How prepared is the stock market for Fed tapering? Very, Clearnomics CEO says

Clearnomics CEO and Founder James Liu reviews market predictions as investors await the Fed's official tapering announcement.

Video Transcript

ZACK GUZMAN: I want to shift over, though, for what this means from the market, of course, since as well as it's been signaled, there are questions as how investors might react to what we hear. For more on that, I want to bring on James Loo, Clearnomics founder and CEO, back with us.

And James, good to be chatting with you again, man. I mean, when we look at it, as Brian highlighted, it's been well choreographed, I think. And that's kind of the main consensus that everyone knows this is coming. Jay Powell's warned everyone tapering was going to begin. I mean, how prepared do you think the market actually is, though, when you look at where we're at now?

JAMES LIU: Yeah, good to chat with you, Zack. Basically, the market completely expects that this will happen tomorrow the Fed has well telegraphed this, as you say. In fact, we would go a step further and say that it would be a mistake for the Fed to not start the tapering process very soon now that they have-- primed, essentially, for that outcome. So at this point, the market has moved past that. They're looking at when the next rate hike will be.

But I think the other thing to talk about here as well is that the Fed has somewhat been behind the curve. So it's not just that the market has been pricing it in. It's that the Fed has adjusted to meet what the market had expected. If you recall, you had the big spike in interest rates earlier this year in Q1, as the market anticipated that the Fed would have to start to adjust interest rate policy and their balance sheet policy. And so you have the Fed adjusting to that over the last two dot plots with a higher prospect of raising rates probably by the second half of next year. So overall, we think that the market fully expects this.

Now you may still see some volatility as people sell the news over a short period of time, but broadly speaking, we don't see any major hiccups for the broad market. And the market performance we're seeing right now, as of this moment with all major indices at all-time highs, that reflects that sentiment.

JARED BLIKRE: Yeah, and it looks like Powell will get to avoid a taper tantrum. But you mentioned raising rates. That is the next step. And if the Fed was behind the curve this year, what happens if they get behind the eight ball next year? Get a little bit stuck? Do they raise a little bit early? How does this get factored into the market? Because we've seen the Fed here before, maybe it was decades ago, but a little bit late to reacting sometimes.

JAMES LIU: Yeah, it's a good point, Jared. The problem is that the Fed is in a conundrum. If inflation and persistently higher inflation across all measures, CPI, PPI, PC, you name it, if that's because of supply chain disruptions, there's not that much the Fed can do. Now, the Fed can try to burst a bubble when it happens in terms of high inflation, just like they did in the '70s. In the '70s, there was a variety of issues, not least of which was the oil price crisis that happened at that time.

The Fed was still able to step in, in order to prevent a inflation spiral. Are we seeing an inflation spiral coming up? Not really. I mean, you know, you have these supply chain disruptions, but you know, we can argue what the definition of transitory is. But I think we would all agree. Eventually, those will be resolved, issues at ports, production issues in Asia, that sort of thing. So really, the Fed is in a conundrum where they can't really affect the underlying problems that are out there today. So what will have to happen is maybe they push up their rate hike projections a little bit higher. But ultimately, that's not really the issue.

And what we've seen from this Fed in particular is that they are going to probably lean extremely cautious because they want to get unemployment down as low as it was before the pandemic. And right now, we're in the 5% to 6% range. Before the pandemic, we were in the 3% to 4% range. So there's a ways to go for the Fed before we get back there. And although the Fed may have to balance that with inflation, that's what this Fed has shown that they want to emphasize.

ZACK GUZMAN: Yeah, that's the big thing, though, too, right? We talk so much about inflation. And then the whole transitory thing is getting harder to defend, I think, the longer we see prices elevated. And I wonder, too, I mean, you know, there's a lot that could move the market.

So let's just be clear, even as well choreographed as everything was here, it only takes a word or a phrase that the market can catch on to. And I think inflation does seem to be one of those biggest catch-alls for maybe what we could see reaction to. So I mean, expectations there. What are yours in terms of how they plan to tackle what I think a lot of people say right now is-- I don't want to use hyperinflation like Jack Dorsey's using here, but just maybe running hotter than they even want it to.

JAMES LIU: Yeah, well, Zack, you have seen the rhetoric from the Fed change over the course of the last year. You know, at first, they talked about it being transitory. Inflation, that is. And then what you've had recently is an acknowledgment that inflation is running much hotter because you just can't deny it at this point. And that is what clearly justifies tapering. Now the thing they've also said, however, is separating the tapering process from the rate hike process.

And so although this may justify tapering right now, you know, that could be a nine-month process through the middle of next year, depending on the numbers they choose. And so, it would require another set of criteria in order to get to that rate hike. Now that being said, you know, the Fed is in a tough spot. Markets, we think, are basically pricing all this and taking it in stride. As you say, not much would be necessary in order to shock the market somewhat. So the Fed suddenly did take inflation much more seriously over the next three to six months.

You could see an adjustment in the market. We already saw that earlier this year. Interest rates jumped. You had the 10-year jump up to over 1 and 1/2% very quickly and before coming back down. And so those types of adjustments can happen in the market. But what you want is for that to happen slowly over time like we saw this year, rather than abruptly like we saw during the taper tantrum.

ZACK GUZMAN: We'll see what happens. Of course, again, all the live coverage here on Yahoo Finance Live, but a good preview there. James Liu, Clearnomics founder and CEO, thanks again for the time, man. Be well.