The Issue at Hand by Madison Investments
In this episode, Chris Aleman and Mike Sanders take you beyond the headlines to focus on what actually matters: the Fed’s dual mandate, the economic data driving policy decisions, and the implications for investors.
Whether you’re preparing for client conversations or evaluating portfolio positioning, this episode provides a framework for interpreting one of the year’s most closely watched Fed meetings.
When the Federal Open Market Committee (FOMC) convenes for its June 16-17 meeting, all eyes will be on how new Fed Chair Kevin Warsh communicates policy amid a backdrop of economic and political uncertainty. The ongoing conflict with Iran has pushed energy prices higher, contributing to inflation concerns and largely extinguishing expectations for rate cuts. Meanwhile, a resilient labor market, improving productivity, and continued AI-driven capital expenditures point to a strong economy, at least on paper. And then there’s the media attention on how Warsh will handle political pressures, given how vocal President Trump was about his desire for lower rates during the nomination process.
Key Takeaways
- Focus on the Fed’s dual mandate as the primary framework for policy decisions.
- Current data points to rates remaining unchanged at the June meeting.
- Gauge the dot plot for insight into the Fed’s current thinking on the future path of policy.
- Rate hikes would do little to address energy- and AI-driven inflation.
The Discussion
Chris Aleman: Today, we’re going to be discussing the upcoming FOMC meeting. That’s the Federal Open Market Committee meeting, which is going to take place on Wednesday, June 17th. So essentially, what we’re going to be discussing is that there’s a lot of noise, there’s a lot of pundits, there’s a lot of talk going about what’s going to be happening on this one because there’s a lot of good news. The new Fed chair is going to be starting, Warsh, and then we also have the old Fed chair, who’s still going to be present. So that’s going to be interesting with all that noise going on. But I think our job here today is going to be to separate that noise from the substance.
So, Mike, I guess what we want to start off with – let’s start with the basics. What is the Fed trying to accomplish with these meetings, and what is their goal?
Mike Sanders: Yeah, so the Fed has a dual mandate. It’s full employment and stable prices, which is loosely defined as 2%, Core PCE, Personal Consumption Expenditures. When they’re looking at policy decisions during these meetings, it’s really about achieving those goals and seeing if one of them is outside the target number that they’re looking for. And that’s really what’s getting discussed and what the policy actions are trying to focus on.
Chris Aleman: Speaking of those outside numbers, I mean, if I can quote some current statistics to you, some of the things that I was very shocked by. Inflation came in 4.2% for May, which was higher than 3.8% for April, which is the third consecutive month of acceleration. Then we look at the jobs number that came in that crushed expectations, which came in at 172,000. So what I want people to understand and what we should be on the lookout for is, should we be expecting cuts or should we be expecting hikes from this upcoming meeting?
Mike Sanders: Yeah, I think neither, actually. I think there’s going to be no decision, or they’re going to keep rates the same.
Chris Aleman: Great, great answer there.
Mike Sanders: Just going back to the data, right? Not only was this this past month’s number strong, but the prior number was revised up. And then on the inflation side – you were quoting headline – the Fed cares maybe a little bit more about Core. And Core was around 3%. So adjusting for the differences in PCE versus CPI, it’s still above their 2% target. So if you think about the Fed’s dual mandate, the unemployment rate was 4.3%. So, the dual mandate is showing that inflation’s still above their targeted level, and the unemployment rate is kind of staying the same, so, stable. Given the current environment, I think the Fed will do nothing and watch, just given what some of the drivers of that inflation currently are.
Chris Aleman: Well, I guess that’ll be interesting. Because you’re right, the data is pointing to where we have no idea where it’s going to go. It should stay the same, but we’ll see what they end up doing. I guess that brings up a good point, though, in terms of what they’re going to be doing – let’s talk about Fed independence. So, one of the things that’s been talked about – I don’t want to say recently a lot, is the current administration’s goal of trying to get the Fed to have cuts. And essentially, what they’re trying to do is they want to spur growth. Now, the new Fed chair coming in, that was the expectation that was coming. So when I posed this question to you about Fed independence, is there a chance that they’re going to remain independent or is it going to be going with what the administration wants?
Mike Sanders: I think they’ll remain independent. Again, Warsh is one vote of many, and so he needs to build consensus to actually have policy shifts. And like I said, the data right now speaks to a little bit more concern on the inflation side, although you could argue where that inflation is coming from. It’s not really coming from wage growth.
Chris Aleman: Yeah, I mean a lot of it’s going to be energy-related.
Mike Sanders: It’s energy, it’s AI, and the AI demand is inelastic. That’s not going to change by 25 basis points of a hike. And so, I just don’t see Warsh coming in and trying to – at least during the Q&A afterwards, trying to really push this dovish environment, because I think that’s going to really harm his long-term credibility.
If he comes out and is talking differently than the statement that was discussed by the entire committee, and he’s talking a little bit more dovish, when in reality you could argue that they need to be neutral or hawkish, long-term credibility for him is going to take a hit. And you probably see that getting impacted out the yield curve. Because if the Fed does move rates or they somehow can push through rate cuts in this environment – I don’t think that’s the case – I think that has pretty big implications for longer-term interest rates.
Chris Aleman: So, I guess your expectation is he should “say status quo”, essentially, “let’s not rock the boat”?
Mike Sanders: Yeah, if I were to say, you have dovish, neutral, and hawkish, he needs to be neutral to slightly hawkish. Just given all the commentary from the Fed officials, they want to remove specific language, they want to tweak the verbiage, if you will. You can’t come in and then talk about cutting interest rates when every other official seems to be neutral to higher interest rate leaning.
Chris Aleman: Well, that makes sense. I guess down the road, maybe not this meeting, but maybe some of the next meetings, maybe in the next six months, what do you need to see in the data to make you think that we’re going to have either hikes or cuts? And how does that impact bond investors from a risk perspective?
Mike Sanders: We can paint two different scenarios. So, in the hiking scenario, down the road, I think you really have to see inflation start to creep into some of the core services than you have in the goods area. I think that’s where wage-induced inflation is going to be concerning for the Fed. Long-term inflation expectations are still anchored, but if those start to creep higher and you start seeing inflation in other areas, maybe that weren’t directly impacted by and sustained, directly impacted by energy prices, that’s when the Fed’s going to get concerned and have to seriously consider increasing interest rates. On the flip side, for the Fed to cut rates, you’re really going to have to see a deterioration in the labor market, which again, seems to be strong.
Chris Aleman: Which we’re not seeing right now.
Mike Sanders: We’ve always thought that the Fed would be quick to aggressively cut rates – or even not aggressively – just cut rates if they saw cracks in the labor market. Until you see that, if you’re going to stick around a sub 4.5% unemployment rate, the non-farm payroll data break-even is lower because of immigration. But if you see that staying consistently at 50ish, give or take, and less 4.5% unemployment rate, the Fed’s not going to move. But if you start seeing those numbers falling and the rate going higher, I think it’s in play for further cuts –
Chris Aleman: When you say it like that, how should bond investors, again, as I mentioned in the opening question, how should we be positioned given those expectations?
Mike Sanders: Looking at the curve, there’s still a lot of uncertainty out the yield curve given some of the fiscal issues and the inflation issues. So, just be a little wary of what you’re owning out the curve, from our perspective. From a spread perspective, we talked about all the risks in fixed income investing, and spreads are fairly snug, at least how we measure them. So, just be very, very aware because market pricing and the data can change very, very, very quickly, and you just have to make sure – wherever you’re going to buy fixed income – you need to understand what risks you’re getting exposure to, and that’s going to definitely drive returns.
Chris Aleman: Well, I think that about wraps it up. I think it’s going to be an interesting Fed meeting to say the least on Wednesday, the 17th. Please join us next time, where we’re going to recap exactly what was said and expectations going forward. If you have any other questions or need any other information, please visit MadisonInvestments.com. Take care.