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U.S. Federal Reserve Chair Powell testified before Congress that the Fed will continue to provide the economy the support it needs for as long as it takes. Kim Parlee speaks with Scott Colbourne, Managing Director, TD Asset Management, about inflation and opportunities for fixed income.
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- US Fed Chair Powell testified before Congress this week. And amongst many things, he also said that "While the economic fallout has been real and widespread, the worst was avoided by swift and vigorous action-- from Congress and the Federal Reserve.... [and the Fed] will continue to provide the economy the support that it needs for as long as it takes."
Here to unpack what that means and also his outlook for inflation, Scott Colbourne joins us. He's managing director with TD Asset Management. Scott, always great to have you with us.
Can I ask you just to start? We heard from the Fed chair last week, obviously, with the rate decision. This week, are you hearing anything different from what we heard last week? Or is it reinforcing the same message?
- Yeah, it's reinforcing the same message. It's a Fed that is very optimistic and encouraged by the outlook for economic growth, the recovery on the jobs front. But reinforcing the message that the recovery is far from done and that the Fed is going to be very supportive of that recovery. And so it's a continuation of a very dovish message that we heard last week.
- What about inflation? I mean, he talked before that saying that our best view is that the effect on inflation will neither be particularly large nor persistent. And then we know, of course, that people have been watching commodity prices. We know what's been happening on that front, with the exception of the past couple of days in trading. What are you seeing? And is this confusing, I would say for the bond markets?
- Well, it's a great question. It's the crux of the matter for the bond market at the moment. So the Fed marked up its growth forecast. So we're talking about 6 and 1/2 to 7 and 1/2% growth in the US this year plus inflation.
So great nominal growth. And they've marked up their inflation forecast. But at the same time, they're very reluctant to mark out a path towards raising rates. And so on the other hand, the bond market has been pushing the Fed a little bit here, right?
So they've priced in some rate hikes in early in 2023 before the Fed has acknowledged that they might do that. So that's really the tension between this great optimistic outlook for growth, a recovery, a post-pandemic, a recovery on the jobs front and a recovery on the inflation.
And, yet, the bond market, I think, is seeing this as a bit of a contradiction or a challenge to the policy that the Fed has set out. So it's going to be resolved ultimately. But for the time being, today's message and last week's message from the rate decision is, look, we're going to be patient. And the bond market is going to have to grapple with that patience.
- Jerome Powell gave himself some latitude in terms of what he is talking about by talking about an average inflation target regime. On average, things can overshoot and take a while till they come back. So what do we do with that? How do we figure out what they're going to do there?
- Well, inflation is going to pop up this second quarter of this year-- 3% in the US, 2 and 1/2% in Canada. The Fed has introduced this new policy framework that the Fed staff put together average inflation targeting.
Basically, what it says is, look, we've had a better part of two decades worth of undershooting inflation. You can see core in the US of 2%. So over the cycle, we're going to let it run a little bit above that. And there's a lot of uncertainty in that policy stance because it's new.
This is new, as I said, last fall. And we need to determine what the Fed reaction function is going to be. So how long are they going to be prepared to let inflation overshoot 2%? Is it a year? Is it 2 and 1/2%? Is it 3%? And so that's really the challenge.
But at the end of the day, I mean, as you pointed out, the Fed chairman's commentary today is, look, we don't believe that this spike in inflation due to the pandemic shock, the commodity supply shock. The recovery out of this V-shaped recovery is going to last and create lasting inflation.
This is tension between a cyclical pop in inflation or an enduring inflation. Again, that's the tension in the asset markets. So what do we with that divergence?
- Scott, I've only got about 15 seconds. And that's not fair for this question. But opportunities, threats for the bond market-- what do you see?
- Look, as a bond manager, I'm happy that I'm actually losing money this year. It's a good news story. We've done our job last year. So we're playing defense. It's about preservation of capital and looking for selective opportunities as rates reprice.
But I'll tip my hat to my colleagues on the equity side, the commodity side, because really, that's what your portfolio is going to make money this year. So it's just a defense story and fixed income this year.
- Scott, always a pleasure. Thanks so much.
- My pleasure. Thanks again.
[MUSIC PLAYING]
- US Fed Chair Powell testified before Congress this week. And amongst many things, he also said that "While the economic fallout has been real and widespread, the worst was avoided by swift and vigorous action-- from Congress and the Federal Reserve.... [and the Fed] will continue to provide the economy the support that it needs for as long as it takes."
Here to unpack what that means and also his outlook for inflation, Scott Colbourne joins us. He's managing director with TD Asset Management. Scott, always great to have you with us.
Can I ask you just to start? We heard from the Fed chair last week, obviously, with the rate decision. This week, are you hearing anything different from what we heard last week? Or is it reinforcing the same message?
- Yeah, it's reinforcing the same message. It's a Fed that is very optimistic and encouraged by the outlook for economic growth, the recovery on the jobs front. But reinforcing the message that the recovery is far from done and that the Fed is going to be very supportive of that recovery. And so it's a continuation of a very dovish message that we heard last week.
- What about inflation? I mean, he talked before that saying that our best view is that the effect on inflation will neither be particularly large nor persistent. And then we know, of course, that people have been watching commodity prices. We know what's been happening on that front, with the exception of the past couple of days in trading. What are you seeing? And is this confusing, I would say for the bond markets?
- Well, it's a great question. It's the crux of the matter for the bond market at the moment. So the Fed marked up its growth forecast. So we're talking about 6 and 1/2 to 7 and 1/2% growth in the US this year plus inflation.
So great nominal growth. And they've marked up their inflation forecast. But at the same time, they're very reluctant to mark out a path towards raising rates. And so on the other hand, the bond market has been pushing the Fed a little bit here, right?
So they've priced in some rate hikes in early in 2023 before the Fed has acknowledged that they might do that. So that's really the tension between this great optimistic outlook for growth, a recovery, a post-pandemic, a recovery on the jobs front and a recovery on the inflation.
And, yet, the bond market, I think, is seeing this as a bit of a contradiction or a challenge to the policy that the Fed has set out. So it's going to be resolved ultimately. But for the time being, today's message and last week's message from the rate decision is, look, we're going to be patient. And the bond market is going to have to grapple with that patience.
- Jerome Powell gave himself some latitude in terms of what he is talking about by talking about an average inflation target regime. On average, things can overshoot and take a while till they come back. So what do we do with that? How do we figure out what they're going to do there?
- Well, inflation is going to pop up this second quarter of this year-- 3% in the US, 2 and 1/2% in Canada. The Fed has introduced this new policy framework that the Fed staff put together average inflation targeting.
Basically, what it says is, look, we've had a better part of two decades worth of undershooting inflation. You can see core in the US of 2%. So over the cycle, we're going to let it run a little bit above that. And there's a lot of uncertainty in that policy stance because it's new.
This is new, as I said, last fall. And we need to determine what the Fed reaction function is going to be. So how long are they going to be prepared to let inflation overshoot 2%? Is it a year? Is it 2 and 1/2%? Is it 3%? And so that's really the challenge.
But at the end of the day, I mean, as you pointed out, the Fed chairman's commentary today is, look, we don't believe that this spike in inflation due to the pandemic shock, the commodity supply shock. The recovery out of this V-shaped recovery is going to last and create lasting inflation.
This is tension between a cyclical pop in inflation or an enduring inflation. Again, that's the tension in the asset markets. So what do we with that divergence?
- Scott, I've only got about 15 seconds. And that's not fair for this question. But opportunities, threats for the bond market-- what do you see?
- Look, as a bond manager, I'm happy that I'm actually losing money this year. It's a good news story. We've done our job last year. So we're playing defense. It's about preservation of capital and looking for selective opportunities as rates reprice.
But I'll tip my hat to my colleagues on the equity side, the commodity side, because really, that's what your portfolio is going to make money this year. So it's just a defense story and fixed income this year.
- Scott, always a pleasure. Thanks so much.
- My pleasure. Thanks again.
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