Shock, Awe, and a Hawkish Turn: The First Warsh Fed Meeting

Lawrence Gillum (00:00):

Hello, and welcome to this week's edition of LPL Market Signals. Lawrence Gillum, Chief Fixed Income Strategist on the LPL Research team, and I'm the host this week. Last week ushered in the beginning of the Kevin Walsh, led Fed. Walsh, who is the 17th Chair of the Federal Reserve, but only the 11th in the modern banking era started his tenure off strong. We had some drama, some intrigue, and some surprises, which tend to be a good recipe for daytime soap operas, but not so sure about an FOMC meeting. But to help unpack the major takeaways from last week's fed meeting and to discuss our updated economic projections, I'm joined by LPLs, Chief Economist, Dr. Jeffrey Roach. Jeff, how are you today, sir?

Jeffrey Roach (00:39):

Hey, Lawrence. Thank you. That's a very well said intro with drama, intrigue, excitement. This was certainly something that's historic, I think, and that's not hyperbole, although we do have another announcement to make in terms of a previous Fed chair. Mm-Hmm <affirmative>. If you want to mention that might be appropriate today.

Lawrence Gillum (01:03):

Yeah. So unfortunately we do have some somber news as we record this on Monday, June 22nd. The maestro, Alan Greenspan has passed away at a hundred years young. So I think for a lot of us in this industry, we started during his tenure. So Alan Greenspan was the head of the Federal Reserve from 1987 to 2006. So if you started your career in this industry anytime between those two time periods, you are certainly familiar with Alan Greenspan. So maybe some thoughts broadly Jeff on Alan Greenspan.

Jeffrey Roach (01:39):

Yeah. One of the things that I think he contributed to is this whole notion of looking at business company corporate level data and trying to, you know, square that up with the official government data. So he's very much a granular micro kind of guy, and I think that was a really good thing, I think that stuck around even to today. He as you know, Lawrence, from me talking about this, he very much was a part of my beginning formation as an economist. He would call my boss at Bank of America. And what a good legacy. He really did not, without a few bumps and scrapes, certainly, right. A lot of people do complain about some of his deregulation bent his free market type of bent, and that was one of the reasons that some say might have caused the great financial crisis. But besides that, I think he, he well earned that moniker maestro.

Lawrence Gillum (02:51):

Yeah, absolutely. I mean, when you think about the tools, certainly Ben Bernanke, his successor, he provided some additional tools, but Alan Greenspan was certainly there to increase some of the communication efforts. You know, before he started releasing statements, there was really just no idea what happened within the Federal Reserve halls or if interest rate policy changed or not. Maybe they've gotten a little bit too far away from that, that communication style over time. So there are some parallels we think with this new Kevin Walsh led Fed and some of the things that that Alan Greenspan introduced during his tenure. One of my favorite quotes though, and you know, he was always great with words and great with you know, sentences and, and whatnot, but Alan Greenspan, one of his most famous quotes is, if I seem unduly clear to you, you must have misunderstood what I said. So a lot of great quotes from him and didn't make it in, understanding what the Fed was up to. But you know, there was certainly some steps in the right direction.

Jeffrey Roach (04:01):

Yeah, that's right. And it's worth highlighting him not only just of his passing today as we record, but also the fact that Warsh did look, does look up to him, Greenspan, and I think it's a model for him. And I think it's helpful as we continue to anticipate many more years of exciting press conferences to harken it back to how Warsh was influenced by someone like Alan Greenspan. So his legacy does live on.

Lawrence Gillum (04:30):

Absolutely. That's a great point, certainly that Kevin Walsh you know, taking over for, for J Powell who took over for Bernanke, and then Greenspan is kind of the you know, the architect to a lot of these tools that the Fed is using, but his legacy will go on throughout this Kevin Walsh led fed it seemed. So maybe let's switch gears and talk about this Kevin Walsh led Fed. There were some surprises. It seemed really the main takeaway was that it was a lot more hawkish than a lot of people were expecting, us included. What were some of the main takeaways for you?

Jeffrey Roach (05:06):

Well, I think the first, of course, no surprise here in the sense that there was no change in interest rates. The Fed funds rate is unchanged at this meeting unlike some of the pressures coming from the executive branch of the government wanting a chair to cut rates. So he certainly did not live up to those expectations of being dovish, but he also did live up to the expectations of somewhat of a shock and awe strategy that we've learned to live with over the new administration. And just like we've seen in so many other departments inside the beltway, Kevin Walsh did the same thing. He did a little bit of a shock and awe in this press conference. In fact as we're showing you a clip from the conference, he's announcing something brand new, and it's all about shaking things up.

Jeffrey Roach (05:58):

So, five task forces, and those task forces are made up of both internal experts, also external private sector experts to discuss things like inflation communications. How do we tell the markets what we're thinking as a committee? Also, one committee's going to be focusing on data, the methodology of the data, the collection of the data. What kind of data can we be given 21st century technology that didn't exist back in the seventies, for example, how to modernize the way the Fed looks at the economy. I think this is quite fascinating. No one expected this to happen but it actually might be something positive. I think yet to be seen. It's the very, very early stages here. But in principle, I would certainly welcome a lot of these new ideas or at least new questions to ask to reassess and to rethink what they're doing.

Lawrence Gillum (07:05):

Yeah, that's right. Greenspan was a big proponent of the government not measuring productivity correctly. He came in and provided some additional context and, you know, that ushered in a kind of a lower inflationary environment, higher product productivity environment. One of the task forces that Kevin Walsh has laid out is related to AI and productivity. You know, certainly the communication task force is interesting as it relates to Greenspan too. So there are some additional kind of, you know, overlaps or similarities with this first Kevin Walsh led Fed meeting and the Greenspan legacy.

Jeffrey Roach (07:51):

Yeah, that's right. And of course, in addition what we learned with this new chair and a little bit of a surprise is that the statement summarizing the activity, the committee was one third the length of a normal statement. So very crisp, terse, straight to the point. We didn't change rates. We will tackle price stability. I do think even though it was quite short, one of the things that I think is very helpful to remember is they were clear in connecting the dots between hot inflation running above the 2% target that the Fed has with supply chain problems, particularly in the energy sector with the Strait of Hormuz being challenged, whether it's open, closed, partially open, partially blocked those are clearly the factors driving inflation. And so my takeaway, and this transition probably to some of your follow up questions, Lawrence, and topics on projections here, my takeaway is this, we could actually see the committee pivot a bit and maybe pivot quite quickly once the strait opens up free flow of crude around the globe that actually might ease up inflation pressures.

Jeffrey Roach (09:11):

Hence the committee has a whole new set of dynamics to work with.

Lawrence Gillum (09:16):

Yeah, and that's right. I mean, timing of these meetings is kind of important to bring up as well, certainly the timing of this meeting last week, it was, it really took place before a lot of the progress was made in terms of getting an agreement between the U.S. and Iran potentially opening up the strait more directly over the next 60 days. So could you wonder, do you wonder if these economic projections from the Fed are maybe a little bit on the high side? They did increase their inflation expectations for this year. Both core and headline PCE numbers were revised higher. I wonder how much of that can be revised lower if we do get the agreement between Iran and the U.S. and open up that strait more broadly.

Jeffrey Roach (10:03):

I think that could be revised lower pretty quickly and pretty dramatically just like it did in reverse, right? So when you think about it and when you're referencing forecasts and revisions that's all based on the summary of economic projections that the Fed produces periodically throughout the year. One of the items, for example, that are under review I think that chair is interested in revising how that's presented, not necessarily if it's presented. So personally, I don't think that they're going to do away with the summary of projections altogether. And one of the reasons why we think it's so helpful is that they often tell us and compare what has changed and how it changed since the previous publication. So they don't publish a summary of economic projections after every meeting, but a few times a year, I think it's like every third meeting maybe. So what they did from the previous, they'll actually say in the line item here, and I have it up on my other screen, they'll have a projection and then they'll say, what was March's projection? So June 17, relative to the March projection. So they revised down growth, they revised down unemployment rate, and they revised up both headline inflation and core inflation, which is core excluding food and energy.

Lawrence Gillum (11:26):

Yeah. And one of the big takeaways with those economic projections, you know, aside from what we just talked about as it relates to the change in direction for some of those, those forecasts, but we did get a pretty, I would say hawkish prize as it relates to the dot plot. Dot plot, as we know, represents the individual expectations of monetary policy for those individual fed officials. It's anonymous. There were 18 out of the 19 members that presented their interest rate forecast. Kevin Walsh, notably absent, I'll ask you about that in just a second. But it was a little bit more on the hawkish side with about half the committee expecting no change to monetary policy in 2026. But then half the committee suggesting one rate hike may be necessary, six members suggesting two, at least two hikes may be necessary, and then one official suggesting maybe three hikes could be necessary sometime this year. Pretty hawkish.

Jeffrey Roach (12:25):

Yeah. And that was one of the reasons why things got so volatile right after the event. So the Fed releases a statement, it was very short, as we mentioned, just a few minutes ago. And then 30 minutes later as you're seeing here on the screen, the chairman takes the podium and, and fields questions from reporters. So I think what's interesting in terms of the dot plot is perhaps they kind of soften that maybe that's one of the things that gets cut and goes to the chopping floor when they reassess the summary of economic projections. Maybe it's not that detailed, and maybe it's a little more high level, like you just said, Lawrence, to present it to say, Hey, half thinks no cut, the other half thinks at least one hike. And maybe not the granularity of perhaps members that are suggesting more than one hike, which is a little bit like where we were last year, where when Miran was on the voting committee and he was, you know, dissenting and suggesting multiple cuts, and you're thinking, well, that's never going to happen.

Jeffrey Roach (13:30):

It's an outlier and not necessarily helpful for expectations going forward. So I think the key takeaway is this, if the president can get something you know, pushed across the finish line here with a memorandum of understanding, getting things reopened in the Middle East, perhaps those inflation numbers improve, particularly by the time we roll into the fourth quarter of this year. And that's why it's one of the things where I think, okay, maybe yes, there's, there's chances of a hike if this geopolitical tension remains, but probably not as many hikes given the fact that there does seem to be other pressure points where we're not growing quite as fast as we could in this economy.

Lawrence Gillum (14:22):

Yep. That was kind of the big takeaway from the market's perspective anyway, is that now post that dot plot release, a 75 ish percent chance of two hikes priced into the market this year, I've been arguing and you know, I, it's getting, you know, increasingly difficult to have this position, but I've been arguing that the bar for a rate hike is a lot higher than the bar for a fed on hold throughout 2026. If you're right about the potential, call it fourth quarter surprise, inflationary pressures start to ease a little bit. Maybe, you know, we don't get a hike per se, but maybe we just get a fed on hold throughout 2026. What do you think?

Jeffrey Roach (15:05):

That's right. I mean, so much does depend on how negotiations go and how successful they are in the very near term. And then I think also it does, it does help us to think there are some signs of China weakening, and because of that, perhaps that's going to ease up some of the pressures on inflation. So some of the global factors in addition to the supply chain factors could give us that fourth quarter surprise as you just said it. I kinda like it that way, saying the fourth quarter surprise.

Lawrence Gillum (15:37):

Yeah. I will say what the Fed going forward though, is inflation expectations, market implied, or even just forecasted inflation expectations remain relatively well anchored, so they're not caught behind the data as it relates to expectations. So that should provide the Fed a little bit of comfort in terms of being able to stay on pause for a little bit longer. One thing I do want to cover real quick Jeff, is that you did release a publication last week, your Economic Navigator, a great piece. Where you do outline some of our expectations as it relates to economic growth inflation growth, as well as the labor market. What were some of the key takeaways from your new publication?

Jeffrey Roach (16:21):

Well, I think the first one is this, that the components of growth, particularly software research and development, the components on computers and tech related equipment, all those categories could actually continue to drive growth in the next several quarters and maybe going into 2028. Definitely a little bit of a interesting take. And I make that case as I looked at some of the data in previous cycles where there's some structural shifts going on, most notably in the nineties. So that's one thing to think about. There's more to go in terms of the business capital spending in those categories. Then the next thing I discuss is the fact that, you know, perhaps we could indeed see crude oil prices go back to kinda the pre-crisis levels. And it all depends on China and the Chinese demand for imported oil.

Jeffrey Roach (17:22):

And it looks like because of such a drop in imported oil in May, looks like we could see a slowdown in in demand for petroleum products in China that will further suppress and maybe create the framework for a fourth quarter surprise, as you said, in terms of the inflation data. And then the third and final point in terms of projections I do think that the Fed may be missing something a little bit in terms of expecting. Their view is inflate I'm sorry, unemployment rate will actually drop from here. I think that it's possible as more people reenter the labor force looking for work being creative, trying to, you know, get into labor force, it's possible that that could provide some upward pressure and unemployment still very, very historically low unemployment numbers, but maybe not as low and not a directional change in a downward direction as the Fed expects.

Lawrence Gillum (18:23):

So potentially better inflation throughout the rest of this year, if things go right or well within the mideast. And then of course, what's going on with China then perhaps maybe a kind of an adjustment a little bit higher in terms of the unemployment rate. So that really kind of points to a perhaps a loosening of monetary policy versus the hike that's priced in. So if those things come to fruition, maybe the job market isn't as robust as the Fed expects, but the inflationary pressures are better than what the Fed ex fed expects. Could we get a cut this year instead of just a fed on hold?

Jeffrey Roach (19:04):

Well, before the attack on Iran, I thought we could get a cut and even in the first month or so, you know, throughout April, okay, yeah, maybe a cut. But since this has dragged on for so many months, I think we just have inflation a little more deeply embedded, hence we're probably not going to be able to get that cut that we expected as we started 2026. So that's providing a little bit of uncertainty in those retail rates. When you think about mortgages, think about auto loans credit card rates, all those rates that hit the end consumer. I think that's one of the reasons why we've had a little bit of reversal there. However, in the last week or so, I think we've kind of be begun our descent, again in a very small, small way as it relates to mortgage rates. And that'll certainly be able to, to help things particularly the housing market to kind of clear up a little bit as we go the latter half of this year.

Lawrence Gillum (20:08):

Yeah, and you never discount the fact that this is a midterm election year. And I'm sure there'll be some efforts by the Trump administration to help out on the affordability side, whether it's on the mortgage side or on the gas prices side. We have seen some declining gas prices, which is helpful, I guess, I think now the national average for a gallon of gas is under $4 a gallon. Not back to the, you know, high twos but certainly below $4 a gallon is helpful from the 4.50 peak that we saw a couple months ago which again, should help with the inflation story, which should, should help with the, the growth story as well.

Jeffrey Roach (20:50):

Yeah, that's exactly right. And a sentiment and consumer confidence. So, you know, it's interesting and you think about it in terms of the allocations that go to gas is pretty small, you know, 4 or 5% of total household expenditures. So it's a small number, but it really does determine a lot on how the consumer feels about how the economy's going.

Lawrence Gillum (21:15):

Yep. Great point. And we do get some sentiment data, I think this week as well. So maybe kind of bringing us home here, Jeff what's on the calendar this week that you're paying attention to?

Jeffrey Roach (21:26):

Well, there are a number of things. Later in the week, we're going to get the fed's preferred metric of inflation the personal consumption expenditure price index. It's a mouthful. That's why we often just say the PCE Deflator or PCE price index. The reason why it's helpful and probably not necessarily too market moving this week, because we already know from the CPI report that was already released earlier this month. The increase, of course, it's mostly energy driven and we're probably not going to see much of a different story when we get the PCE number. So I'm also looking at some of the ISM numbers that's based on business activity. It's a survey based on how businesses are feeling in terms of new orders, employment prices paid for their inputs, overall, new orders, exports, imports, I mean, you name it. So it's a really good look on several industries from, you know, construction, mining, manufacturing, financial services, insurance. So that's very helpful to give us a good look on the economy. Then later in the week on Friday, we get some sentiment numbers. Unfortunately, the sentiment numbers are not quite as helpful because it's such a partisan divide right now. So it's not really giving us a really good, clear signal like we're getting from some of these business surveys.

Lawrence Gillum (22:54):

But still markets pay attention to it nonetheless. So you, you never know what you're going to get or the reaction out of markets when you get this information. Mm-Hmm

Jeffrey Roach (23:03):

<Affirmative>.

Lawrence Gillum (23:04):

All right. So with that we can, we can wrap up, Jeff. Now. This was the, the first meeting of the Kevin Wash era. If they're all going to be like this, I will you know, offer you some, some help and some prayers. This could be a pretty volatile type of, you know, FOMC meeting, recap type schedule. There's a lot, a lot of drama, a lot of intrigue and surprises this week. Hopefully they're not all like that. But it is great to have your perspective nonetheless. So thanks Jeff for joining this week, and thanks everyone for tuning in. We will be back next week with another episode of LPL Market Signals. Until then, have a great week, everyone. Take care. Bye-Bye.