Pelle: Fed Made 'Small Mistake' in Holding Interest Rates

SPEAKER_1 (0:00)

And I do want to bring Sam back into the conversation, though. Turn our attention to this week's inflation data and its impact on the economy with Alex Pelle, US economist at Mizzouho Securities USA. Alex, thanks for being with us. Now, we get PPI, it comes in a little cooler than expected. We get CPI, it comes in hotter than expected. When I look at them year over year, producer prices are still up 6.5%, CPI is up 4%.

I mean, how are you looking at that, particularly with the month of October, and producer prices in coming a little bit lower than expected with overall consumer inflation higher?

Alex Pelle (0:34)

Well, thank you for having me. And these are great questions. So I think the big takeaway, the very high level takeaway here is that inflation is too high. And whether you look at CPI, whether you look at the month over month or the year over year, whether you look at PPI, the month over month or the year over year, we're not at 2%.

You don't see twos anywhere. And really what that means for the Fed is that they really don't need to hesitate to hike. They can move forward. The direction is clear. And investors continue to be in this moment of transition where the Fed is in motion, inflation is high, but we're still solidly in expansion for the economy.

SPEAKER_3 (1:17)

So it's not a question of if they hike, but how much they hike now, Alex? How high do they go, do you think? 25 or 50?

Alex Pelle (1:26)

No, I think in December the base case is still 25

But the debate around the table is going to be between 25 and 50 It's not going to be between and 25 Of course, unless something sort of an outlier event happens between now and the December meeting. But in the main range of scenarios, that's what the debate is going to be. We think from there, the Fed is going to hike two more times cumulatively. So for cumulative three hikes in total.

And the risk there continues to be, given how high inflation is, of a risk of additional hikes from there or for additional front-loading of hikes. So that's why the debate, really, in December is going to be centered around that 25 or 50

SPEAKER_1 (2:12)

So Alex, if we're potentially front-loading then, is the implication then that the Fed has gotten itself behind the curve after holding in October?

Alex Pelle (2:22)

Holding in October was a small mistake, especially given now that we've seen Core CPI print at 0.3 for three months in a row.

I think it is a small mistake that can be made up for, including, by the way, the Fed hiking also in January, so back-to-back hikes. But yes, there is probably some makeup that the Fed has room to do, given that they skipped October, and given that the data, particularly the inflation data, has continued to come in hot.

SPEAKER_3 (3:05)

So what do you think the goal is then, Alex? I mean, how many data points do you think they would need to see to feel satisfied that the job is done?

Alex Pelle (3:17)

Well, there is going to be some lag between actually the implementation of some cumulative policy adjustment and the inflation data. I think really the first best guess is that they're going to take away the insurance hikes from 2025 and that's the cumulative 75 basis points of hikes, including two additional hikes from here.

At some point, we do need the energy issue to not get worse. We also expect that we're going to start to see more clearly productivity improvements from the AI story, and there will be some moderation in demand. We should see, and I think we already perhaps are starting to see, and we have retail sales as well next week, where we're going to see spending across the economy take a little bit of a step down. Our run rate on total economy sales or nominal GDP this year is tracking over 6 percent, which is not consistent with price stability or really even close. So we really need to bring that down into the lower fives and then assess, and I think the Fed's cumulative 75 basis point adjustment, including an adjustment of an equivalent amount across the curve, should be able to get us there. So I do think we'll start to see some of the spending just moderate on the edges, and taking really that froth out that we particularly saw at the start of the year.

SPEAKER_1 (4:43)

Alex, what does this do to yields? Because at the top of the show, I was looking at a 10-year that was just south of 515