All eyes are on the FOMC as interest rates continue to drive the markets. Join us as José Torres, senior economist at Interactive Brokers, breaks down the previous day's FOMC meeting and Chair Jerome Powell's press conference.
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 Jose Torres, senior Economist at Interactive Brokers. Today we're going to discuss monetary policy including yesterday's Federal Open Market Committee meeting. Jose, welcome and thank you for joining us.
Jose Torres (00:36):
Thanks for having me, Gary. Good afternoon.
Gary Siegel (00:40):
So was there anything in the FOMC post-meeting statement or Chairman Powell's press conference that surprised you or grabbed your attention?
Jose Torres (00:51):
Sure. So I think that one of the surprises was that he didn't appear overly joyous about the progress on inflation. He kept saying, we got to, it's just one month of data. We have to wait and see more. And I think that was my main takeaway. I think equity investors were expecting a much more dovish speech, but it was really right in the middle, right where he can thread that needle, where he can be dovish and hawkish simultaneously that perfect balance. In fact, that balance has been so pronounced that today moves in capital markets have equities moving higher and bond yields moving higher. So bond investors are cautious at this juncture, but equity investors are more of in a hip, hip, hooray kind of mode.
Gary Siegel (01:53):
So do you think that this was an idea by Chairman Powell to sound hawkish because in the past it seemed that when he even tilted dovish, financial conditions would loosen further?
Jose Torres (02:12):
Absolutely. I think that financial conditions have loosened pretty significantly throughout this year, despite the Fed continuing to increase rates, despite the Fed continuing to reduce its balance sheet, that is a primary risk because what happens, and we're actually seeing it now, when financial conditions loosen due to animal spirits and investors being perhaps overly joyous, what happens is that inflation actually goes higher. And we're seeing that right now in the commodity space with commodities registering their best month in a while, oil above $80, orange juice at all time highs. And part of that, those conditions loosening and creating a path for more economic growth and signaling elevated demand.
(03:11)
And in the past when Chairman Powell was particularly dovish, and there's some examples of this recently, so remember in the January meeting, Chairman Powell kept saying disinflation, he talked about it 13 or 14 times, now this time in the July meeting, he didn't want to repeat that January effect. And the last year he actually, when the fed funds rate was around two and a half, he suggested that the rate was neutral, which was another dovish statement. And throughout the cycle we've seen that sometimes the statement itself is hawkish. But then when Chair Powell starts talking — and because he is genuinely a nice guy he tends to appease some reporters questions — and equity investors take that and run with it. And we've been seeing that throughout the cycle. Some meetings are dovish, others are hawkish, and this one seemed to be right in the middle.
Gary Siegel (04:08):
So it seems clear that depending on what data come in, the Fed doesn't believe it's done. At the previous meeting, the SEP suggested two hikes this year, which we received one yesterday, but things can change. What was your takeaway from the statement? What do you think is happening going forward? More hikes? One, two, none?
Jose Torres (04:35):
Yeah, so I think an important aspect is the totality of all the economic data together. And while inflation has been cooling, the job market remains significantly robust. Whether you look at job openings, labor force, participation from the supply side, wage growth, job growth, and while these few reports show some good progress on inflation, I'm actually forecasting that the July CPI report, which comes out next month, is going to have about core and a headline increase of about 0.4%. That's consistent with annualized inflation around 5%. And also jobs for this month growing at 280,000. So if you ask me which direction the short-term data is going in, it's going in the direction of another Fed hike. But to Chair Powell's point, it's about the totality of the data. So even if July data, which is actually released in August comes in very hot, there's another opportunity in the month of September for that August data to come in cooler,
(05:48)
right before the meeting. Keep in mind of course, also between the July and September meetings, we also have the Jackson Hole presentation, which last year served as a reminder that the Fed's number one goal was inflation. And to remind you, in July, Chair Powell was a little dovish, interpreted as dovish, and stocks went up, the S&P 500 went up to like 4,320. And then after Jackson Hole we went on to make a new low in October. So it went from 4,320 down to around 3,490. Right. And now that was in a span of two months. So that's also lurking in the background if economic data heat up,
Gary Siegel (06:36):
Well Chairman Powell goes to great lengths to remind us that inflation is still higher than they want it and that they won't be moved by one report or one data set. We got a lot of data this morning and we have more coming in before the next Fed meeting, which is September 19th and 20th, as you said. But let's talk about today's data for a minute. Jobless claims suggested that the labor market remains tight and GDP came in stronger than expected. In fact, it accelerated from last quarter, which was very unexpected and consumption fell. What do these numbers tell you? What did today's numbers tell you?
Jose Torres (07:23):
Well, the numbers tell me that the economy has been significantly more resilient than all of us expected. Well most of us rather. I mean last year in the first two quarters we had negative GDP growth and that was pretty much before the Fed did anything. And if I would've told you last year that we're going to go and hike 525 basis points up to a rate around five and a half and economic growth is going to accelerate, right? If I told you that, you would look at me and say, how could that happen? That's a 23 year high in rates, right? The highest since the dot.com era, 2000. And it's really, really come as a big surprise. And part of it is the liquidity injections that occurred during the pandemic. You had the monetary policy stimulus from the Fed and you had the fiscal stimulus from Congress.
(08:23)
And those actions created an environment where companies have so much liquidity and households have so much savings. So the rate sensitivity of this economy is actually a lot less than previous cycles. Also previous cycles we were more manufacturing heavy, which is more rate sensitive, and now we're more services, less production of goods and more spending on services. And I think those are some of the moving parts that are making it where the economic data is really hot. Companies want to make money, they're fine to sacrifice margins in the short-term to keep workers employed. They don't want to trim labor to preserve margins and then not be staffed up for the next economic cycle because during the pandemic companies had a tough time hiring and retaining adequate talent. So this time around they're being more cautious on that front and I think that's really what's creating this environment of the consumer continuing to spend. They have jobs, they have savings, but there are some headwinds lurking in the next few months. And the consumer staying strong is essential to the soft landing narrative. The soft landing narrative can't happen if the consumer falls off a cliff in the fourth quarter of this year.
Gary Siegel (09:56):
So do you think today's data suggests the odds might have risen a bit for soft landing?
Jose Torres (10:06):
Yes. Odds of a soft landing, the path is wider after this morning's data just because it appears that the Fed, it has had, companies are working on the Fed side here by not trimming labor. They're making it where consumption can stay high even as inflation drifts lower.
Gary Siegel (10:32):
One of the things that surprised me about the meeting was once again the decision was unanimous. And from the speeches we've heard from Fed members in the past three, four months, it seems like there's some division on the panel about what the right move is. Are you seeing that as well?
Jose Torres (10:56):
Yes, I am. And if I'd have to imagine the more dovish members, I think, and what they're doing is they're analyzing the risks of the labor market more than the risks to inflation. We have presidents Goolsbee of Chicago, Harker of Philadelphia and then board members, Cook and Harker, they're the ones that appear to be more sensitive to the labor market, they want more time to pass. Whereas other members, other voting members such as Chairman Powell such as President Williams and Kashkari from Minnesota, they tend to be more hawkish. They tend to be more sensitive to inflation and they think that because the labor market is a strong, wages are strong, unemployment rate is low, consumption is strong, they think that it's okay to just continuing to raise rates and maintain a tight monetary policy until inflation gets where they want it.
(11:56)
And just one more thing on that one, the Fed is really worried that once they let their guard down on inflation and cut the first time or the second time, that inflation is going to come back really, really strong. During the 1970s that happened a few times under chairman of the Fed, Arthur Burns and then even in the eighties Volcker, considered the inflation-fighting hawk, even he had to deal with a resurgence in inflation after they cut rates a few times. So it's something that's really present in Chair Powell's mind to not stop until the job is done.
Gary Siegel (12:39):
You're right about that, Jose, he seems very intent on letting us know that he will not stop until the job is done. So the yield curve has been inverted for more than a year, which many believe signals that a recession is coming at some point. And for more than a year, people have been talking, people and economists and analysts have been expecting that there would be a recession. Why does the economy continue to surprise forecasters and defy the doomsayers?
Jose Torres (13:16):
Yeah, I mean it's the yield curve is a great indicator, but it's really a credit area indicator and then in an economy where credit isn't as sensitive as it once was, then that lag from when the yield curve first inverts to when the downturn actually shows up, it takes longer. And they talk about this all the time, monetary policy working its way with variable lags and uncertainty. And that's what we're seeing what we're seeing here today. And in the past, the softness from those rate-sensitive sectors — real estate and manufacturing — though that weakness would spread over to the overall economy a lot faster. And this time we're seeing it spread, but it's just a lot slower and it's more like a rolling recession where real estate bottoms then comes back, then manufacturing bottoms and comes back and consumer spending softens a little bit and comes back. And that's sort of what we're seeing.
(14:25)
But overall, especially with the data we saw this morning, I mean the summary of economic projections had GDP growth at 0.4%, and so far the two readings we've had gotten this year show one in excess of 1.5% and then today in excess of 2%. So we're growing a lot faster than what the Fed wants us to grow in order to get to that 2% target. And it's consistent with that uptick in commodity prices that we're seeing, we're seeing those loosening financial conditions, bond spreads narrowing, complacency in capital markets and consumers continuing to spend that's driving that economic growth higher alongside renewed inflationary pressures in the very short term. But the supply side has been a help. Used car inventories are arising significantly. That's weighing on goods prices. That's a very good story that supply chains are normalizing and it's making trade more efficient.
(15:33)
So goods deflation is great and that helps the Fed a lot. Also on the real estate side, we're seeing home builders are building a ton of homes and that's helping on the shelter side. We've underbuilt in America for a long time, since the 2008 great financial crisis and existing homes, there's really no incentive for homeowners to sell now and then replace their low mortgage rate with the high one and have to pay thousands of dollars more, so that market is frozen. So we're getting some supply on autos, on homes, supply chains normalizing, and that's really helping inflation from a supply-side standpoint and also the onshoring that that's going on from the supply side. That's more of a medium- or long-term mover, but that's also helping as well.
Gary Siegel (16:30):
And what is your view on recession? Is one coming and if so, when and how bad?
Jose Torres (16:37):
Yeah, so I think we're going to have one in first quarter of next year. I think the consumer is going to begin to wane. You have student loans coming up, you have savings dwindling, you have those and you have continued inflation and high interest rates. So I think that that's going to weigh on consumers and well have a recession, but it won't be an employment recession, like what we're used to, it'll be more like an affordability investment kind of recession where consumers still have jobs but they're not consuming as much due to pressures from affordability and high rates marginally. Those consumers that do get unemployed, theirspending totally drops off and that's enough to get us into recession with an unemployment rate around maybe 5%, not eight or nine or 10% or what we're used to in the movies during a great depression where folks are on lines looking for a job. Structurally, we live in a different world. Demographics just don't support an unemployment rate that high. We still have labor shortages. On the earnings calls companies talk about it all the time. So it's not going to be an employment kind of recession, more like your 401k is not going to go up 20% every year, that kind of recession.
Gary Siegel (18:01):
The market seems to be skeptical that about the Fed's projections. Are you still seeing that as well?
Jose Torres (18:12):
So I think they are skeptical, but slowly they are slowly, they're getting online with the Fed in terms of what the Fed wants to do. In fact, this morning we saw that the data shifted, that this morning's economic data shifted odds of a September rate hike up to 24, 25%, right? That's up from around 15%. So I'm expecting with the hot numbers that I'm expecting, like I said earlier, I'm expecting that to get closer to 50% and I'm expecting September to be a live meeting, assuming of course that the data that comes out in September, which will reflect August, assuming that that data is strong as well. We are going to have a live meeting in September and maybe even a reminder in Jackson Hole of what's to come in September.
Gary Siegel (19:04):
What else do you think we might see at the Jackson Hole conference?
Jose Torres (19:10):
So one thing about the Jackson Hole conference last year is that Chair Powell didn't take any questions. So it'll be interesting to see if he uses that opportunity as he did last year. It's just a way to come out and just tell the market, tell them what he's seeing, what the committee's seeing and what the goals are and maybe a time to re-anchor monetary policy expectations. I mean when we look at the two-year yield harboring right around four nine right now we're actually at a lower level on the two-year than we were prior to the regional bank crisis in March. Within that time period, however, the Fed increased its terminal rate forecast from 5.13 to 5.63. So why did the Fed increase the terminal rate forecast 50 basis points, but indicators of monetary policy to your yield are actually lower from that point and that's also part of the market sort of wrestling with the Fed on how long it can stay above 5%.
(20:19)
But given what Powell said yesterday and given the economic data coming in, it appears that we are in a regime of higher yields. We're not going to have the 10-year yield at one or 2% like we had during the pandemic. Those days are long gone and we're transitioning into a new period here for companies, for households, for governments. This year the government, the U.S. Treasury is going to pay a ton of money in interest costs as a percentage of the budget so that's going to force some in the medium- or long-term, some decisions that aren't that popular regarding entitlements, Social Security and Medicare, as well as how much of a share of the world's currency reserves the dollar going to make up. That's been slowly coming down. Still the dollar is significantly more important than any other currency in the world trade, but those questions come out more in the medium- to long-term, like five to 10 years or so where it's a different world due to the pandemic as well as the pandemic's response that created inflation.
Gary Siegel (21:29):
So core inflation is still above 2% and like you said, you think it's going to remain that way. The SEP suggests that the Fed won't wait until the rate is down, the inflation rate is down to 2% to cut rates. Yet at the press conference yesterday, Powell wouldn't commit to that. Do you think that the inflation projections are wrong, the rate expectations are off or that the Fed will cut rates before inflation reaches 2%?
Jose Torres (22:06):
So I think they will cut rates before inflation reaches 2%. And I think what'll happen is you'll start to get some month-over-month readings that are negative, you'll start to get some deflation month-over-month. But those deflationary readings will come at a time where the year-over-year readings are still at around 2.6, 2.5. So if you get two or three readings where you have negative inflation and maybe some bad job reports where job growth is maybe negative or less than 80,000, let's say in five digits, that can also push the Fed to cut rates because maybe they're not at 2% a year-over-year level, but in over a three-month change for example, they're negative. So I think that that's what will happen.
Gary Siegel (22:58):
So if there is a recession early next year, how much impact will that have on the Fed and rates?
Jose Torres (23:09):
So this is a good question and I think that
(23:14)
Similar to what I said earlier on, inflation being higher than usual, I think that the equilibrium rate here on inflation is, sorry, the equilibrium interest rate is higher than what it used to be. So maybe in the past if a 2% fed funds rate got you at a 2% inflation or kept you at 2% inflation, now you need more like three and a half or four. And I think that's going to be part of the adjustment that capital markets have to make in order to operate in this new regime, which is more inflationary higher for longer rate kind of regime.
Gary Siegel (23:56):
So where are we with the banking crisis? Is that history, something we don't need to worry, we and the Fed don't need to worry about anymore? Or will that still cause issues going forward?
Jose Torres (24:10):
Well, I think that we still have to worry about it. There's about 30 problem banks and if short-term rates keep going higher, that just really squeezes their margins as well as their cost of funds, their ability to, the small banks, their ability to entice depositors really depletes the higher short-term rates go. So I think that that's going to be in a really important consideration in terms of what happens with the banking sector. If short rates go down very fast and liquidity is added to the system, then it's not going to be a problem. But if inflation turns up again, like it is right now with commodities, and then if goods start to reinflate, then we have some serious problems and the Fed might have to do two more and then at that point, the small banks, they either fail or they just keep earning so subdued for such a long time and trade at really low price to earnings of multiples.
Gary Siegel (25:19):
Jose, I just noticed that we have a bunch of questions in the queue, so I'm going to try to tackle some of those before I get back to mine.
(25:27)
The first one is about recession, which we've already answered. Another question: Housing affordability is at 2007 levels, M2 is down 4% and the yield curve, the two to 10 is 93 basis points inverted. One of these maybe can be ignored. Can we ignore all three at the same time?
Jose Torres (25:53):
No, I think those indicators point to stress down the line, but similar to the banking problem, it could just be a situation where you just have less earnings and less performance out of the real estate sector for a while rather than a recession or just a credit event. From there, I think that commercial real estate offers some significant headwinds, particularly with office retail and with apartments and I think that's where we have to have our eyes closely on to examine whether we have a commercial real estate problem that can spill over and provide some problems for the overall economy. As a reminder, most of commercial real estate loans are floating-rate kind of debt deals where when rates go up, the bills go up significantly, but it's not just a debt expense problem, insurance costs are also going through the roof, maintenance is going through the roof, labor costs are increasing. So that's really weighing on activity and in those commercial real estate sectors and I think that's where we could have a credit event in the coming months.
Gary Siegel (27:10):
The next question is about Jackson Hole, which we answered. Question after that. How do you see the Fed using forward guidance going forward?
Jose Torres (27:23):
Well, I think once inflation is back down to between two and 3%, I think that the Fed might bring forward guidance back just to not shock the markets as much as they have in the last three years. I think that's what will happen. I think you'll have a cleaner view of where rates will be and what quantitative tightening will look like and all of the above.
Gary Siegel (27:55):
Next question is do you think rates have peaked? I think we touched on that, but I'll let you answer that again.
Jose Torres (28:03):
Sure. I don't think so. I think that the two years and the 10 year yields, for example, I'm targeting those peaks to be around the two year about five and a quarter and the 10 year around four and a half. So we still have some ways to go, but as a trade, folks are really liking treasuries here because you know can lock in 4% over a long period of time while you weighed out some equity volatility, which we really haven't had much of since March. So it's interesting that treasuries are all in producing capital gains and income has really increased a lot since we've seen these yields rise pretty significantly. Now, investors of all ages are interested in treasuries and money market accounts, and similar to what we saw in 2018 and when 10 years started rising and rates started rising, that treasuries started to become a real important role in portfolios and we're seeing that now.
Gary Siegel (29:04):
Next question is how do you view the tone of Chair Powell versus Lagarde?
Jose Torres (29:12):
I think Lagarde is a touch more hawkish, and I think that given how the two institutions are set up where the ECB governs about 17 or 18 countries, I think the way that that's set up makes it where Lagarde's role has to be more hawkish, where Powell just is just in charge of one country, albeit the largest economy. But I think that's really the structure of the ECB versus the Fed makes it where Lagarde has to be more hawkish.
Gary Siegel (29:48):
Will countries keep buying gold?
Jose Torres (29:55):
I don't think so here. I think gold worked as a safe haven and has increased already. I think rallying gold already happened. I don't see it rallying much more from here.
Gary Siegel (30:11):
The next question we have from listeners is what are the leading indicators the Fed is looking at and why aren't they looking at wages?
Jose Torres (30:21):
Well, I think they are looking at wages. The leading indicators they're looking at a lot at initial claims is a big one. Retail sales are a big one. The weekly Redbook retail sales report, that's one that comes out every week. They look at that. Where manufacturing is historically was more important as a leading indicator than it is now just because back then in the economy was more rate-sensitive. So a lot of these leading economic indicators, it's actually interesting, they're more tilted to our rate-sensitive economy. They haven't been updated yet. The Conference Board's leading economic index has been negative for, off the top of my head, I want to say 15 months straight. And every month it just shows a more dire, dire, dire picture. But when you look at the indexes that have more labor market components in them where the strength is like the coincident economic index index or the lagging economic index, those indexes are actually showing pretty modest positive growth. So I think we were talking about earlier, how long does it take the leading indicators to weigh on economic activity. I think that's where we have to be focused.
Gary Siegel (31:37):
And another question, when do you think the Fed became more concerned with backstopping the stock market in the U.S.? I guess the first question would be, do you think they have?
Jose Torres (31:54):
I think the Fed is more like a fixed-income kind of shop. It's perfect for bond subscribers. So they focus on credit, they focus on spreads. Equity markets are in an ingredient of financial conditions, but they're not the major determinant. But one thing we do see in the equity markets is that the animal spirits do have a significant role and that's important to watch, I think for the Fed, and I don't think they do, but I think they should just, when you see the market start to run and run and run, the equity market, that could preclude some problems on the inflationary front as mainly through the wealth effect. Folks have more money, they're more rich, they see their accounts are bigger, so now they want to transact more, get into the economy, start buying homes, start shopping, all that kind of stuff. And that's a really important aspect here at Interactive Brokers. We've seen a lot of the me-me mania since 2020, all that fiscal spending brought in a new generation of investors. So I think it is an important aspect. And equity markets are becoming more of a traditional household conversation. It's more popular. Financial inclusivity is higher now in America than it was 20 or 30 years ago, right? Young kids now they're trading stocks on their phone, they're doing all kinds of stuff. So I think from financial conditions and animal spirits, but also from a cultural perspective, I think the Fed should be watching equity markets more.
Gary Siegel (33:46):
What do you think are the biggest risks the economy going forward?
Jose Torres (33:51):
I think the biggest risks, the biggest risk is goods prices. Right now we have a situation where services prices remain high, they're still growing. We have commodity prices, which are growing rapidly in the short term, but goods are deflating. We're hearing it on the conference calls, mainly new and used cars. But for example, Tesla, they've been discounting prices. They're open to more price discounts. When we look at Ford, they just dropped $10,000 on their new F-150 electric truck. We're seeing a lot of those trends in goods that the prices are going down because consumers are starting to run out of money, but also high rates are making it where those durable goods are much less affordable. So if that starts to pick up with commodities and services, then we're in environment now where inflation is back to going up 0.5, 0.6% and would require a significant hawkish tilt more than they are now from the Fed.
Gary Siegel (35:00):
So what does all this mean that all these items that we've discussed, what do they mean for the bond market?
Jose Torres (35:08):
Well, I think for the bond market, it means that as we have to adjust to a new inflationary regime with higher yields, and that means that there's going to be more inclusivity for bonds in traditional investment portfolios just because of the higher yields and the attractiveness direct to folks all over the place. I think that as the Fed leaves the market of buying treasuries by reducing their balance sheet, that's an important aspect as you know who is going to pick up those bonds that the Fed is letting roll off of their balance sheet. And the Fed is a good buyer to have in a market because they buy no matter what, right? They buy when there's volatility, when there's not volatility all the time. So I think the Fed, off the top of my head, they peaked that 24% of treasury ownership. How much is that going to drop? And to what extent are those bonds going to get picked up by private institutions and individuals.
Gary Siegel (36:18):
So we have another question from the audience. How do you view the housing market as interest rates have increased, given the fact that interest rates have increased?
Jose Torres (36:32):
Well, I think housing markets are very interesting. You're seeing new home prices come down, but existing homes go up in price. And we have this big bifurcation in the market where new homes are performing well, but existing homes aren't doing that well. There's some risk on the Airbnb front. Some folks added too many Airbnb units and vacancy has been rising in some of those cities and revenues have been declining while costs have increased. So there is going to be some risk from Airbnb for selling later on this year. But existing homeowners just have so much equity and there's no incentive for them to sell and there's no credit event that's going to force them to sell. So as far as the residential real estate market, it's probably going to stay flat for a while from here because affordability is going to cap price gains, but also homeowner reluctance, reluctance to sell is going to underpin price declines.
Gary Siegel (37:39):
When do you see M2 picking up?
Jose Torres (37:44):
M2 is not going to pick up for a while. Next, maybe next year or two, the Fed would have to ease up and deposits would have to enter the banking system, which I don't really see that happening with fed funds over 5%. So as they reduce their balance sheet, that also puts downward pressure on M2, so they're, they're going to keep doing that for a while until there's another credit event. What happened in March, they added $400 billion back to the balance sheet in about two weeks. But to the extent that keeps going down, that weighs on M2.
Gary Siegel (38:43):
So how can inflation go down if there's a contract being negotiated like UPS and wages keep going up?
Jose Torres (38:55):
And that's what Chair Powell was talking about yesterday with labor market softness being necessary to bring inflation down to 2%. And also what I spoke about earlier about that unemployment rate going up to 5% eventually, and companies are going to have to trim labor, it's, going to take a long time and it's really going to come a lot from small cap companies that can't really manage debt burdens as well as the large caps. But no, you're absolutely right with that being a significant risk on the inflationary front and why are wages picking up? And part of it is expectations. Consumers go out, they look at homes, they look at how much it costs to eat out, they look at how much it costs to fill up their automobile with gasoline, and now they're saying, Jesus, I want to get paid a little more because all these costs are hurting my budget, constraining my budget.
(39:53)
Also in the background, we have student loan payments coming up. We also have credit card bills almost, or over a trillion dollars off the top of my head that's growing pretty significantly. Consumers are relying on credit to continue to grow, and that's driving them to go to their employers and say, Hey, we want more money in aggregate. If employees sweep these discussions, and let's say the teamsters have to pay eight, five or 6% raises, UPS has to do the same thing, yellow company has to do the same thing and a few others, then now we're talking about wages growing significantly faster than what the Fed would like. And right now they're growing faster than what the Fed would like, even without those agreements going in favor of the workers. Now, Chair Powell didn't want to comment on that yesterday, but I think that's probably what he would have answered. If all the employees get their way, not all, but if the employees generally get their way in those discussions, then that sets a precedent all across the economy for higher wages and that's a risk.
Gary Siegel (41:20):
So is there any concern over the Mortgage FA forbearance program and homeowners not being able to make up the balances due? Can this spike foreclosures?
Jose Torres (41:32):
No, no concern there. Too much equity in their homes, no incentive to not pay. Home values are high, taking away the incentive to pay adjustable rate mortgages or a low share of total mortgages, FHA loans, which are low down payment, kind of 3% down payment loans. Also a low share of total real estate right now. So no, I don't see a spike in foreclosures. Residential real estate is actually one of the strongest asset classes going into what I'm forecasting as to be a 2024 recession.
Gary Siegel (42:13):
Is there a big difference between the Fed using PCE versus CPI to measure inflation?
Jose Torres (42:22):
So I'll do this question first. So PCE and CPI. So yes, and sorry about that, Gary. So CPI actually counts shelter a lot more than PCE and PCE counts healthcare more than CPI. So there are some differences in how it's calculated and the Fed transition to using PCE more than CPI. But I would say on balance, they pretty much reflect inflationary pressures overall.
(42:58)
What I was going to say about the previous question, that last point was that folks are seeing homes now also as a hedge against rent, right? Rents are high, and unless you move to a new place, your current landlord is probably going to want more rent. And that's a big thing, ladies and gentlemen, that I think the market is mistaken on thinking that rent rents are rolling over, new rents are rolling over. These are multifamily apartment owners that are desperate for people to come in to fill their apartments. They're going to lower their price, but current landlords know that it's a burden to leave where you're at. They're also suffering from inflationary expectations and seeing everything increase in price. And it's a less transparent market. The renew your lease market is a less transparent market than if you just want to rent a new apartment. So landlords are passing those rent increases on those folks that want to stay. But I think that every time I put on a news channel or read the paper, everyone's talking about new rents rolling over when new rents really don't make the bulk of rents overall. Most people stay where they live a few years. They don't move every year.
Gary Siegel (44:25):
So what is the forecast for the mortgage market? Fannie and Freddie are suggesting 2025 or longer before things really begin to move
Jose Torres (44:38):
On the mortgage market. So we're talking about rates or transactions. I mean, let's hit both. I think rates stay high. 30-year paper is particularly risky when there's not that much liquidity and people gobbling up mortgage-backed securities. And then there's refinance risk as well. So that mortgage rate has to have a wider spread than usual to the treasury. So if I think that the 10 years should be between four and five, it's four right now. I think the mortgage rate should be between seven and seven and a half on transactions. We'll see what the appetite is for consumers and new prospective home buyers to continue to purchase new homes. So the extent that they keep buying new homes, then that's great for the market. But I think that they're not going to continue buying new homes. Rates are just going to be high for a long time, and most people are saying, Hey, I can just buy and then refinance right away. Well, you refinance when rates go down and rates aren't going to go down as sharply as what we've seen the last few cycles.
Gary Siegel (45:52):
Okay. We're running out of time. We have enough time for just two more of these questions from the audience. Did any part of Chair Powell speech leave you unsettled?
Jose Torres (46:07):
No, I think he's doing, frankly, I think he's doing a good job. I think that the pandemic really blindsided monetary policy officials and government officials and really didn't know what to do. I think that the response was too long in 2022. The Fed was still buying treasuries and mortgage backed securities just last year. So they could have been more proactive in ending the monetary policy stimulus. So I think they're doing a good job now, trying to make things right.
Gary Siegel (46:44):
Okay. Last question from the audience and one more from me and we're done. When do you think the Fed will hit the 2% inflation target, and how do you see productivity going forward if remote or hybrid work stays in place?
Jose Torres (47:04):
I think 2% in early 2025. Productivity, I think that productivity increases from here. I think you have generative artificial intelligence going to make companies more efficient. I think I'm actually a fan of the remote work, the remote work possibilities. I think that folks, while there are some headwinds, not enough team building or not enough face-to-face time, I think that work, it's been my experience that workers actually are more productive from home. So I think that that'll continue to be an aspect of corporate life in America. And we're seeing it in commercial real estate with office vacancies stay remaining high and companies failing to bring everyone back to the office. I think it remains an important aspect of work.
Gary Siegel (47:59):
And the last question from me. What questions are you getting from clients and what are they worried about most?
Jose Torres (48:08):
Yeah. So clients, they're worried about equity prices being too high, and they're worried about interest rates staying too high for too long, but they have to park money. And they're looking at short term paper as an easy way to make an annualize 5% without taking much risk. And folks are really, really concerned now, Gary, about higher valuations. The equity market here is trading at 20 times forward earnings. That's a lot higher than average in an environment of higher rates. And it's pretty much pricing in Goldilocks that everything is going to work out exactly the way the Fed and investors want it to work out. Inflation's going to come down, employment's going to stay robust, and earnings aren't going to be bad. But just now this quarter, this reporting season in the second quarter is actually the worst earnings trough since the pandemic. So we'd have to see a real meaningful pickup in earnings for the equity market to stay where it's at.
Gary Siegel (49:15):
Well, this concludes our event. I want to thank my guest, Jose Torres, senior economist atInteractive Brokers, and I'd like to thank our audience for joining us today and for the many questions they submitted. Thank you and have a good afternoon.
