0:00

So, we’ve talked a lot about inflation. And we’ve all seen the data; it’s going up, it’s coming down, and maybe it’s going to go up again. What do you guys say?

0:12

Maybe this is one area where we differ in our views, where I do think over the long term that the Fed is going to achieve its 2% mandate of inflation, especially because when you break it down—and this is something we've talked about in a number of pieces that we've put out and on our various calls—is that roughly one-third of overall inflation is shelter related. And it’s the one component that continues to slide month after month, especially now, where we’ve seen mortgage rates go up to 7.5–8%. That has a significant impact on the overall level of demand.

0:45

Now, the one piece that also has to balance out there is the supply side of the equation, and we’re continuing to see new home inventory come online, which will help balance out prices a little bit. But if that measure—the shelter component of CPI—continues to slide over the course of the next year, I think we do continue to move towards the Fed’s 2% mandate of inflation. Not, perhaps not by the middle of 2024, but I think we are going to get there.

1:13

But, see, you’re moving the goalposts here. You said, “Oh, no, this is doable, and this is sustainable.” Once you give your forecast, you’re generally done. Give them a number; give them a date; never give them both. Right?

1:23

You also said, “Over the long term, it’s achievable.” But is that a short-term achieving of the goal? Because housing and rent doesn’t stay down, right? Because I’ve always been . . . I have agreed with you until we got to about this point—and I’m not saying now I’ve changed my mind. I always thought the last 100–150 basis points was going to be the hardest part of the Fed’s job. Because it has a big impact.

1:49

Yeah, and you especially have the fishhook now going on with energy prices, and energy prices correlate very closely to food prices, as well as other components of the economy. So, I guess I would caveat my comments by saying, if the shelter piece continues to slide, the other areas, like energy, have to moderate to some degree as well. It’s probably fair.

2:11

Yeah, and one of the things, you know, it’s always important when you’re talking about monetary policy and how it drives inflation, is remembering the fact that monetary policy works with a lag. Right, so it takes time for the effects of higher rates to bleed into the overall economy. And we’ve seen that in a number of places, but one of the places where it actually can have a pretty quick impact is in housing, right, to the point that you made about interest rates affecting mortgage rates. Well, the impact from those higher rates then takes time to feed into the data, right. So, while it can slow the pace of housing sales, which we've absolutely seen over the past couple years, prices tend to catch up with a lag. So, based on the sales data we’ve seen and the price data we've seen, I do expect to see continued improvement on the shelter side, which to your point, Pete, should help on the overall inflation side.

3:03

And generally, what we’ve seen from the data is that there’s a lag of about 12 to 18 months with changes in home prices, and those changes being reflected in the shelter component of CPI. So, you know, we’ll see what occurs over the next 6 to 12 months on that front.

3:21

What’s interesting about that is we're talking about the next 6 to 12 months. I see us moving down to maybe 3—I’d be okay with 3, maybe a little bit below that. You know, longer term, though, we have the disinflationary effects of AI potentially, and better productivity growth, which seems to be happening. But then you look at higher . . . you look at, you’re not going to see the globalization benefit we got over the past 30 years. You’re not going to see the very low real wage growth, which we’ve seen over the past 30 years; a bunch of disinflationary effects over the next decade are not going to be there to the extent that they were for the past 20. So, I’m more in the 3 to 4 over time. We may touch to 2 in the short term, although I doubt it. But I still think we’re in the 3 to 4 over time.

4:11

Absolutely. That’s a very valid point, especially when you consider the onshoring, or the reshoring, of a lot of manufacturing activity, which, to your point, you know, we don’t benefit from the globalization and the lower cost of labor abroad if a lot of those industries are being brought back on shore.

4:29

With that being said, I do think it’s also important to remember, the Fed has signaled that they don’t expect to get inflation down to 2% next year, right. Based on their most recent projections, they don’t expect to see their primary measure of inflation get to their 2% target till around the end of 2026. And that outlook, with a slow improvement against inflation, I think should be remembered, right? It’s not necessarily going to be a sharp hook up and then a sharp hook right back down. It’s a sharp hook up and then takes some time to get back to what’s a more normal level. And over the course of that normalization process, the Fed has also signaled, through their dot plots, that they’re open to cutting the federal funds rate even before inflation reaches their target, right. They just want to see continued progress in the right direction, and they’d be willing to adjust monetary policy accordingly. Right, because we’re at very restrictive levels right now with the top federal funds rates at 550. Well, the argument there is you could still be restrictive at 5, or 4.5, or even 4% on a federal funds rate, with inflation still running above the 2% target.

5:35

But I think that’s what the market has to get used to is higher for longer. Right, I think you even saw it last week when long rates started to come down, risk assets went and completely rallied unlike anything that we’ve seen so far this year. I think if there’s one thing that could set us up for disappointment next year is if the Fed doesn’t cut, but there's an expectation that they will cut and be more aggressive, that risk assets could sell off. So, add that to the list of risk factors for 2024.

6:00

The key part of that is that people have to get used to this, right. And this is kind of where the . . . what your baseline is, right? And as the guy around the table with all the gray hairs, 3% inflation and 5–5.5% on the 10-year is not bad, right? Like I lived through that; people had jobs, the economy grew, they bought houses, the equity market went up. Right? So, it’s this . . . the market’s hung up on when the Fed’s going to cut rates. Where my view is, if we can just figure out what normal is, you can make investment decisions based off “normal” that can be quite additive to portfolios, but it’s the short term, you know, to Brian’s point, the 10-year went from 500 to 450. And the S&P took off. It’s just clouding the decision-making process.

6:51

And I think that’s exactly right, Chris. In fact, at our National Conference that’s what I talked about. You know, what’s normal? What should interest rates be? You know, and the short version is, they should be inflation plus a risk premium. Historically, the inflation rate has been 2 to 4—call it 3, call it 4; risk premium has been 2 to 4. So, rates have almost always traded between 4 and 8. So, now we’re at about 5; that’s still at the lower end of the range, but inflation is also kind of low. So, you know, the question as I see it is not so much “when’s the Fed going to cut?” It’s, “why would the Fed cut?” And I don’t think we see a compelling reason, until we see employment fall off a cliff. And with the market the way it is, as you say, Pete, I’m not sure we see that, so higher for longer makes a lot of sense to me.

7:40

I was asked last week, if we accept that rates are higher for longer, what does history tell you about what the appropriate asset allocation should be for that? And as I started thinking about it, my answer was—I don’t think that interest rate part of it is the key determinant, right? Because if you go back to what you just said, the mid to late ’90s and the dot-com boom, rates were over 4%. The BRIC-led commodity boom in ’05–’06—rates were over 4%. Entirely different approaches to portfolio construction in the same rate environment. So, I think, ultimately, once we accept it, other factors start to drive investment decisions and where you want to be positioned in portfolios.

8:28

And that’s actually, I think, a really good insight. It’s not the absolute level; it's the change. You know, if, in fact, rates are going to be stable more or less where they are right now, then rates come off the table as a factor driving market decision-making. That’s a wrap. All right, guys. Good job, guys. Thank you. Thanks, that was fun.

8:53

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