Recession watch: ‘We have seen some of the economic indicators come down,’ strategist says

Kathy Jones, chief fixed income strategist at Charles Schwab, breaks down the Fed minutes, the odds of a recession, inflation, and more.

Video Transcript

SEANA SMITH: We want to talk a little bit more about the markets, what we're seeing play out in fixed income specifically. And for that, we have Kathy Jones, Charles Schwab chief fixed income strategist. Kathy, help us make sense of what we've seen recently in the bond markets. Like Jared just said, we're seeing some relief in the 10-year yield today, pulling back just a bit, but still hovering around 2.7. Help us make sense of these recent moves.

KATHY JONES: Well, I think the bond market is responding to a couple of indications. One is that we're seeing some hints of somewhat moderating growth. There's some recession worries out there. It may be a little too early to call a recession, but we have seen some of the economic indicators come down a bit.

And we've also seen the Fed talk about tightening and talk about tightening and talk about tightening. And the more they do that and the more they signal that they are dedicated to getting inflation under control, the easier it is for the bond market to kind of relax a little bit and say, OK, we're going to see hikes in short-term interest rates, but we're seeing inflation expectations come down. And that's actually helping lift the bond market.

DAVE BRIGGS: Kathy, anything surprise you from the Fed minutes today? And given how everything has-- well, the world has changed since that meeting. We had Snap, we had Target, we had Walmart. We had existing, new, and-- new and existing home sales have plummeted. How relevant are the Fed minutes?

KATHY JONES: Well, they're a little bit old at this stage of the game, and we already had, of course, a press conference after the meeting. So we knew most of what was coming out. I do think, although there were no big surprises in here, there was a commitment on paper to say we're going to go at a 50 basis points at a time until we feel more comfortable, we're closer to neutral. So that's at least two more 50 basis point moves. And as we get into the fall, maybe a couple of 25 basis point moves. So it was fairly explicit guidance there, which is a bit more than the Fed often does.

Now, best laid plans, they may not get there. There was some reference to those tightening financial conditions. As you indicate, stock prices are down. Credit spreads are widening. All of these are indications that, typically, the Fed might be concerned about. But right now, they want tighter financial conditions, so they noted them, but really didn't make any indication, it's a concern for them.

And then I think the third thing that might have been somewhat interesting is, there is some talk among the members to actually have outright sales of their mortgage-backed securities. But that's well down the road after they've finished sort of this roll-off process. So it was noted in the minutes, which is unusual. But there is no time frame on it. And it seems to be a very long-term event, when and if it happens.

DAVE BRIGGS: Kathy, given how the circumstances, as I just mentioned, have changed since that meeting, how does it alter the job, if at all, of the Fed?

KATHY JONES: Well, I think for right now, they want to stick with the plan that they have. But they're going to have to watch the economic indicators pretty carefully because inflation's still elevated, although we're seeing a little bit of a sign that it might be starting to come down a bit. But they're going to have to watch those financial conditions. They're going to have to make sure that some of the decline in the markets doesn't spill over into the real economy.

In other words, if companies can't fund themselves in the capital markets, if we start to see lending really get curtailed, unemployment start to rise, then I think the Fed has to pay attention to that. And that might alter their plans. But for right now, they'd like to stick with whatever plan they have, at least for the next two to four to six months.

SEANA SMITH: And Kathy, given the uncertainty over the Fed and exactly what the Fed policy is going to look like six to 12 months out from now, what are you telling your clients?

KATHY JONES: So we've been-- we came into the year suggesting that clients keep the average duration in their portfolios low, meaning not take a lot of interest rate risk. But now that rates have moved up so much and the Fed's actually being aggressive, we think it's time to start actually adding some duration into intermediate term bonds, say, because the yields are much more attractive than they've been before. And whenever the Fed's in a tightening cycle, you usually see at the peak sort of a convergence of flat yield curve. And we're starting to see signs of that.

So we're encouraging, on the one hand, a little bit more in the way of exposure to interest rate risk, but less exposure to credit risk. So, as the economy shows signs of slowing down in response to Fed rate hikes, we really want to be concerned about not being too low in terms of credit quality and say those high yield bonds or emerging market bonds very low credit quality, because that's usually where it starts to hurt when you start to see this tightening and global financial conditions.

DAVE BRIGGS: June 14, the next meeting. Do you sense that Jerome Powell will do whatever it takes, no matter what we see from the markets, to tame inflation?

KATHY JONES: That's certainly what he's saying consistently over and over again. And I will only note that he has invoked the name of Paul Volcker many times over the last couple of months. No one wants to be the Arthur Burns of the modern day Federal Reserve, the guy who let inflation get out of control. They all want to be now Paul Volcker, the hero who got inflation down. And you might have different interpretations of whether all that's true, but he has used Paul Volcker's name many, many times. So I think there is a commitment there to getting inflation down.

SEANA SMITH: Kathy Jones, Charles Schwab chief fixed income strategist, thanks so much for joining us.