With the government reopened and data expected to flow, the Federal Open Market Committee may cut rates again at its Dec. 9-10 meeting. Steve Skancke, Chief Economic Advisor at Keel Point, will break down the meeting, Fed Chair Jerome Powell's press conference and the new Summary of Economic Projections.
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Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Gary Siegel (00:10):
Hi, and welcome to another Bond Buyer Leaders event. I'm your host Bond Buyer Managing Editor Gary Siegel. Today we're going to discuss the Federal Open Market Committee's meeting and monetary policy. My guest is Steven Skancke, chief economic advisor at Keel Point. Steven, welcome and thank you for joining us.
Steven Skancke (00:34):
Thank you, Gary. It's always great to be with you and it's always great to talk about the topics that Bond Buyer and Bond Buyer readers and followers like to discuss. It plays to what I love most.
Gary Siegel (00:52):
So for the audience, there will be no specific question and answer session, so if you have a question, just pop it into the queue at any time and we'll get to them. So Steven, was there anything in the post-meeting statement, the dot plot or Fed Chair Jerome Powell's press conference that surprised you or grabbed your attention? Well,
Steven Skancke (01:14):
Nothing was a big surprise, Gary. It went as we had expected, we knew that there was going to be a quarter percent rate cut. We knew the statement with the announcement and chair poll and his press conference were going to be hawkish about it to manage expectations that this was going to continue. I mean, this was the third quarter point rate cut in a row, and so nothing surprising about that. I think we were, what would grab my attention was that the statement of economic policy that they issued along with it shows only one more rate cut until the end of 2026, and the expectation would be that that would be sometime mid-year 2026 after President Trump has named a new chair to replace Jerome Powell. The other thing that wasn't really expected, but I guess it's not a big surprise, is that the Fed is going to start, is going to initiate purchases of short-term treasuries to maintain an ample supply of liquidity, and they're going to do it at a rate of 40 billion a month between now and April of next year.
(02:47):
That should be well received in financial markets. It's not inflationary. Yes, it builds the Fed's balance sheet, but at the same time it just removes some of the friction that we've seen in that market and in the repo market in the past. So that was interesting to see as part of the announcement. I guess the other thing that just is worth noting, and again, not unexpected that there were dissents, but that the voting members and the non-voting members are starting to stake out positions for where they'd like to be next year. And I think part of that is pre-positioning for when there's a new chair so that an incoming chair understands what the lay of the landscape is like and what the expectations are for cutting rates further so that there's a little bit of, I guess, inertia that pushes back against the notion that someone is going to come and a new chair is going to come and it's just going to be Katy Bar the door with rate cuts. So that was worth seeing. Not a big surprise, but certainly worth noting
Gary Siegel (04:21):
The SEP or the dot plot showed that there were more than just two Federal Reserve officials who thought rates should not be cut. Assuming that some of them are not non-voters, what do you make of that?
Steven Skancke (04:40):
I think that's part of the general concern. I would say that those would be the Powell camp of wanting to be cautious and hawkish and because there were enough votes to affect the rate cut, they didn't have to vote the cut, when you look at the spot, the application is that six of the 19 members, not all of those six are voting members right now, but six of the 19 wanted no cut. Of course, President Trump's most recent appoint, but Stephen Mira wants six cuts more in 2026. So that's not a surprise, but the one six that really wanted no more cuts, were just stating that position. And I would say that Jerome Powell would probably be in that camp too, but we don't know who the dots were, but I think we can sur that he would be included there to cut in December because of, well, the ADP number that we saw, 39,000 jobs lost according to the ADP projection in November, but it was the lesser of two problems to go ahead and cut. Now as a matter of safety,
Gary Siegel (06:28):
Do the dissents and the wide variation in the dot plot suggest that Powell is a lame duck or does the fact that he wanted a rate cut and got his rate cut mean that he's still in power until he's out of power?
Steven Skancke (06:47):
Yeah, I would say Gary, yeah, there's always going to be some lame ness to someone whose term is ending in the next six months, but he still commands a lot of respect among the governors and the Federal Reserve Bank presidents. And so his camp was happy to vote with him to the extent that he needed their votes, but they would tend to be more in the camp. Again, as I said, as I think he is too in seeing no more cuts until they have sufficient data to suggest that there should be more cuts.
Gary Siegel (07:44):
So Steven, all signs point to Kevin Hassett being the next chair of the Federal Reserve.
Steven Skancke (07:51):
Yeah,
Gary Siegel (07:52):
What do you know about him? What will this mean for rate projections? What will this mean for rates? What's your take on Kevin Hassett as the next chair?
Steven Skancke (08:03):
Well, certainly the president is interested in him, and I think the president tried to convince his treasury secretary to go over there. Steven Bessent wanted none of it and told the president he was more effective where he is. And the reality is that he is probably the principal trade negotiator to work out some of these things that have become problematic for the president for the country, and he's doing a great job of that. So he's not going to go, Kevin Hassett has been around Trump for a long time and the president trusts him, and so he's a logical choice. And really Gary, his views are well understood.
(08:55):
Yes, he would be fine with a couple of cuts, one, two or three cuts in 2026 if those seem warranted based on where the labor market goes. But we know from things that he says publicly, stuff that he's written part of Trump's policies that he's okay with nominal GDP running a little hotter because he believes that Trump administration policies are supporting productivity, growth, deregulation, and that day along with the tax cuts will support expanding the GDP capacity so that it can run a little bit hotter without being inflationary. Now for the stock market and crypto and short-term rates, Kevin Hassett will be well received. Those markets, those markets will respond well be a steeper yield curve. That's okay. When we've lived with an inverted yield curve for so long, what happens about the 10 year treasury still sort of hard to know that, hard to read that you and I follow the 10 year treasury day to day, week to week to see where it goes. I've always found it to be a good indicator of market sentiment and telling us things that don't get clouded by just the diversity of activity in stock markets.
(10:42):
I think what happened to the 10 year treasury, if Kevin has it, is the pick really depends on what he does when he gets there. As I said, my belief is that he'll be a leader of stability and continuity and he's a savvy enough guy and trusted enough by the president who would nominate him that he can go a little bit slow on rate cuts if there are going to be more rate cuts because he has the president confidence that that will actually get him to where he wants to be in a more certain way than by coming in and just starting to slash the short term, which is going to push the 10 year treasury up. We saw that last May when the president was talking about firing Powell and putting his own guy in there to cut rates and the treasury Secretary had to rush over to the White House and explain why bond markets and that he didn't want to see the 10 year go above five that I just need to be clarified and the president did. I mean the president's a savvy guy, whether you like all of his policies or not, he is sensitive to getting what he wants, but in a way that helps him get there. So he listens to people he trusts Hassett is one of 'em. I think the markets would feel good, certainly okay, but I think also good about that appointment. And I also believe out of the gate, he's going to show that he is a continuing hand of stability even if he's moving in a somewhat different direction than the current chair.
Gary Siegel (12:52):
So we have a follow-up question from our audience.
Steven Skancke (12:55):
Okay.
Gary Siegel (12:56):
Which of the known candidates to be the next Fed chair most strengthened confidence in the Fed's independence and which most erode confidence in the Fed's independence? And does it matter?
Steven Skancke (13:12):
Oh, definitely it matters. And as I mentioned briefly, we've seen that already when the president was acting as though he were in charge of the Fed and he could tell 'em what to do. My guess is that the two that would give the most confidence about the continuing independence of the Fed would be if the current treasury secretary were appointed, which I said he doesn't want to be, or to be candid, Kevin Hassett, I think would give markets confidence that as close as he is to Trump, that he would be effective in building a consensus in maintaining the independence of the Fed because he just like scent understands that to get what they want, the Fed has to appear to remain independent Now as to who would not have that confidence. I mean there have been some names floated, well, the fellow, I shouldn't say the fellow, the chairman of the Council of Economic Advisors who the president has their reportedly on a temporary basis would not be well received by the market just based on the stuff that he said since he's been there.
Gary Siegel (14:54):
So Steven, what is your personal view of how many rate cuts we're going to have next year? Base case,
Steven Skancke (15:02):
Base case? I think base case one, I think high probability two and any more than that, only if there's something that comes to trigger a problem in the economy.
Gary Siegel (15:28):
So we have another question from the audience. Do you think the rate cuts will make the housing market more liquid?
Steven Skancke (15:40):
It certainly ought to have that impact.
(15:43):
Putting more liquidity in the banking system will help reducing short-term rates, which benefit savers gives them an impetus to go ahead and move because the opportunity cost of where they have their money is greater if they just continue to hold it and less if they invested in housing. Housing prices are just expensive. They've gone up. And part of that is going to continue because of the labor shortages in the construction trades, the impact of tariffs on building materials, appliances and furnishings. And the quickest way to improve the housing outlook would be to think about how the current policies, not that they're necessarily wrong, but the way they're being implemented has really spooked the labor market and it's particularly has been particularly adverse in the housing market. So prices are just higher and going higher, and that's a problem within the housing market. Parts of residential availability, multifamily in particular, apartments even more particular are in abundance right now and lower interest rates would help that. But for single family homes and to a certain extent, multifamily homes, condominiums, it will certainly be helpful to have interest rates come down. But I think the bigger challenge is in the cost of housing and that's largely tariff and immigration policy related.
Gary Siegel (18:11):
So we have another question from the audience about the Fed purchasing treasuries. The Fed purchasing treasuries would create more liquidity. Could this create a byproduct effect that would lower consumer rates?
Steven Skancke (18:33):
Yes. Yes, it can do that as more liquidity is available. It also happens when the Fed funds rate is cut. It has been cut three quarters of a percentage point already. What banks charge one another and what banks charge in their credit cards, particularly if liquidity allows some of the bank related or bank owned credit card rates to come down, that would certainly be a positive impact just to go from where they were to where they are now and what the target is that the Fed is targeting Fed funds average rate of 3.4% by the end of 2026, that'll be helpful to those credit card rates to borrowing rates and to what savers can expect.
Gary Siegel (19:39):
Do you think the Fed and the bond market are on the same page now?
Steven Skancke (19:44):
Gary, that's always a great question. It's just hard to know. I say generally they trend in that direction. I think the bond market is appreciative of the Fed buying short-term treasuries to bring liquidity back into the market. It just relieves a friction point that we've seen in the past that was just frustrating to the bond market. And when the bond market is frustrated, there's friction, you're going to see rates tick up. The aggravation factor plays out there as well. I think that they're both looking at the same thing. The fact that the Fed is trying to be deliberate about it, it's using forward guidance, I think pretty effectively. They're trying to be transparent so that there aren't any big surprises to the bond market. I think at least until now, chairman Powell has been very open, although appropriately respectful of the executive branch of government in talking about what they're trying to do to be at least, I would just say accommodating some, but ready to mitigate some of the adverse impact of some of these policies. I think where the bond market probably gets the biggest angst is out of fiscal policy uncertainty. The One Big Beautiful Bill increased the deficit by sort of three to 400 billion a year. So we're going from 1.8 trillion to 2.2 or 2.3 trillion annually at a time when we're running mostly at full employment and have economic growth above 2% annualized in the United States. And how all that plays out is, I think there's a lot of opaqueness around that.
(22:31):
At one point the president was saying, well, we're going to collect 300 billion in tariffs and this is going to be used to offset the extra 300 billion in deficits that were incurring. And that helped. Bond markets have been pretty stable, relatively stable, but then in the last couple of months we've heard that the president talk about that $300 billion in tariff revenue being spent any number of different ways in part to mitigate the negative impact of the tariffs, even if it's not identified as the negative impact of the tariffs. The conversation about 12 billion to farmers, a dividend check to consumers being funded out of the tariff revenue. And then on top of that, you have federal district courts, federal appellate courts having ruled is in position of largely the reciprocal tariffs as unconstitutional. And now the Supreme Court is taking it up. We'll see what they do.
(23:53):
It's going to be hard for them to line up with the president. And I think the big question and bond markets will certainly have an opinion about this is whether if the Supreme Court decides that the reciprocal tariffs have to be terminated, then the next question is, okay, does the government have to give back the body? They've collected a good chunk of it already, and that's part of the money that was being used to offset the increased deficits. So that'll have an impact. And that's just an uncertainty area. You and I know financial markets, bond, bond markets included do not like uncertainty. And there's just uncertainty around this terrifying. There's uncertainty around the deficits and the president has telegraphed that he is not concerned about deficits borrowing the money to spend if it's part of building infrastructure and incentivizing working, saving, investing, if it's part of the rollout of AI and deregulation diesel for it, it's an investment in the future. And that I think is where you get a disconnect between government and bond markets. I don't see so much in the Fed. Now, obviously with the new Fed share, that does increase an element of uncertainty in the monetary policy outlook, but that's right now sort of a small part, a smaller part and in the category of to be determined.
Gary Siegel (25:57):
So we have a follow-up from the audience on tariffs. You pretty much answered it, but I'm going to ask it anyway. Does the market believe that the administration can or will direct tariff proceeds to pay down the debt even if it's nominal? Would it be received positively?
Steven Skancke (26:20):
Well, yes, it would be received positively even if it's nominal because it would express a recognized concern about the growing size of the debt and needing to address it. As a practical matter, when you're running a deficit, what you're really doing is you're reducing the deficit because $2 trillion deficit, you can use just hypothetically 300 billion in tariff revenue to reduce that. Or yes, you can make a payment against the debt, but it just bounces right back up. So the net effect obviously is that you're reducing the rate of growth in the debt by being able to apply some of that tariff revenue to reducing the deficit to fund current spending.
Gary Siegel (27:31):
And we have another follow up from the audience, very active audience today. When could we see that the higher tariff impact into our economic reports, including GDP, C-I, et cetera?
Steven Skancke (27:47):
Well, we've, we've seen it start to come in to the economic reports already, companies, big retail companies. You think of the companies that have provided the greatest benefit to the American consumer through their innovations in supply chain management that allowed them to source so much of what they have sold in the United States, passing along the economic benefit to US consumers, particularly in the middle and lower income groups. And they have been absorbing some of that increased in their cost largely by defraying it over a broader spectrum of things that they sell so that it's not all that the cost increase is not imposed on the things that the tariffs supply to. But even though we had fabulous third quarter earnings reports from the s and p 500 up 13.9% year over year in the third quarter, and the outlook for the fourth quarter also strong, the impact of those tariffs will continue to flow through into the economy and will be paid at the end by the end use consumers. Part of it gets paid by, well, all of it's paid by the importer. Part of it's paid by US manufacturers especially have lost jobs as a result of the tariffs. So the tariffs have had a very negative impact on US manufacturing and US manufacturing jobs because of the increase in the cost of their doing business and in the cost of the products that they sell. And so the demand for their products has diminished and they reduced their labor supply or their labor demand.
(30:24):
The counterweight to that has been the impact of deployment of artificial intelligence that has been labor saving by increasing productivity, but it's also been cost saving in how those imported goods, whether they're end used products or intermediate goods, get taxed when they come into the United States.
Gary Siegel (30:55):
Steven, are you at all worried about stagflation?
Steven Skancke (31:00):
Not at this point, Gary, at the beginning of this year, it was certainly something that I was paying a lot of attention to, but for it to be a problem, you have to have stagnation in addition to inflation. Now, inflation continues to come down. We saw from the September personal consumption expenditures deflator that it ticked down from 2.8, 2.7. The Fed in their summary economic projections is expecting that to come down to 2.5% versus their September projection of 2.6% for the fourth quarter of 26 20 26. So the belief is that the trend for inflation is going downward. It's interesting to note that in the December updated summary of economic projections that the Fed released yesterday, that their 2026 fourth quarter GDP year over year, fourth quarter over fourth quarter has been revised up to 2.3% from where it was at 1.8% in September. Most of the economic projections that I see for 2025 show us ending the year with GDP growth of about 2% when the tariffs started getting rolled out.
(32:51):
The GDP growth, US economic growth for 2025, which had been 2.8% in 2024 was being forecast at one and a 5% on the encouraging end of the spectrum and 1% or less on the frustrating or discouraging end of that spectrum, those numbers are now revised up basically a whole percentage point. So the consensus forecast now is right where the Fed would have us go at the end of 2026. For 2025. It looks to be in the range of 2% year over year for 2025. Economic growth. And the Feds projection for 2.3% in 2026 is also an indicator that the stagnation part of it doesn't seem to be where economists and markets are right now.
Gary Siegel (34:09):
So we have a follow-up from the audience. Again, you basically answered the first part of this, which is what are the indicators that wouldn't suggest we are headed toward a period of stagflation? But the second part, the only thing that appears to be holding up the economy at this moment is ai, but that also leads to unemployment in theory. Have any thoughts?
Steven Skancke (34:37):
Yeah, can
(34:45):
You hear me okay?
(34:46):
Yeah.
(34:48):
Oh, okay, because I thought I was still on mute. Sorry. AI is certainly a big contributor because it has created large amounts of investment both in the infrastructure to create the AI capabilities and intellectual property, but also in the deployment and adoption. And the deployment and adoption has been far broader than was expected. And it has created, well, it certainly created improved productivity. It's created a labor technologies and it's allowed some firms certainly to stop hiring. And in some cases there've been announcements of layoffs. I think at the end of the day, and we've seen this with computerization that came in the eighties and nineties, and then the internet when it just took off, it didn't reduce the demand for labor. It certainly recharacterized it a little bit. What I hear mostly is that you're not going to be replaced by ai if you're using ai.
(36:25):
If you're not willing to become knowledgeable and use it or proficient, if you're a new entrance to the labor force in ai, it's going to be harder for you to find and maintain a job. But for those who will use it, I think the opportunities are even more robust. And if you think about the US economy growing 2%, if it's just 2% in 2025 and it's 2.3% in 2026, that's higher than the average that we've had over the last 15 years since we came out of the great recession in 2007 to 2009, we've sort of grown somewhere between 1.8 and 2% in the first Trump administration. The economy grew for at least a couple of years around two and a quarter, and then it accelerated even further over the last four years, grew 2.8%. Last year jobs increased significantly even as AI was being deployed.
(37:49):
So I don't think, and I don't believe that it's going to be detrimental to the labor market overall. Certainly there will be transition issues, there will be disruptions, there will be retraining needed, but the opportunity for growth and employment I think is very positive. The other thing that has a big impact too is that last year, Gary, we job increase on a monthly basis averaged a lot. And last year, and as it has been for the past several years, you needed about 125,000 new jobs per month just to be breakeven. That is to hire the folks who are coming into the labor force every month, and to keep the unemployment rate steady 125,000 a month with having sealed the border and policies that have removed undocumented workers from labor force. That number is 50,000 a month. And in an economy that's growing, that should be an easy number to cover each month.
(39:23):
I mean, the outlook for the unemployment rate consensus among economists, the belief in the Fed is for the unemployment rate to remain steady, and that's positive. Yes, as I said, it will be challenging for people who aren't interested in adapting to use AI in their current jobs where it's applicable. But apart from that, I think the outlook is robust. The other thing I would just add is the way United States in particular has increased its standards of living over decades, including the last 15 years, is productivity growth. And we saw productivity growth in the second quarter of this year, year over year, up three and a half percent. The outlook of that to continue to happen is positive wages, wages and salaries on average have grown higher than the rate of inflation except for that period in 21, 22. But on average, it has grown faster than the rate of inflation over the last 10 years. And that says you can do that without pushing up inflation when you have productivity growth, and AI is the sort of made to continue to feed into that.
Gary Siegel (41:09):
So we have another question from our audience. If the Fed begins buying treasuries and particularly mortgage backed securities, would that be considered another round of quantitative easing, or is there more to quantitative easing than that?
Steven Skancke (41:27):
Well, I think the short answer is if they're buying mortgage backed securities, the answer is yes. That would be quantitative easing. The Fed has said that it wants to buy short-term treasuries to increase liquidity in the banking system as liquidity in the banking system has declined. And without that, you start getting friction in the overnight repo market, which is just not helpful. And so as a technical matter, even buying short-term treasuries could be defined as quantitative easing, but that's not the intended purpose. The intended purpose is to provide liquidity, to reduce friction in just the financial markets within the banking system. So we don't have some of the problems that we had mostly pre COVID.
Gary Siegel (42:37):
Last question from the audience. What do you think about tariffs in relation to inflation? When the economy is affected more, when the economy is affected as time goes on, would you think inflation is an option? And in turn, what about interest rates?
Steven Skancke (43:00):
Well, Gary, as you know, in addition to being in the financial world, I'm also an economist, and I can't help myself when I say that tariffs are just bad for the economy. They do contribute to inflation. They are attacks on consumers. They tend to be pretty regressive, which means that they are disproportionately impacting lower and middle income groups. And so just overall, they're not good for us. The question is can they be used to restart to stimulate industries that have just gone offshore? And the answer is yes, they will do that, or they can do that if there's a belief that they're going to be there permanently. Because the reason a lot of those industries went offshore was that domestic manufacturers just couldn't compete anymore. And so yes, you can rebuild some of those industries in the us but it'll be at a cost. That cost is inflation and it's paid by consumers.
(44:26):
So it's not a good result. Long term, we all just pay more. It reduces our standard of living. Can it be used in particular ways? Sure, it can. And I think the current administration has tried to do that. Some places, I think they're probably getting it right and others, I think it's been problematic to say the least, and it's been harmful to businesses, particularly small businesses. If you look what's going on and small businesses, they've been very frustrated and it's been challenging for them. If you look at things like the AI industries, the hyperscalers, it's been costly to them too. They're better able to deal with it. And they've also, because of their size and commanding presence, have been able to get some waivers of some of those things. We've seen it with Apple, we've seen it with others, and the president has now allowed Nvidia to sell its chip into China, whether China will buy them.
(45:48):
I think that remains to be seen. China has been very deft in using its export of rare earth minerals to the United States as a counterweight to the president's general inclination to tax stuff coming out of China at a far higher rate that's been rolled back, but it has also been a cost to us industry that is very reliant on rare earth minerals. US government has put hundreds of billions of dollars into rarer mineral companies to try to mitigate some of that. The decision to put money into Argentina was driven largely by securing a supply of rare earth minerals to keep it from falling into the hands of China. Of course, the downside of that was that Argentina used the money to waive the tariff on exporting its soybeans to China. And so now the president is faced with spending another amount of money, presumably of tariff revenue to transfer 12 billion to the farm community, to ameliorate the negative impact of US tariffs and China causing China to stop buying US soybeans, although they started a little bit recently to do that. So we get these spillover effects that have come out of some of these tariff policies that impact us in ways that we don't always suspect when they're imposed in the first instance. It's been a challenge. They're trying to address it as best they can, but at the end of the day, it's a negative impact of imposing these tariffs, maybe without fully understanding what all of the impacts are going to be and how that's going to affect American industry and American consumers.
Gary Siegel (48:17):
Well, we're out of time, so this will conclude our leaders event. I'd like to thank the audience for tuning in, and of course, my guest, Steven Skancke, chief economic advisor at Keel Point. Always a pleasure, Steven.
Steven Skancke (48:33):
Always a pleasure to be with you. Gary. Thank you for having me on.
