Jefferies Chief Financial Economist Aneta Markowska joins Yahoo Finance Live to discuss inflation, the labor market, Fed rate hikes, and the likelihood of a recession in the next 12 months.

Video Transcript

- But let's get a little bit more commentary on this from an expert. Aneta Markowska is the Jeffries chief financial economist and joins us live on the program. Appreciate you taking the time on this Monday morning, Aneta. We were just talking about the Federal Reserve now.

What do you see as the big factor for them going forward? They said they're going to be data dependent. But again, you're seeing some signs of maybe we've reached the top here on inflation. Do you feel that markets are pricing in what is going to be a predictable Fed reaction function over the next few meetings?

ANETA MARKOWSKA: So I do agree that we've probably reached peak in terms of headline inflation. And that, I think, will allow the Fed to slow the pace of hikes to 50 basis points in September. I think they do another 50 in November and then step down to 25 bips.

But I think the market is a little bit premature in pricing cuts at the beginning of next year, because core inflation at that point will still be well above 4%, right? So I think it's easy to shave the three percentage points off the top of inflation if commodity prices stabilize. Let's say we can shave another due to easing supply chain pressures.

But we're still going to be left at the end of the day with pretty robust service inflation. A lot of it comes from the housing market, but also from the labor market, which continues to be tight. And that goes back to those two negative quarters of GDP. Was it recession or not?

And the answer is not, because we didn't create any slack in the labor market. In fact, the labor market continues to tighten, as we will likely see about 250,000 jobs created this Friday. That's still well above trend growth in the labor force. So we still have a labor market that continues to tighten, wages that continue to be under pressure. I don't think we've seen any convincing evidence yet that wage pressures are easing.

And so I think when we get to the first quarter of next year, we'll find that inflation is probably flatlining around 4%. I think that's the floor set by the labor market. And ultimately, that means that the Fed will have to continue to hike until, again, we've seen more convincing evidence that the labor market is starting to soften. And so, again, I think that those hikes that are priced into the curve in the first quarter of next year are a little bit premature.

- So, Aneta, that begs the question, where are we starting to see any of that impact from those rate hikes we've already seen from the central bank? I mean, you in your notes specifically point to what we're seeing in the housing market. Can you elaborate on that a bit more and what kind of pullback you've seen?

ANETA MARKOWSKA: Yeah, so when you look at GDP data, housing is really the only sector where we've seen any policy impact, because remember, policy works through nominal demand, not necessarily real demand. And nominal GDP actually continues to be very robust in terms of consumption, business investment, or even government. It was really inflation that squeezed those sectors and caused real GDP to contract. But in terms of nominal, housing, again, was the only sector where we've seen any softness.

Look, I think policy works with lags. And I think I think the drag will really start to kick in early next year. It's just a little bit too early to expect in the first half of the year. Again, I think that squeeze to first half GDP was predominantly from inflation. And I actually think that that will reverse as we go into the third quarter, given the declines we've already seen in gasoline prices.

- Now, Aneta, when you talk about financial conditions, I mean, you say that in the housing sector you've seen maybe some tightening. But, look, broadly speaking, what's been interesting is the 10-year yield really falling over the last, let's say, seven to eight weeks. Now, when you look at that, is that bond markets pricing in the confidence and the Fed being able to wrangle inflation? Or is that bad for the Fed, because you don't see longer-term interest rates actually rising that could further quell demand?

ANETA MARKOWSKA: When I look at the market, I think that the market's pricing in a scenario where the slowdown that we've already seen in data just snowballs into more of a full-blown real recession much quicker than I expect. I don't think the real recession comes for another 12 months. I think we need to see a lot more margin compression. We need to see the Fed actually push the funds rate more deeply into restrictive territory.

And so I think that's still 12 months away. But the market seems to be pricing a very quick snowball effect that takes the economy down around the turn of the year and then causes the Fed to hike very quickly. Again, I think there are good reasons to argue against it. We just need to-- margins are on track to actually expand in the second quarter and each cycle highs.

And it just would be extremely unusual to see a full-blown layoff cycle and a recession at a time where corporate America is at peak profitability. Healthy companies don't cut costs. They don't lay off people. And, frankly, we haven't really seen too many indications of that from the earnings call so far.

So I still think that the cycle has a bit more runway. In fact, I think growth is likely to accelerate here, at least in the third quarter of the year, maybe even in the second half. And then I think we'll see another slowdown next year that ultimately snowballs into a full-blown recession.

But the market, I think, almost hopes for a quick recession that acts as a reset and makes inflation go away and allows us to start over. And perhaps that's a little bit of wishful thinking. I think the reality will be a little bit more messy than that.

- Yeah, Aneta, really quickly on that point, I mean, you say we haven't necessarily seen some significant cuts. We've, obviously, been talking a lot about the tech space, a lot of major companies talking about slowing hiring, some-- we should focus, they are more startups-- who are saying they're going to cut jobs as well. How do you think we should be looking at some of those announcements? I mean, some would argue that this space is kind of contained in some way and that we have seen incredible growth. And maybe they grew too quickly. I mean, how do you look at that in the larger context of where you think jobs are going?

ANETA MARKOWSKA: Yeah, so that's a great question, because I mentioned that corporate America as a whole on average is still very healthy. But there is always a distribution, right? And then there are those tales of companies that haven't been profitable to begin with that have been burning cash. And as long as they had access to liquidity and free money, they were able to expand rapidly and hire a lot of people.

And once they lost access to liquidity because market conditions have changed, they've had to very quickly shift from expansion to self-preservation, right, and preserve that passion to extend their runway. And I think that's predominantly where we're seeing layoffs so far. And that's actually a very normal part of the business cycle. Initial claims typically start to go up about one to two years before recession.

But what causes a recession is a full-blown layoff cycle. It's when some of the healthier companies start to lay people off and there's no one else to pick up that slack. That's when, that's when everything starts to unravel and that recessionary dynamic starts to take hold.

So I think we're certainly on our way there. But I think we're still in very early innings. And again, it's really just those weak companies laying people off. And what claims data tell you, with initial claims grinding higher but continuing claims continuing to be very low, it suggests that anybody who was laid off as a result of that weakness around the edges of the corporate sector is being picked up fairly quickly, but by some of the healthier companies.

So again, it's a process. It's a continuum. And I still think we're relatively early in that process.

- Yeah, always good to get your insight there. Aneta Markowska, Jeffries chief financial economist, good to talk to you today.