Uncertainty Around Future Policy

LIZ ANN SONDERS: I'm Liz Ann Sonders.

KATHY JONES: And I'm Kathy Jones.

LIZ ANN: And this is On Investing, an original podcast from Charles Schwab. Each week, we analyze what's happening in the markets and discuss how it might affect your investments.

KATHY: So Liz Ann, you and I are both on the road this week, and I'm sure you're getting a lot of questions about some of the policy changes in Washington, as am I. Potential tariffs, the effect on the economy, inflation, the markets, immigration reform, tax policy, and we had the pleasure and privilege of being with our colleague Mike Townsend, who covers a lot of the issues in Washington for us, so that's been fantastic, but what kind of questions are you getting these days?

LIZ ANN: Well, you're right. And you and I are at IMPACT, and we did our panel last night, and there was a lot of discussion about tariffs. I'd say if I had to put it in sort of a thematic button in terms of what types of questions, some of them are broad with regard to policies and questions around that old line of "Do you take him literally or take him seriously?" and how that applies to tariffs and immigration this time. Do we assume that the campaign promises go to that degree? And of course, our answer is, and even our colleague Mike Townsend's answer is, "We don't know." That's something we're going to all have to wait and see about. But certainly, one of the things we talked about on stage, as you know, yesterday is that it is really, really hard to argue the other side of "Tariffs will slow growth and raise inflation." And at the extreme of what has been proposed, they're highly inflationary. So I've been getting a lot of questions about the inflation impact of tariffs. And I answer often by also weaving in the immigration side of things. And to the extent that there are mass deportations that, of course, lowers labor supply and, all else, equal raises labor costs, which if you add that into the mix, that puts upward pressure on inflation. And that could be part of the reason why your world has been affected with higher bond yields, which to some degree also reflect that economic growth has been fairly resilient. But now as we look into the future, the inflationary impacts of both tariffs and immigration come into play. 

I'm really curious as to your thoughts on the December Fed meeting. There is still a decent amount of data between now and then, including the PCE version of inflation, which is the Fed's preferred measure, and we get another jobs report before the next Fed meeting. But what would your betting odds be in terms of the Fed moving by another 25 or pressing the pause button for that meeting?

KATHY: I would say the case for a pause is getting stronger. And the reason is the economic data have been resilient, as you mentioned. Ever since we started to get the upward revisions in September, to the data, what we see is an economy that's really growing at a pretty healthy rate, 2.5 to 3% with pretty full employment. The unemployment rate has edged up, but it's stuck around 4%, which we used to think was actually below full employment.

And wage growth has been pretty healthy. So we don't have a lot of areas of the economy that are suffering. There's a few: housing, obviously, being one of them. But financial conditions are pretty easy. Credit spreads are very, very tight. There's no difficulty financing for corporations. And stock market, well, it was at all-time highs. It's certainly not showing signs of cratering and tightening financial conditions. So when you look at all that, you'd say why would the Fed need to move now, particularly with all of the uncertainty about what policy's going to be going forward and how that'll affect inflation. So we know that the labor market's in good shape right now. If that were to change in the next report, I think the Fed would respond to it, but I don't know that that's a likely event.

Inflation is still declining, but the pace has slowed. We're still not at the 2% target for core PCE. And certain areas like services, especially housing and insurance, are stuck. Then as you mentioned, immigration reform, which could reduce the labor force size by as much as 8%, maybe a little bit more, that could have a big influence.

So you know, Powell has said, I think, reasonably that they don't want to deal with fiscal policy until they know what that fiscal policy is, and that's a long way down the road. On the other hand, we know from previous experiences at the Fed in 2016, when there were all these policy changes proposed, they did discuss them and model potential outcomes at the meetings before they were actually implemented just to have, you know, a baseline kind of evaluation of what it might mean.

So it'll be interesting to see, this week we get the Fed minutes from the last meeting, then jobless claims, and as you mentioned, the inflation numbers. So I think I would be watching those minutes pretty closely to see how much discussion there was around fiscal policy at that stage of the game. And then of course we have payrolls coming up and another CPI report before the next Fed meeting. So I would make the case for a pause. I don't know if the votes are there for pause versus to go ahead another 25. I know that they've had another 25 on the of the agenda for quite some time. But I would say right now I would lean towards a pause and wait-and-see and then take another look at the next meeting.

LIZ ANN: Yeah, that's the camp I find myself in at this point. But of course, to your point, the data can change that perspective. But in there, you mentioned housing. I'm glad you did because although it's not a huge driver of the economy, it had started to show some signs of life in the period from when the Fed started telegraphing a shift to easier monetary policy and in the very early stages of rate cuts.

But given the backup on the long end, we saw a really, really quick reversal of those, some of that better data. And the most recent news has not been great at all. We had weaker housing starts, sales were OK, but nothing gangbusters. Inventory is now rising. I mean, refi activity is basically imploded here. So one of our themes for a while now in this whole notion of the roll through of rolling strength and weakness in the economy that's been going on for the past few years in this pandemic era that, if and when you started to see services maybe take it a bit on the chin because that's been the big strength in the economy—it's been the strength in the inflation numbers—that maybe you have some offsetting stabilization improvement in areas that have had their hard landings like housing, like manufacturing, and unfortunately that doesn't seem to be happening, and it shows you just how sensitive an area like housing can be given what's happened to longer-term interest rates. So I think that's something that's worth watching, especially if the economy weakens, and it starts to hit services, but inflation stays sticky, keeping the Fed in pause mode, you don't likely get that lift from housing and/or manufacturing. And I think on the manufacturing side of things too, as we touch on, there's so much uncertainty with regard to policy. So things like not just capital spending, but capital spending intentions continue to be weak. Rightly so, because I think if you're a business leader, and you're trying to plan out, you've got to be in wait-and-see mode in terms of those policies like immigration and tariffs. So I think we may be at sort of a stall point in that cyclical activity while businesses wait to see what policy proposals become actual policy.

KATHY: Yeah, and I think there's plenty of permutations of the policies. So yeah, you could take them at face value and say, "All these things are going to happen." But you also know that sometimes when we impose tariffs, we provide subsidies to the companies that might be affected. We did that previously when we put some tariffs on China, and then we subsidized farmers who had lost market share to China.

They've never really fully recovered that market share. China now buys a lot from Argentina and Brazil instead of the U.S. because that trust is broken. So we get tariffs, but do we get subsidies too? I mean, I think if you're, like you say, if you're a business leader, what are you going to bet on, right? What is going to affect you most? And is it going to be offset by something else? And then are there counter tariffs?

You know, the uncertainty, which is, I think, a terribly overused word in our business. But in this moment in time, I would say it's at a very high level because you have everything in play, and it can go many, many different directions. And so again, I think that makes a case for the Fed to maybe pause, take a beat, say, "You know what, we need to just sit back and watch how this plays out." Now, I think there will be some at the Fed who will say, "You know what? Rates are still high relative to inflation. We're in good shape. We don't want to ruin what we've got going in the economy here. Let's do another 25, and then we can sort of sit back and wait and see next year." So it's kind of 50-50 in my mind. I would be in the pause camp, but I know that there are some at the Fed who probably are still inclined to do another 25. 

LIZ ANN: Well, you and I are both in the pause camp.

KATHY: Yeah.

LIZ ANN: But I haven't gotten any calls from senior members at the Fed asking our opinion, so we can pontificate.

KATHY: Well, I will be going to a conference, one of the Fed conferences in a couple of months, so I'm kind of anxious to see how they stack the panel and see who they have up there. That's always kind of a good indication of where things are going. But then we have the Ukraine-Russia thing and the nuclear threat that hit the market. So bond yields have been all over the place.

We've just kept churning back and forth but staying at a relatively high level. And I think that that is uncertainty translated into higher yields. And in the bond market, the way that translates is an increase in the term premium. And "term premium" is just a fancy word for the extra yield investors demand to invest in longer-term Treasuries versus short-term. So you can either buy a bunch of three-month T-bills and roll them over for 10 years, or you can buy a 10-year bond. Usually you want more yield from the 10-year bond to protect you from what might change in the market. And usually, what changes is inflation. And so I think that what we're seeing is a big move up in the term premium. Recently it had been actually negative. Now it's positive. And there's plenty of room for it to move higher if this uncertainty continues, or if the threat of inflation picks up, or some other development that could affect yields. I think, fortunately, in the bond market, we actually quantify just about everything. And that's how we're going to watch it. But I don't know, in the stock market, how do you measure that? 

LIZ ANN: We just wing it. The stock market just wings it. 

KATHY: Of course.

LIZ ANN: I mean, there is a tie-in to your world. And I think the bond market is to some degree in the driver's seat for the equity market. But there also are myriad moves on a day-to-day, intraday, week-to-week that really have very little explanation. I think there's less rationality more often in the equity market than there is in the bond market.

KATHY: Well, you have a lot of other factors to watch too, indeed, that are harder to quantify perhaps. 

LIZ ANN: So we are off next week for Thanksgiving. We'll give our listeners a little bit of a break. And every week, of course, we like to say thank you for listening. We are so appreciative of everyone who's been really supportive of the podcast, especially those of you who have given us feedback on Apple Podcasts or on X and LinkedIn. And Kathy, since it is Thanksgiving next week, I wanted to ask if in addition to friends and family, is there something you are thankful for this year?

KATHY: Gosh, I feel like it's been a very busy year, but a very good year. And I guess I would narrow it down to I'm really grateful for my colleagues. I have a wonderful team, Cooper Howard, Collin Martin, that I work with, Simoa Santiago, who's behind the scenes and does so much for us, and Diane Jacobs, who keeps me on track and makes sure I show up where I'm supposed to show up occasionally.

And for you and your team and everybody in our little SCFR world, it's been a great collaboration. And I think this podcast has been a great way for us to spend time together, where previously we just didn't have that much time to converse and to chat and to share ideas. How about you?

LIZ ANN: Couldn't agree more. I'm obviously very thankful for this past year and this podcast. This has been a lot of fun. And you're absolutely right. We were—probably on a weekly basis—you and I are together on Zoom calls or WebExes, but that's usually a larger group. 

It used to be a rare opportunity for you and I to just riff and converse, but getting to do it in this format, and having people that want to listen. And of course, our team that you and I are looking at right here on screen, and Matt Bucher and Patrick Ricci and Kory Hill, they're phenomenal. I'll reiterate your praise for your team, my slightly smaller team, Kevin Gordon, who we all know and love is just so off the charts. And to your point about Diane, Adrienne Beata keeps us on track, going in the right places. I often say that Adrienne manages me and Kevin maybe more than me managing Adrienne. So it is nice. And since SCFR, our Schwab Center for Financial Research, got wrapped into the broader Schwab Asset Management organization, we're just surrounded by really talented people whose voices we heard more indirectly in the past when we were in somewhat of our own silos. So I'm very grateful we have that collaboration with a larger group of really, really smart people. So very thankful for all of those. But even though we said aside from friends and family, you have to throw in, you know, friends and family, my kids and my husband. So it's going to be a lot to celebrate.

KATHY: We're celebrating my mom's 99th birthday this week. So she is … talk about off the charts.

LIZ ANN: That is unbelievable. Well done. That's incredible.

KATHY: Yeah, well, I hope I got those genes, you know, I'm hoping I got those genes, but we'll see. 

LIZ ANN: Yeah, my dad's going to be 95 in a few months, so getting there as well. It's really remarkable.

KATHY: Yeah, the 0.03% of the population or whatever it is, pretty rare. So that's good stuff.

LIZ ANN: So that's it for us this week. I hope everybody has a wonderful Thanksgiving. As always, you can keep up with us in real time on social media. I'm @LizAnnSonders on X and LinkedIn. I'm not on Facebook, Instagram, or WhatsApp. So if you think you see me there, it's an imposter.

KATHY: And I'm @KathyJones—that's Kathy with a K—on X and LinkedIn. And if you've enjoyed the show, we'd be really grateful if you'd leave us a review on Apple Podcasts or a rating on Spotify or feedback wherever you listen. You can also follow us for free in your favorite podcasting app. We'll be back with a new episode in two weeks.

For important disclosures, see the show notes or schwab.com/OnInvesting, where you can also find the transcript.