?
Lowe: Inflation is the issue in the market right now. It's driving the rates market. It's driving the Fed to raise rates, which is driving fears of recession. The Fed is raising rates because of inflation and, as you mentioned, inflation is very high; it's at a four year high. CPI consumer price index is at about 9% right now.
It's very broad-based. It includes goods, services, commodities – they’re all going up right now. And if you look at alternative readings, which we do to measure the persistency of strength of inflation, those are also high. One [reading], “trimmed means,” you take off high inflation and low inflation. And there's another called sticky inflation. All those are showing persistency.
It is an issue for the markets right now and is what markets are focused on.
Branstad: So, no matter where you look, inflation is high.
Lowe: It's high. There are signs that it might be peaking, but it's also impacting the economy. Inflation essentially works as a tax on consumption. And if you look at consumer confidence, it is very, very low. And inflation is what's driving that right now, despite the economy doing relatively well. And the reason is because it erodes what we call real income. In other words, your income after inflation is negative right now. People are losing ground; their buying power is going down. And ultimately that feeds into corporate earnings eventually, and recession fears.
Branstad: I know that gas prices have started to come down a little bit. Are there any other signs of easing yet? Signs that we've peaked? That inflation is going to start moderating here?
Lowe: It has moderated at least in the near term, across several categories. Supply chains are loosening up a little bit. You can look at things like freight rates or shipping rates. Those are coming down. Goods prices are coming down, particularly those that were over-ordered or over-bought during the pandemic, things like bicycles or Pelotons, things like that.
Commodities, as you mentioned, have clearly rolled over, used car prices; you can look at inventories within retail companies. Those are very high right now and that's putting price pressure down. So, it's pretty broad-based right now. And the other thing you can look at to gauge expectation for inflation are market-based measures. There are derivative markets inflation, and those show inflation declining – probably around peak.
Lowe: You can look at Treasury Inflation-Protected Securities, called TIPS. Those have an imputed inflation right in there. Those have also been declining for a while.
Branstad: The Fed, obviously – the Federal Reserve – one of their big primary mandates is to keep inflation in check. They've been raising rates. Are they doing enough? Are they doing too much? How is the Fed's response to inflation been playing out so far?
Lowe: Yeah, well, the Fed is hiking very aggressively, the most aggressive that they have really since the 1990's, at a rate. That's the main impact. In previous cycles, most recent cycles, they hiked a quarter point at a time and they're doing 50 basis points, 75 basis points. So, it's a very aggressive hiking cycle.
The Fed intends to top out at about 4% for Fed funds rate if you look at the projections. They are strongly committed, in their own words, to defeating inflation. They have to. Because if they don't, they lose credibility for inflation fighting and that would be a bad thing for markets and bad thing for them. You know, markets don't think that it’ll get as high as projected. Markets right now [believe] the Fed gets somewhere over 3%. And then they have them cut it.
So, why would that be? It's implying that either inflation starts easing in response to the Fed, or that people become more concerned about the economy. And then rates start going down or they lower rates, and the Fed will have to eventually cut as the economy either goes into recession or it slows down significantly.
Branstad: The market is both reacting to what the Fed is doing and trying to predict what they're going to do next. What level of confidence does the market have that the Fed is going to be able to slow inflation and not bring about a recession?
Lowe: Not very high right now. You know, the reason recession expectations have gone up is because Fed cycles traditionally end poorly. When the Fed is hiking, often a recession follows. You know, there are so-called “soft landings” where they manage to engineer a slowdown in the economy and dampen inflation. But those are somewhat rare.
Branstad: Steve, what's our view on inflation now? What are our expectations here at Thrivent Asset Management? And what are we doing to prepare for that?
Lowe: Yeah, certainly. We expect inflation to continue to ease. You know, we're probably near peak inflation within the next few months and in the near term, and then inflation will fall. I think there's a good chance, however, that once you get to the 4% or so range, it's going to be a lot harder to get down to 2% for a variety of reasons. And inflation tends to be a little sticky. And also, there are a lot of macro trends such as deglobalization that work to push up prices.
So, it could be problematic for the Fed getting that last stretch down. And there's a scenario where they raise rates, cut, and then inflation comes up again, and they end up having to raise rates again.
Branstad: And obviously, even if inflation comes down from 4% to 2%, that doesn't mean prices are going down. The higher prices in a lot of these areas are probably here to stay. How does that going to impact the consumer going forward?
Lowe: Well, inflation is a rate of change.
Lowe: If the price of gas went to $5 [per gallon] and stayed there, next year [inflation would] be zero, but it's still a higher level. It’d be more likely that you're going to get pockets [to decrease] than for overall inflation to go down; you're going to have to have commodities come down.
Branstad: An actual decline in prices that's not just a level-off.
Lowe: Yeah, actual prices decline in spots are most likely. And ultimately you have the wages adjust over time.
Branstad: We've talked a bit about how the Fed is reacting and trying to tame inflation. What does that mean for rates in general?
Lowe: It has a mixed impact on rates. It depends where you are, and the Fed funds is a short-term rate.
Lowe: You're going to see short-term rates go up until they cut and then they'll start coming down. But in the meantime, you've already seen what's happened. Longer-term rates are declining, and that's a function of expectations that the economy slows and then inflation rolls over. And one of the results of that is that the curve inverts. And the curve has inverted already in different parts. And that's usually a sign, again, that when longer rates are lower than short rates, it's a sign that people expect the economy to slow.
I think there's a good chance that the cycle highs for ten-year rates are close to that. They peaked out around 3.5%. We could definitely make a run toward that. I don't think we’ll get over 4%. And in a downside scenario, you could see them go for 2%.
Branstad: So, in general, we would still expect that the short-term rates to keep going up a little bit because the Fed's got more hikes to do.
Lowe: Exactly. The short-term rates will go up until the Fed finishes or until close to that. And then typically they don't stay high for very long. In the history of Fed hikes, they don't say what's called the terminal rate – where they stop – for long because, ultimately, the economy generally slows.
Lowe: And they start cutting rates again. Or inflation falls.
Branstad: Okay, cool. Thank you.
Thanks again for joining us today. For more information, please visit us at thriventfunds.com. Goodbye, and we'll see you next time.