McBride: Inflation Has Fed's Attention

Summary

---

WSJ Your Money Briefing: McBride: Inflation Has Fed's Attention

Date: July 26, 2017
Host: Charlie Turner
Guest: Greg McBride, Chief Financial Analyst at Bankrate.com

---

Episode Overview

In this episode, host Charlie Turner is joined by Greg McBride to discuss the Federal Reserve's latest monetary policy decisions, the outlook for interest rates, and what shrinking the Fed's massive bond portfolio could mean for the economy, investors, savers, and consumers. The conversation explores the impact of sluggish inflation on future rate hikes and how the Fed's actions post-financial crisis continue to influence today's markets.

---

Key Discussion Points & Insights

1. The Fed’s Current Stance on Interest Rates

• Fed Holds Rates Steady: The Federal Reserve concluded its recent two-day meeting by leaving short-term interest rates unchanged, aligning with expectations.

• Possible Delay in Rate Hikes: There may not be another hike until late in the year, potentially December—or possibly next year—depending on inflation trends.

  “I think the Fed's going to have a tough time rai[sing] short term interest rates again until inflation starts moving toward that 2% threshold rather than away from it.”
  —Greg McBride (01:20)

Inflation's Influence

• Soft Inflation: Recent data shows that inflation is running below the Fed’s target of 2%, both at the headline level and when excluding food and energy.
• Fed’s Response: This lack of inflation “certainly doesn't give them any urgency to hike rates again,” noted McBride. (01:56)
• Implications for Borrowers and Savers:
  • Borrowers with variable-rate debt (credit cards, home equity lines) benefit from a slowdown in rate hikes.
  • Savers may see slower increases in returns, losing recent positive momentum.

    “Unfortunately, I think it may also rob some of the momentum from savers that we've seen beginning to build.”
    —Greg McBride (02:20)

---

2. Economic Performance vs. Fed Expectations

• Track Record of Overestimation: The Fed has a “habit of overestimating” economic growth and the number of rate hikes.

• 2017 a Closer Match: This year is a rare exception, with the Fed potentially coming close to its forecast of three hikes.

  “That's kind of an annual tradition, sort of like, you know, taxes and Christmas.”
  —Greg McBride (02:58)

• Economy Softer Than Hoped: While softer than hoped, the gap between expectations and reality is narrowing compared to past years.

---

3. The Fed’s $4.5 Trillion Bond Portfolio

• Origins: The massive portfolio was built up through purchases of Treasury and mortgage-backed securities during and after the financial crisis.

• Effects of Purchases:

  • Drove long-term interest rates, particularly mortgage rates, lower.
  • Encouraged investment in riskier assets, pushing the stock market to record highs and fueling home price recovery.

  “Fixed mortgage rates are still right around 4%. So check that box. That worked.”
  —Greg McBride (04:16) “Stock market's at a record high. Home prices have rebounded nicely…”
  —Greg McBride (04:25)

Potential Impact of “Unwinding”

• Reversing Course: Slow shrinking of the balance sheet could eventually push long-term rates higher and introduce more stock market volatility.
• Possible Outcome: Could “put a ceiling” on home price appreciation, especially with weak wage growth.

---

4. Timeline for Action

• Expected Sequence:

  • September: Fed likely to begin shrinking the bond portfolio (“balance sheet normalization”) soon after its September meeting.
  • December: Another rate hike possible by year end, but only if inflation picks up.

  “At this point, they've certainly teed up the start date for the balance sheet normalization to come at that September meeting… They have latitude to raise rates again, probably by December. Again, the caveat being they need the inflation numbers to move closer to 2% instead of away from 2%.”
  —Greg McBride (05:43)

---

Memorable Quotes & Moments

• On the Fed’s Accuracy:
  “That's kind of an annual tradition, sort of like, you know, taxes and Christmas.”
  —Greg McBride (02:58)

• On the Success of Bond Purchases:
  “Check that box. That worked.”
  —Greg McBride (04:16, 04:25)

• On the Caveats to Future Rate Hikes:
  “Again, the caveat being they need the inflation numbers to move closer to 2% instead of away from 2%.”
  —Greg McBride (05:55)

---

Segment Timestamps

• 00:24: Charlie Turner introduces the episode and the Fed’s recent meeting.
• 01:00: Greg McBride discusses inflation’s impact on Fed policy.
• 01:56: Shift in focus from rate hikes to bond portfolio downsizing.
• 02:45: Analysis of the Fed’s economic projections and outcomes.
• 04:13: Deep dive into the Fed’s bond portfolio and its market impacts.
• 05:29: Speculation on timetable for balance sheet moves and rate hikes.

---

Conclusion

Greg McBride offers a concise but thorough analysis of where the Federal Reserve stands, highlighting that soft inflation is delaying further rate hikes and shifting the Fed’s attention to unwinding its balance sheet. Borrowers may get some breathing room, but savers should temper expectations. As ever, the Fed’s cautious approach hinges on economic data, especially inflation, and its next steps will set the tone for both markets and consumers through the remainder of 2017.

---

Transcript

[Deel Advertiser]

Deal replaces fragmented payroll vendors with one global system. No third parties hire, manage and pay teams in 150 countries operate like a local everywhere. Visit deel.com WSJ

[WSJ Announcer]

this is yous Money Matters from the Wall Street Journal.

[Charlie Turner]

Welcome to youo Money Matters. I'm Charlie Turner in New York. Thank you. Fed policymakers wrapping up a two day meeting left short term interest rates unchanged Wednesday. That was no surprise. Any rate hike may not come now until the end of the year. The Fed also signaled it could launch its plan to slowly shrink its $4.5 trillion bond portfolio after the next meeting in September. Joining us to talk about the Fed meeting and statement is Greg McBride, Bankrate.com's chief financial analyst. Greg, weren't investors looking for signals about whether a slowdown inflation might alter the Fed's plans for rate hike this year?

[Greg McBride]

Well, inflation definitely has the Fed's attention. In June, they had said that they had noted their concerns that inflation had been softening. The data has only gotten softer in the past month. And in the latest statement they noted that on a trailing twelve month basis, inflation, no matter how you look at it at the headline level or even if you exclude things like food and energy, it's well below, it's declined and it's well below the 2% mark. So the bottom line is this. I think the Fed's going to have a tough time ra short term interest rates again until inflation starts moving toward that 2% threshold rather than away from it.

[Charlie Turner]

I don't know. It sounds like from what you're saying, they could put off a rate hike until sometime next year even though, you know, household spending and business investment continue to expand as they say. It just sounds like inflation is not strong enough to justify another rate hike.

[Greg McBride]

Well, it certainly doesn't give them any urgency to hike rates again. So I think in the more immediate term, they're kind of shifting their focus away from the movement on short term interest rates to focus on kicking off the balance sheet downsizing that bond portfolio. But as far as short term rate hikes are concerned, it'll be much later this year if we get one, if we get one before the end of the year. And even that is going to be contingent upon some improvement in those inflation numbers from the Fed's perspective. So for consumers, those variable rate credit cards that have been steadily marching higher, the home equity line of credit that's been steadily marching higher, you're going to get a bit of a reprieve from that. But unfortunately, I think it may also rob some of the momentum from savers that we've seen beginning to build. After three rate hikes in the last

[Charlie Turner]

seven months, the economy hasn't been exactly performing great guns this year. Has the economy performed basically in line with the Fed's expectations for 2017?

[Greg McBride]

Well, the Fed has this habit of overestimating and they overestimate economic output, they overestimate how much they're going to raise interest rates. And you know, that's kind of an annual tradition, sort of like, you know, taxes and Christmas. But you know, this is the first year where they may be close. Right. They said coming into the year they're going to raise rates three times this year. They've done so twice in the first, just in the first half of the year. And that gives them the window to do so again before the end of the year. The economy's been softer than expected again. But you know, the departure isn't as wide this year as what we've seen from the Fed in the past. But they're overestimating of the economic output. You know, that's really become a normal thing for them.

[Charlie Turner]

A time honored tradition. I'm Speaking with Greg McBride, he is chief financial [e-mail], and you're listening to youo Money Matters. Thanks for listening everyone. Greg, how does the Fed's plan to shrink its $4.5 trillion bond portfolio play into this? I know during the financial crisis they purchased all this money which was in treasury and mortgage securities. How does that plan to shrink this portfolio work in with interest rate hikes?

[Greg McBride]

Well, let's look at what effect that those purchases had in the years that followed the financial crisis when the Fed was buying all of those treasury securities and buying all those mortgage backed bonds. The goal and the outcome was that it pushed long term interest rates lower, specifically mortgage rates. They targeted mortgage rates by buying those mortgage backed bonds. And you know, as we talk today, fixed mortgage rates are still right around 4%. So check that box. That worked. The other thing that buying all those bonds did is it incentivized investors to go into riskier assets. Well, stock market's at a record high. Home prices have rebounded nicely from where they were, you know, after the financial crisis. Check that box. That worked too. But if they're going to start unwinding that portfolio even at a snail's pace, you've got to wonder if eventually we see the opposite effect. Do we see long term interest rates move up rather than move down? Do we see a heightened level of volatility in the stock market that we haven't seen in a few years? Do we see the type of sharp drops and corrections that we haven't seen in a few years? And, you know, does that, you know, put a ceiling on how much home price appreciation we can see, particularly with wage growth still pretty sluggish?

[Charlie Turner]

All right, so do you think the timetable is like this? The Fed could start to shrink its bond portfolio, say after the meeting in September. September, and then maybe enact another rate hike in December. Could the timetable work roughly like that?

[Greg McBride]

I think it definitely lays out that way. At this point, they've certainly teed up the start date for the balance sheet normalization to come at that September meeting. So expect that to kick off by October 1st. And yes, they have latitude to raise rates again, probably by December. Again, the caveat being they need the inflation numbers to move closer to 2% instead of away from 2%.

[Charlie Turner]

Greg McBride, Bankrate.com's chief financial analyst. Greg, thanks for joining us.

[Greg McBride]

Thanks for having me.

[Charlie Turner]

And that's yous Money Matters. I'm Charlie Turner at the Wall Street Journal.

[WSJ Announcer]

For more insights, enable the Wall Street Journal skill on any device with Amazon Alexa. Get all of our podcasts as well as the latest news and market updates. The Wall Street Journal Listen ambitiously still

[Deel Advertiser]

running global payroll like a relay race deal replaces fragmented payroll vendors with one global system. No third parties. Hire, manage and pay teams in 150 countries with in house local experts and white glove delivery and deal plugs into what you Already use Workday SAP Netsuite operate like a local everywhere. Visit deel.com WSJ that's D eel.com WSJ.