Fed rate hikes present 'real chance for economy to get hit hard': Strategist

Commonwealth Financial Network CIO Brad McMillan joins Yahoo Finance Live to discuss Fed rate hikes, how markets responded, and the outlook for inflation and the economy.

Video Transcript

SEANA SMITH: Brad, it's great to see you. So certainly, I guess a different day as we're looking at the Dow up just around 13 points, following yesterday's losses, although the NASDAQ still clearly in the red. What do you make of the trading action that we've seen over the last 24 hours?

BRAD MCMILLAN: It's interesting, Seana, because we see this movie over and over again where the Fed comes out and says, we're going to keep hiking rates until inflation stops, and the market starts to talk to itself and says, well, maybe they're really going to pivot.

And then the Fed says, no, we're really going to keep hiking rates, and the market goes down. And then the same thing happens. This is just the latest iteration. It's about interest rates. It's about the Fed. It's not about the economy. It's the market reacting to the Fed, and we're going to keep seeing this until inflation comes back down.

SEANA SMITH: We're going to keep seeing this until inflation comes back down. It seemed like the market was looking for any sort of hope here, any sort of good news from the Fed. And we certainly saw that reflected in the action after the decision was announced and then when Fed Chair Jay Powell's conference, press conference, got underway. In terms of what the Fed has done so far, the latest rate hike and what we could see over the next month or two at the next two meetings, do you think the Fed is potentially being too aggressive at this point?

BRAD MCMILLAN: I think there's a real chance we're going to see the economy get hit very hard towards the middle of next year. There is the lag on these hikes. They've been very severe, very fast. But that's actually what the Fed is looking for. They're looking to see things come back. We are seeing some slowing growth, but we're not seeing it in the jobs market.

And that's, I think, what the Fed is waiting for to declare victory, to see the jobs market really soften in a material way. They want to see people being able to shop and buy go down. So that's what I'm watching for, is a signal that we are close to the end.

SEANA SMITH: Yeah, Brad, and certainly even from the data out this morning, it doesn't seem like the jobs market is losing steam at the rate at clearly what the Fed would have liked to see. What are you expecting to see in the next jobs report tomorrow? And then looking out, I guess, to what you think the Fed should do at the next meeting, what do you think should be on the table?

BRAD MCMILLAN: I think they should do 50 basis points in the next meeting, and then 25 after that. In other words, keep the pressure on. But at the same time, recognize just how much damage has been done. When you look at the residential investment figures, if we do get a recession, it's very likely to be investment driven. And that's actually better for the average worker. So I'm OK with that.

But right now, with all of the tightening they've done, I would step back and wait. The problem is the market will love that. And that's not what the Fed wants to see either.

SEANA SMITH: Yeah, clearly not what the Fed wants to see. And we saw that reflected in the commentary from Fed Chair Jay Powell yesterday afternoon. Brad, you mentioned the risk of a recession. If we do, in fact, see a recession, I guess how deep of a recession do you think we could potentially get?

BRAD MCMILLAN: I think we probably will see a recession at this point. But I'm not taking a soft landing off of the table. And the reason I'm saying that is, as long as you have this many people working, as long as you have a job market as strong, as this one is, it's very hard to get a consumer-led recession that's anything meaningful.

We are seeing investment go down. We're seeing housing go down. That could take us into technical recession. But if we do get a recession, I think it's going to be short, maybe a quarter or two, and probably no worse than the recession we had last year. Two weak quarters, and then things will normalize.

RACHELLE AKUFFO: And Brad, Rachelle here. We did hear from Fed Chair Powell that that path for a soft landing has definitely narrowed. What is the investor position here, as people are bracing for a potential recession?

BRAD MCMILLAN: Well, I think you have to-- certainly have to stay defensive. Personally, I'm looking at healthcare. I'm looking at consumer staples. I want to be fading the consumer because as I say, I don't think that's where the principal risk is going to be. When you look at it from an investment standpoint, if the Fed is saying we're going to keep raising rates, and if you believe them, that's going to keep the pressure on growth stocks. That's going to keep the pressure on especially tech stocks. And we're seeing that in the market.

So I think it's a time to stay defensive. I think it's a time to focus on value and dividends. I think it's a time to focus on stocks that actually benefit from the average consumer. So I think they're going to continue to do OK.

SEANA SMITH: Brad, what do you make of earnings season so far? I guess, given tech stocks, you didn't mention that. They weren't one of your picks, at least as of right now. And I think a lot of investors would agree with that sentiment. But from the slowdown that we've seen from a lot of those tech giants and the volatility, really, that we've seen in some of those bigger names so far today on the heels of the latest rate hike from the Fed, what do you think that signals, just in terms of the volatility that we could potentially see within that sector over the coming months?

BRAD MCMILLAN: Well, you've got to remember that, really, there's two things going on here. There's the earnings. And obviously, there's been some material news on a number of the tech companies for earnings. But it's not really about earnings for them. It's about valuations. And that's very tough to call because that depends on the expectation of rates. That depends on the expectation of growth. So you get volatility when there's uncertainty, and there's two different dimensions of uncertainty around the growth stocks.

Now when you-- and this gets back to the value stocks. There, it's going to be principally about earnings. And there, you have a little bit more visibility. But until we have some clarity over interest rates, I don't think the-- even if the tech stocks continue to grow their earnings or do well with earnings, that still doesn't address the valuation problem.

RACHELLE AKUFFO: And Brad, obviously, we knew that 75 basis point hike was already priced in. Yet once again, we saw the markets reacting negatively, even though, obviously, Fed Chair Powell has said we're going to stay the course multiple times here. What is it that you think the markets are missing when it comes to risk assessment?

BRAD MCMILLAN: Well, I think it's the triumph of hope over experience. And, you know, I said this a little bit earlier. You know, Powell has said very clearly that, no, we are going to keep hiking rates until inflation is under control. And the market said, no, he really means we're going to pivot. And then he had to come out at Jackson Hole and say the same thing. And markets went down.

And then the last Fed meeting and this Fed meeting. If you look at the projections by economists, they keep saying, oh, no, but rates are really going to start coming down in a couple of months. And that continues not to be the case. I think the best thing we can do as investors is to take the Fed at its word, to say that no, we're not going to see a pivot until we see inflation come down meaningfully.

You know, right now, they have no reason to pivot. They have no reason to stop. The jobs market is still very, very healthy. Inflation is still way too high. Why on Earth would they stop? And I think we just have to accept that that's not going to happen until one of those two things breaks.

RACHELLE AKUFFO: Hence the phrase, "don't fight the Fed." Brad McMillan, thank you so much for joining us this afternoon.