Inflation: The Fed is ‘willing to tolerate some economic pain,’ strategist says

J.P. Morgan Global Market Strategist Elyse Ausenbaugh joins Yahoo Finance Live to discuss the expectations for the Fed ahead of the upcoming FOMC meeting, November ADP report data, inflation, and the outlook for a recession.

Video transcript

BRAD SMITH: The ADP National Employment report shows US private employers added 127,000 jobs for November. That's a sharp decline from the 239,000 jobs added for October. This comes ahead of Friday's jobs report where investors are keeping a close eye on any indications of the Fed's path for rate hikes. Joining us now with all of how this is playing into the markets, we've got Elyse Ausenbaugh, who is the JP Morgan global market strategist, here. Great to have you here with us on set. You got to help us break down some of the numbers, at least on the private payrolls data, and how that could also perhaps protrude into some of the BLS numbers that come out later on this week.

ELYSE AUSENBAUGH: Surely. We are looking for some more softness in the labor market data. That's certainly what the Fed wants to see, especially as they grapple with kind of this decision-making tree of what's going to be the appropriate time to slow their pace of rate hikes, and when are they eventually going to be able to pause.

Our base case is that they're going to give us that slowdown at their December meeting. We're expecting a 50 basis point rate hike. And then come February, we are looking for a 25 basis point rate hike, and at that point, for the Fed to say, OK, let's see how this filters through to the broader economy and what happens in terms of inflation. But the labor market's going to be really important to watch in terms of those kinds of dynamics.

BRIAN SOZZI: In terms of Powell's speech today, do you think he will try to push back against the easing we've seen in markets recently?

ELYSE AUSENBAUGH: He very well could, right? That's kind of the approach that he's taken over the course of the past couple of quarters. I think it's interesting to note that the Fed minutes, when you were looking at it anonymously and collectively, did seem a little bit more dovish than some of the rhetoric we've been hearing from Fed individuals in their speeches over the past couple of weeks. Powell does seem to be one of the more hawkish standouts. So we're going to be listening very closely to see what kind of guidance he gives and how he's feeling about the December decision.

JULIE HYMAN: Elyse, what kind of weight do you and your team give to that ADP report, especially considering we've got the jobs report, more broadly, in a couple of days. Because the ADP report seems to show us that, are things slowing more than people have been pricing in?

ELYSE AUSENBAUGH: I think it's a signal. It's an important thing to pay attention to, particularly when markets seem so sensitive to every single data release coming out regarding jobs and inflation, and even the anecdotal headlines in that regard. So we pay attention to it. But Friday is definitely going to be the bigger report that we're going to be digging into and paying attention to.

BRAD SMITH: So of the Fed's two mandates, price stability and then, additionally, full employment here, or maximum employment, you know, how deep of a recession do you feel like they are willing to incur or see the US economy incur in this pathway for their rate hikes as well?

ELYSE AUSENBAUGH: Well, up to this point, they have made it very clear that their exclusive focus pretty much is on the inflation half of that mandate. I think they are willing to tolerate some economic pain. That's what their last issuance of the summary of economic projections showed. And time will kind of tell, right? We don't think that the soft landing scenario is necessarily off the table. I'm sure the Fed would still love to see that come to fruition, even if it has been historically elusive.

But having these expectations set that they are willing to let the unemployment rate rise, particularly to bring some of that tightness out of the labor market and willing to tolerate some broader economic pain beyond just what we're seeing in the housing market, I think is something investors need to be paying attention to. And it's a key reason why we do expect a recession to come to fruition in the second half of next year.

BRIAN SOZZI: How concerned are you about these tech layoffs? I mean, just this morning, we have another tech company in DoorDash laying off close to 1,300 people. Is that a sign that the economy is really slowing down, or is this tech sector specific?

ELYSE AUSENBAUGH: Look, I think it is not necessarily tech sector specific. You're seeing this in other areas like pockets of the real estate market, particularly those related to things like mortgage underwriting. But it is worth noting some of the nuance in the labor market recovery that we saw post-pandemic.

The tech sector and some of those more growth oriented segments of the economy were the ones that went on the hiring sprees, and that are currently employing a lot more people than they were before the pandemic. So, to us, it actually makes sense that that's kind of the first shoe to drop and the first place that we're starting to see some of that tightness come out.

JULIE HYMAN: If that is the place-- I mean, I don't know. Maybe I'm drawing too many conclusions here. One would think those are the higher paid workers in general who are getting laid off. Does that then also provide sort of more cushion as we go into a recession versus if it was lower income workers who are losing their jobs en masse?

ELYSE AUSENBAUGH: Potentially. I think that's a fair thing to say, especially when you combine that insight with this whole conversation around the pent-up excess savings from the pandemic. What our analysis is showing us is that the wealthier demographic does still have more of that cushion to kind of perpetuate lifestyle, even as inflation threatens to chip that away.

And so to the extent that these lower income households can keep their jobs and continue to benefit from wage inflation, particularly if that wage growth actually becomes positive in real terms, that could help cushion some of the fallout economically when we think about the implications of recession.

BRAD SMITH: If you are a lower income household and are paying the higher necessity prices right now, or even if you're an employee that's gotten laid off as part of the company cost restructuring that we've seen, as many businesses are just trying to prepare themselves for what a recession may look like, this doesn't seem like a soft landing to you. So the vibe is clearly off.

And we can tell that, perhaps, from some of the conversations that people just had at their Thanksgiving tables last week. So when, or at what point, do you believe that the vibe of what we're actually thinking and experiencing and discussing actually catches up in terms of some of the data that we're seeing, too?

ELYSE AUSENBAUGH: Great question. I mean, that vibe is so palpable. This feels like the recession that everyone sees coming. And up to this point, the economy has remained relatively resilient outside of the housing market. But when we apply a historical analysis, what that shows us is that things are actually kind of rolling out as expected. Housing is the first thing to kind of fall apart, given that it is pretty interest rate sensitive. And then comes things like manufacturing output and employment. And then broader economic employment and inflation tend to follow with a lag of a couple of quarters.

JULIE HYMAN: Elyse, just quickly, what is your best idea going into 2023 from a strategy perspective?

ELYSE AUSENBAUGH: We are pounding the table on core fixed income. I think if this recession base case does come to fruition, the expectation is that longer dated interest rates will fall in anticipation of Fed rate hikes-- or excuse me, Fed rate cuts to come. We're not necessarily expecting that to be a 2023 dynamic.

But as investors and markets start to look beyond the recession and towards a Fed that would eventually pivot and become more dovish, you should expect to see longer dated interest rates fall. And so we're very keen on adding duration right now, locking in these elevated yields while you can, because we don't think that this opportunity is going to be on the table one, two years from now.

BRIAN SOZZI: Good call out. Elyse Ausenbaugh, JP Morgan global market strategist, thanks for coming to the studio. Appreciate it.

ELYSE AUSENBAUGH: Thank you.