The markets expect a Federal Reserve rate cut at its September meeting, maybe 50 basis points, in fact Federal Open Market Committee officials have predicted they'd cut rates twice this year and have yet to do so. New projections will be published after this meeting. KC Mathews, executive vice president and chief market strategist at Commerce Trust will discuss the meeting, any Fed action, the new Summary of Economic Projections and Fed Chair Jerome Powell's press conference. Join us live at 1 p.m. on September 18.
Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Gary Siegel (00:11):
Hi, and welcome to another Bon Buyer Leaders Event. I'm your host Bon Buyer managing editor Gary Siegel. Today we're going to discuss the federal open market committee meeting and monetary policy. My guest is KC Mathews, executive Vice President and Chief Marketing strategist at Commerce Trust KC. Welcome, and thank you for joining us.
KC Mathews (00:36):
Hi, Gary. Good to see you. Thanks for the invitation to talk about this great topic.
Gary Siegel (00:42):
Well, it looks like people can't see me for some reason. I don't know what happened to my camera, so we'll just continue without it. And for the audience, I just want to let you know there will be no special q and a session, so if you have a question, just feel free to ask it in the queue anytime you'd like. So KC, was there anything in the statement, the SEP or Fed chair, Jerome Powell's press conference that surprised you or grabbed your attention?
KC Mathews (01:18):
I don't know, Gary, if I'd call it a surprise. I mean, you and I have been in the business a long time. We've known each other for a long time. I was thinking about it. I think I've analyzed over 240 Fed meetings in my career, and I think we always maybe expect the Fed to tell us exactly what they're going to do, which they're not going to do. So I don't think there was a surprise on our end. This is exactly what the Fed communicated back in late August that the Jackson Hole Symposium, where, hey, the risks, the balancing of the risks might change and they might have to rethink their posture. Oh, the market like that. And that's exactly what they did. Perhaps something that not even grabbed our attention, again expected is we have a new member on the FOMC that aggressively wants to cut rates. So maybe the attention grabbing issue is the dispersion of the members' forecasts. I mean, you almost need a legal pad to capture the dispersion in their forecast. But again, you kind of knew that you knew there's a Fed governor from Kansas City who was very hawkish and really the Kansas City Fed Governors have always been very hawkish that maybe didn't want to move. And then you had a new member that wanted to move aggressively. So that is worth maybe mentioning, but I wouldn't call it a surprise at all.
Gary Siegel (02:54):
Well, chairman Powell said during his press conference that there was no widespread support for half point cut. Was that surprising at all, or how'd you feel about that?
KC Mathews (03:05):
Now, again, it's one of those things you expected, right? We know maybe the drama, for lack of a better word, between the White House and the Fed, and we have a new member on the FOMC voting member who wants to aggressively cut rates. And it was interesting because I think that question came up in the q and a where Chairman Powell said there was not a robust discussion about it and moved on. So I think it's great that you have robust discussions in those meetings. It's no different than our business, Gary, or I'm sure the businesses of many of your participants, that you want to go into some type of committee meeting with different ideas, different analysis to create a better decision, a better outcome for, in our case, our clients. So I can see why there wasn't maybe widespread support, but you would hope there's discussion and analysis around that.
Gary Siegel (04:14):
What was your impression of Powell statement that there's no risk free path forward? Isn't that always the case?
KC Mathews (04:22):
Yeah, yeah. I guess I discounted that because I'm like, yeah, no kidding. It's a little bit of, that's stating the obvious, right? They have a dual mandate, so they have to, sounds pretty simple, right? They have to maximize employment and control inflation. Well, depending on what they do, if they lower rates aggressively, you could stimulate the economy and inflation again. And if you don't, the employment labor market could become weak and weak and end up in a recession. So there's risks on both sides. It's an extremely difficult task. I'm not sure I would want it, but yeah, there's definitely no risk-free path to making these decisions.
Gary Siegel (05:08):
So what is your outlook for monetary policy, KC? Where does the Fed go from here?
KC Mathews (05:14):
Yeah, I guess at Commerce Trusts that we think Gary is the Fed will continue, and I believe Powell said this in one of his answers. It's really they will continue with standard operating procedure. The Fed will analyze all of the high frequency data that we get from week to week. They'll try to get their handle on where the economy is, economic activity inflation and the labor market just like they've always done. And I think Powell said something like, we're going to keep doing what we do. Something like that. And as the data, I do think we think commerce trust that the Fed will continue to lower interest rates at what we call a measured pace. Because what we do and decisions we make for our clients, it really doesn't matter if we got the December meeting, they didn't lower rates in December, but they did it in January. As long as we're directionally correct, we can make a really good profitable decisions for our clients. So I think they will continue to do what they've always done. They'll look at the data, they'll sit in their meetings and debate the data and do the analysis and have kind of a arm wrestling analytical meeting, which will be good.
(06:37):
And I think the conclusion is they will continue to lower rates at what pace? Right now we are in the two more cuts this year, but if they throw that second cut from December into January or even the next meeting, again, it's being directionally correct will allow us to position our client's portfolios properly to make money.
Gary Siegel (07:04):
KC, do you think the Fed and the bond market are on the same page when it comes to rate cuts?
KC Mathews (07:10):
Yeah, I guess when I look at it, I would say yeah, eventually there could be dislocations along the way. But yeah, I would say eventually I'm still going to look at the bond market pre clues on what the fed's going to do. So here's an example, right? So let's go back to the beginning of this year. Beginning of this year, we know fed funds was at four and a half percent. The two year treasury was at four 20 ish and the 10 year at four 60. Okay, well, I always believe in my 30 plus year career that the two year treasury will give you some indication of where the Fed is going. Well, that was the case. Maybe it took longer than the street wanted, but yeah, I would say so. And today, well, today we know the Fed Fed funds are down to four point a quarter percent to two year treasuries at a three 50 ish and the 10 years at a 4.1, well, that's totally in sync.
(08:15):
What not only the Fed told us from the Jackson Hole meeting back in late August, but what they just said in this press conference where guess what? Economic activity seems to be okay, but the Fed just lowered their inflation forecast core PCE next year down to two 40 by the end of 2026. Well, if you believe that the 10 year treasury is driven by inflation expectations, it seems to be in sync. And then the other data point I'd give you, Gary, is if you go back to Jackson Hole, whatever it was at 21st of August, once Chairman Powell made his comments, the entire yield curve, the entire curve shifted 20 or 30 basis points down totally in sync with what the Fed just telegraphed. So given that empirical evidence, I would say sure, there are periods where you get dislocations between the Fed and the bond market, but I still think over time the Fed and the bond market are in sync and the bond market gives us clues to what the Fed might do down the road.
Gary Siegel (09:30):
So you briefly mentioned about the SEP. Now it showed one voter was against any cuts, even yesterday's, although if it was a voter, they voted for it. And then there was one who was looking for another 125 basis points of cuts while the others were in arranged. Do those outliers mean anything or just people's opinion and
KC Mathews (10:01):
Well, as you know, I wasn't in the meeting, but the way I would answer it, Gary, is kind of what I was alluding to earlier. I hope they're meaningful conversations. I hope they mean something just like I like people in any committee to have dissenting opinions and provide the analysis that we can arm wrestle over to make a better decision to have a better outcome, I think those are meaningful and helpful. So I think we know who the dissenters are on both sides, and I think that's really good conversation to have. But then at the end of the day, we know that the dissenter on leave rates alone actually voted for, we had what 11 people vote for it, and one said more, I hope since I wasn't there, I'm just hoping, I hope those opinions do matter. I hope their analysis is being considered. So the committee, you've got what, 19 committee members and 12 voters? I would hope that meeting has a robust discussion, all kinds of opinions. And then I would just suggest that somehow Chairman Powell got 11 voters to say, yep, let's cut 25 basis points. And one said, let's cut more. So I do think they matter. I hope they matter.
Gary Siegel (11:44):
Well, the person who didn't want any cuts might not have been a voter. So you don't know the assumption that the one wanting all the cuts is the new guy on the block, Steven Miran. What does that say about the positions President Trump will get to fill and who he picks for those positions and also to chair the panel?
KC Mathews (12:09):
Yeah, well, that's an interesting question, and maybe we start with just a little history lesson on some of this doesn't change. The president appoints these members. You can go back. Let's talk about Chairman Powell. Well, it was back in 2012 when President Obama put Powell on the board of Governors, right? In 2017, it was President Trump who appointed him as the chair. I'm just curious, what do you think Powell said to President Trump back in 2017, and how did he get that spot? Was it I'll do whatever you want, or Nope, I'll do my job and remain independent. So I mean, these presidents do have the authority to put people on the FOMC, so that hasn't changed.
(13:08):
That's been an issue. Maybe we had to think about just kind of the structure and the approval process maybe to remain, make sure we have independence. I am a big supporter of Fed independence because one of the issues I see is, Gary, if you and I were president, we would want a very high approval rating. Every president would. It helps the party for the midterm elections. And if I'm a first term president, it helps me in my reelection when everybody likes me, everybody likes me when interest rates are low and the economy is humming along and making money in the markets. So if that's not the situation, you and I both would probably advocate for lower interest rates, but again, the Fed should be an easy job. Just two things to think about, stabilized prices and maximize employment. So yeah, yeah, it's always a little concerning. But given our career a long career, Gary, this hasn't changed. Presidents have always selected somebody. Obama apparently liked Jerome Powell in 2012 and President Trump liked them in 2017. But the bottom line, so I guess I don't know if that changes anything as far as the independence, but I would hope maybe just leaving that question out there with this comment that I hope that the Fed remains independent. I think it's critically important, the system.
Gary Siegel (14:42):
So inflation remains above target, labor is softening, but critics of the rate cut say inflation is further from the target target and that should preclude a break cut. How would you respond to the critics? Or are you with them that because of inflation, they should have held off?
KC Mathews (15:03):
No, I'm supportive of the Fed. As I mentioned, they have a tough job. But I do think about, and all of us at Common Trust, what we think about, we have these robust discussions and we take our analysis and arm wrestle over it. So I think if you think about the one question would be the Fed was at four 50 and core PCE at 2.9, I was like, why shouldn't we start maybe to make a hockey analogy and Wayne Gretzky don't skate to where the puck is skate to where the puck is going. And I think that's a great analogy with the Fed. They can't just like inflation is high or where's it going? And I would argue, and we would argue as a team that inflation continues to come down. Tariffs are a little bit of a wrinkle in there. We feel that tariffs could be a one-time tax hitting inflation, but one of the big sticking points with inflation has been the housing market.
(16:16):
Gary, I just looked at this at the beginning of the year. If you look at the S and PK Schiller data, 20 city data housing prices beginning of the year, it was like 4.5% or higher, right? Today. And that was the sticking point in most inflation indices today, it's at 2.1%. So it halved itself, right? You got disinflation, not deflation, prices aren't going, but that will help the Fed claim victory that we're closer to the target. Tariffs are a little bit of the wild card. So to answer, you finally answer your question, I'm supportive of the Fed that there's skating to where the puck is. We shouldn't be at four and a half, and I feel we shouldn't be at three just yet. So doing a measured glide path lower and remember that it was good old Milton Freeman in 1959 who said, monetary policy works with long and variable lag. So with the fed's rate change yesterday, nothing changes today. So by not going too aggressive, but allowing monetary policy to change that glide path and then allowing the economy to digest it, and I think the markets agree. When you look at today, the market's positive. A second opinion would just be the market says, yeah, it seems to be going. Okay.
Gary Siegel (18:00):
So you veered the conversation a bit. So KC, I'm going to ask you about tariffs now, in your opinion, are tariffs something that we need to be concerned about and how they will impact inflation?
KC Mathews (18:17):
Well, yes. Again, I'm a bit of a history boss, so if you don't mind one, all presidents abuse tariffs one way or another could be to fight subsidies in foreign countries, could be to support more of a anti-dumping tactic like President Bush did in was it 2002 ish where we need a steel industry. If we need to build any kind of a military weapons or something like that, we can't call China or Russia. We need a steel industry that that industry has to be protected. So along the way you may call it was back in, well, first of all, tariffs were really important before 1913, right? Because we didn't have federal income tax. So in 1913, we had federal income tax, which was a source of revenue that maybe we don't need tariff revenue. But then in 1930, it was President Hoover who signed the Smoot Hawley Act, which boosted tariffs dramatically, and we could argue, did it exacerbate the depression? I think we don't have a definitive conclusion, but one conclusion I think we could probably agree on it, it didn't help the economy.
(19:39):
So I think some of these things maybe aren't a level playing field. And I think with President Trump, if you read his book, the Art of the Deal, it seems like some of this tariff negotiation is you start with a very high tariff, the art of the deal, and then you negotiate and get to the deal. And if that's good for our economy, and I think you do have to compete on a global economy that if it's fair and good for the us, okay, good, I support that and supports American business. I think that's okay if you're too aggressive and just say, no, I'm not going to negotiate in any negotiation. You got to go into it with the idea that we're going to meet in the middle, not it's my way or the highway. So depending on how they handle tariffs in the way it seems to be playing out is they're going to meet in the middle and tariffs might be a one-time tax be inflationary, and then inflation is rate of change. And the next year there's hopefully no change in the prices. So sure, yeah, we got to be concerned about it. We got to watch it really closely, but I don't think that that will be the catalyst to send us into something like a recession.
Gary Siegel (21:04):
And we have a follow up from the audience on this. Is there still a lot of concern with regard to uncertainty from the tariffs and how that will impact the Fed ongoing focus on monetary policy? So basically, I guess they're asking if the uncertainty about tariffs still weigh on monetary policy.
KC Mathews (21:30):
Yeah, I think so. And that goes back to my earlier comment where I believe what the Fed will do will continue to analyze this data as we get it. Because you're right, do we really know exactly where tariffs are going to land? Actually, along with some of my analysts here in our Kansas City office, we were with a Chinese China analyst, macro analyst, and it was like, where are tariffs now? Right? Well, you got the fentanyl tariff, you got the retaliation if you're at 30%, but they're going back to China or Frankfurt, I think they're going to meet in Frankfurt to discuss. So where is it going to end? And that's what the Fed needs to watch. But remember, I do think the Fed looks through that. My hockey analogy, I do think the Fed says, no, that's not going to be an ongoing inflation threat. It's going to be this one time I put a 10% tariff on suit coat jackets. Well, there's inflation on suit coat jackets. And then next year, hopefully there's not. So yeah, I think the fed's going to watch it, but I think to some degree, given their action and their comments, I think they're kind of looking through tariffs thinking that it's a one-time hit to prices.
Gary Siegel (22:54):
KC, are you worried about stagflation?
KC Mathews (23:00):
Well, no. Gary is a part-time economist. I'm always worried about a lot of things. So yeah, well, stagflation, the way I would define it is high inflation, high interest, high interest rates, sticky inflation, and really stagnant GDP. So yes, stagflation is bad, but when I think about it, I'm like, okay, well let's look at the Fed's projections. And instead of KC, the loose cannon or Commerce Trust forecast, the Fed just said things are getting better. Their GDP forecast for this year went from one 40 to one six next year went from one six to one eight. Well, okay, I could make a really good case using empirical evidence that 2%, around 2% GDP is good enough. It's good enough to grow our businesses, hire people, give them raises, and good enough to make money in these companies. So stock prices go up, you just need 2%. We had that from 2010 to 2019, the great moderation and business was good. So here the Fed saying one eight round up to 2% good enough. It doesn't seem like stagflation has a huge threat because 1.8% GDP, as I mentioned, we think e-commerce trust inflation will come down after we get this finalization of tariffs. And here's the Fed moving interest rates are coming down. So I don't think I see much support for stagflation.
Gary Siegel (24:44):
The FED is now focused on the employment rate in the labor markets. How serious are they about hitting 2% inflation? The projections now say they won't hit it until 2028. So do you think they feel that two and a half percent is enough for now, or are they not serious about hitting 2%?
KC Mathews (25:09):
Yeah, really good question. And here's my report card on the Fed. So actually at Commerce Trust, we did a lot of this research, and it's interesting, when you go back in history, what you find is there's only really been one decade where we've had PCE, their favorite measure of inflation below 2%, right? It was from 2010 to 2019, that period labeled the great moderation where 2% GDP was good enough and you had really low inflation in interest rates. That's a good formula. But every other decade, I mean, you can go from 1990 to 1999, well, PCE was at 2.3, maybe close enough, and maybe we don't even want to talk about the seventies, right? Gary, way back where inflation was more like from 1980 to 1989, it was like 5%. So you could go back and say, well, in the history of the Fed, are they really serious? About 2%. I think they're serious about it because I think when you get around and I would say around 2% and around that 2% GDP growth, it's good enough for us. We can manage it business higher people make money, be profitable, and that's good for equity prices and things like. So yeah, I think they're serious about it. I just think it's a pretty tall order given history to get there and stay there.
Gary Siegel (26:54):
KC, we all know that the neutral rate is an estimate and no one knows exactly what it is. Where do you think the Fed has the neutral rate or pegs, the neutral rate, and how does that compare with your view?
KC Mathews (27:11):
Yeah, well, I think it's probably around 3% a nominal, and that's kind of their forecast. I think they kind of alluded to that, something like that. The other thing you could use real fed funds, inflation adjusted, where today we're at 1.6% real fed funds, and historically it should be around 90 basis points or 50 to 90 basis points. And I think that fits in with, if you think about it, if you had 3% nominal fed funds and 2% inflation, the real rate is one, maybe a little bit lower than that. So that's why that's how I got to 3% nominal on Fed funds. I think that's a really good target. I mean, if I was a Fed governor, I'd have a little sticky on my computer, let's say 3%, and I think let's work to get there and then we can reanalyze our star and where it is, where it should be.
Gary Siegel (28:23):
So the yield curve was wrong about a recession this time. Do you think it's still worth watching for clues, KC, or do you prefer the bond market as your indicator of where feds funds go?
KC Mathews (28:39):
Yeah, sorry, what was the first one, Gary? The bond market and what else? For indicators
Gary Siegel (28:45):
Or the yield curve?
KC Mathews (28:47):
Okay, yield curve. Yeah. Okay. So my whole career, I used to, when people would ask me, what are you watching? What are your indicators? What has predictive value in seeing the looming recession? And really it was easy, right? Prior to the pandemic, you looked at the yield curve slope of the yield curve, right? When it becomes inverted, it gave you a red flag, a recession's coming, and it was variable. Like Milton Freeman said, sometimes it was six months in history, sometimes maybe it was 18 months. I think in the great recession it was longer. I think the yield curve inverted 22 months prior to the recession, but it either gave you a yellow flag or red flag, pay attention, things are slowing down. And then at commerce in my career, what I always like to do is think about this economic data. That's an economic jigsaw puzzle.
(29:47):
You have to put a few pieces together before you see the picture. Okay, so yield curve. Yep, one piece of the jigsaw puzzle. But then I would look at the six month rate of change in leading economic indicators. As you know, Gary, LEI is a composition of 10 leading economic indicators. You throw these variables into the blender and you get one index, it's fantastic. But every time, historically prior to the pandemic, that six month average of the LE, I got down to a minus four on the index. That was the yellow flag, the red flag. So if you map that up with the yield curve, it had virtually a perfect track record of predicting looming recessions. It was, like I said, you had some lag. Sometimes it was six months, sometimes it was 12 months, but you really started paying attention. Well, in 2022, all of those signals were blinking red, bright red.
(30:54):
And every economist, including myself, got it wrong, said, well, here's two or three or more variables that say things don't look good. And maybe because of what was different, maybe because of all the liquidity out there, we didn't get a recession. Now maybe Milton Friedman's going to be right and say case long and variable leads and legs. It wasn't four months, it was four years. Always things in the back of my mind, but clearly that didn't work in this cycle. But I still want, it has such a great track record, I still want to pay attention to it
Gary Siegel (31:40):
With the caveat that there are sometimes occasions when it's not right.
KC Mathews (31:48):
I have accepted the fact that occasionally I'm going to be wrong, Gary,
Gary Siegel (31:54):
Not since I know you.
KC Mathews (31:57):
Oh, you're kind.
Gary Siegel (32:00):
So I'm going to take a couple questions from the audience. KC, how do you see these rate cuts affecting fourth quarter GDP going into the holiday season?
KC Mathews (32:12):
Yeah, so at commerce, we have a GDP model, just math. And as you get later and later in the year, it's going to relatively easy to forecast economic activity. So we've got two quarters on the books. The Atlanta Fed right now for the third quarter is suggesting 3.3% GDP. And even if you get some slowdown in the fourth quarter, we put in 2%. That gets you to 2.1% GDP for the calendar year. Now we're a little more conservative than that, so we don't think the Atlanta fed their estimate's going to be quite as high. So we said, what if we get like 2.4 in 2%? Let's be conservative. It still gets you to something like a one eight ish GDP. So I think with interest rates coming down now and probably again in October, it's positive for the consumer. We all know that maybe you got a note from your bank that money market yields are going to come down or came down already. If you have credit card debt, those are going to readjust ever so slightly.
(33:31):
We know mortgages are pegged to the 10 year treasury, and today, yesterday we're at 4% today, maybe we're 4.1, but I saw a stat 60% increase in mortgage applications. Now the other data with mortgages, just a side note, is I think 85% approximately, you'll have to fact check me on this one. 85% of mortgages, fixed mortgages have a rate of 5% or lower. I'm one of them. So you're not going to see a lot of refinancing just yet. But I think people, new home buyers, whatever the case might be, they were waiting for kind of a crack in rates and we're seeing it here. That's all positive for consumers. So a long-winded answer, I think if anything, this is a positive for the consumer. And I might throw in, given our conversation about tariffs every time we delay tariffs, it's for negotiation purposes. It's a positive for consumers and I think we'll see a really good, right now we're thinking we'll see a really good fourth quarter and a good holiday retail spending season.
Gary Siegel (34:48):
Next question from the audience, is the pace of the Fed's balance sheet run off much of a factor in the current environment?
KC Mathews (34:58):
Yeah, I think so. I mean, I think there are things they could do. So they're shrinking their balance sheet. They have been doing that. They have 18, just looked at it again, if I misspeak on the numbers, but we have 18 billion of mortgage runoff every month that they run that off. I don't know if it has a huge impact. If they would continue to purchase mortgages, I think it would continue to help rates go down. So yeah, I do think the Fed has some more levers that they could pull. And I believe Powell said in his statement that they are going to work on shrinking the balance sheet, which does give them levers for the next cycle, which they need. They need some levers for the next cycle. So yeah, I think that's not a negative. I'm neutral on that. I don't think that's a really big positive or a negative, but I think it's a good thing to have optionality in the next cycle.
Gary Siegel (36:15):
Other than being fodder for questions at the press conference, what is the impact of the poor relationship between President Trump and Jay Powell?
KC Mathews (36:28):
Just say that again. What is the relationship?
Gary Siegel (36:33):
Is there any impact? Is there any impact from the poor relationship between the two of them?
KC Mathews (36:40):
Thank you. Thank you, Gary. Again, I don't know, it just seems like in my career, the president and the Fed shared don't go play golf together or have lunch together as the Fed chair occasionally reports to the president of what's going on, here's what's happening. And I think that's the way it should be. So if they're liked or not liked, I mean, I hope they're respected. So I don't know if that matters that much. I mean, it's got to be tough for Chairman Powell given some of the rhetoric on the hill about his position. But of course, Powell's position is up in May, which is right around the corner. I don't think he'll change anything there. And of course, Mirren's appointment was just for the replacement through January. We'll see if that gets extended, but no, I don't know if that really matters. Know what I mean? They both have a job to do. They both need to have their separate places to do their job, the independents. So I don't know if they need to be buddies. Hopefully that answers the question.
Gary Siegel (38:05):
Yeah. Okay. So we have another question from the audience. Who would like any insight or thoughts about Congress's attempt to eliminate the dual mandate?
KC Mathews (38:19):
Yeah, I think there's a very low probability in that. It's kind of funny. I'm here in our commerce trust office in Kansas City, and over the years had a great relationship with the president of the Kansas City Fed. And I remember one conversation I had with her, it was like, Hey, what do you think about having a third mandate for the Fed? And that is the markets, because when you have dislocations in the markets, clearly the Fed speaks to it breakdown in the market. So I was like, what do you think about having that third mandate? He goes, and the comment was something like this, we have to be cognizant of financial markets and what they're doing in response to our action. But she went on to say, Nope, it'll never happen. We'll never have a third mandate. So given that's how I would formulate my answer, even though I guess deep down in the bylaws there is this third mandate of moderate long-term rates, I don't see that changing. I think there's a low probability of that changing.
Gary Siegel (39:29):
So another question from the audience. Thoughts about President Trump pressing the Supreme Court to let him ous fed Governor Cook and remove her from the board as the legal battle tests the central bank independence?
KC Mathews (39:49):
Yeah, I don't know really much about that. And I guess if it's okay, Gary, I really not really want to opine on these legal issues. It is kind of interesting that the president really doesn't use Congress, but rather the courtroom to get things done. And that might be fine, but we'll see how it plays out. Don't know on that one.
Gary Siegel (40:24):
Okay, another question. Was there extra pressure from the new member of the board to cut 50 basis points instead of 25 and seeing as a clear increase in political pressure affecting the independence of the Fed? So I think what he's asking is, well, Powell said that I'll answer this one. Powell said that there was no real talk, there was no real desire to cut 50 basis points. But I'll let you answer the part about do you see their extra political pressure affecting the independence of the Fed?
KC Mathews (41:08):
Well, we knew we kind of addressed this, right? We spoke to it, right? We knew exactly what the agenda was of the new member, and we know exactly looking at the minutes from the Fed or the side-by-side the comments, we know who voted which way. So like I said before, that the new member wanted a 50 basis point reduction in interest rates. And like I said, I think that supports a robust discussion. That's good. What's interesting, Gary, in our earlier conversation, we said we don't really know the one that didn't want to change if they're a voting member. Well, looking at just reminding myself who the voting members are, I would argue yes, they voted for a 25 basis point cut. I think the person that is arguing that is a voting member and voted supported the consensus that Powell's decision to do 25 basis points. So yeah, I think it's a great discussion point and I hope next time next meeting, they have the same robust discussion.
Gary Siegel (42:22):
Another question from the audience, KC, do we need to be cautious with how high equity valuations are right now? Does this AI bull run remind you of any previous bubbles?
KC Mathews (42:37):
All right, I got to dip in the old history here. Well, here's the thing. We always got to be cautious and mindful evaluations, but we know what we do know is in a low interest rate environment, you can get an expansion of price earnings multiples. And here's the other thing is earnings have kept up this year we're going to see corporate earnings. Oh, 10 to 12% might be conservative for this calendar year. And right now, when you look at analyst consensus for 2026, they're like 15% Commerce trust, we might not think 15, but if you got 10 in 2026, it supports stock prices, right? So I think valuations can expand. If the Fed continues to lower interest rates and the economy hums along around 2%, I don't think valuations again is that catalyst to end the equity party. But we have to be mindful of it.
(43:48):
There's no doubt about it. But earnings have been good. Low interest rates, taxes, the big beautiful bill increases free cash flow. Corporate America dramatically and all supports what next year forward PE on the s and p 500 is like 20 times earnings. I would make an argument that you could easily see 22 times forward earnings given low interest rates. Now the question about bubbles, you could go back to the tech bubble where some of these companies that are driving this are somewhere between 20 and 50 times earnings, but they're growing their earnings at 50 to a hundred percent a year. So that makes sense. And then the thing is, when you compare the tech bubble, many of those companies were trading at a hundred times a dream. Valuations were just silliness. So I don't think you can draw analogy to the tech bubble to where we are today. I would argue, and I think I can use it with a lot of good data to say, no, it's not the same today. Valuations are in check.
Gary Siegel (45:09):
So what do you see as the biggest risks to the economy?
KC Mathews (45:14):
Well, there are all kinds of risks out there. One is, if you think about it, is the Fed, historically, the Fed gets blamed for recessions. Why do they get blamed for recessions? Because they tried to slow down the economy, pump the brakes, control inflation, and they raised interest rates. And then all of a sudden they realized, Hey, wait a minute, rates are too high. Or then they paused. Then they realized, Hey, you know what? We held rates high too long. And then they cut interest rates in the last, at least three cycles because I just analyzed this in the last three cycles. That's exactly what happened. Rates were coming down and then we went into a recession. So maybe by holding rates, moving rates too high and then holding them too high, too long, they had that foot on the brake for economic activity and it caught up to 'em. So that's a risk that's always out there.
(46:19):
The other risk is maybe there's more pressure than I think about lowering rates as we just discussed, and being too aggressive and fanning the flame, meaning adding incredible stimulus to the marketplace, but low interest rates, then you have inflation again. Then all of a sudden, it reminds me of the eighties, right? Or you had a double dip recession or you had rates going up and down and how do you manage your business? So I think that's a risk to the economy, the labor market. We know the labor market's critical. We need a growing labor market. We need to do that safely. That's a whole nother discussion someone else can talk about. But just economically speaking, you need productivity gains and you need a labor force that's growing. And given our demographics, we're not going to have more kids. So immigration is a potential solution to that. So someone else can figure out how to do that, but that is a potential solution to growing economy. So if we don't figure that out, you have a economy that's contracting. I think those are a couple of risks that are out there, Gary.
Gary Siegel (47:34):
Very good. And we're running short on time. So this will be the last question. What investments are you keeping an eye on that typically perform well in rate cutting environments?
KC Mathews (47:47):
Yeah, again, commerce trusts. We have a number of analysts that we've got. We gave a little homework to think about these things, and it's interesting. It's really the question I think would be what are interest rate sensitive asset classes and securities that we can take advantage of? One that comes to mind that's in the media quite often are small caps. But here's the thing. Right now, we are not going to increase our allocation of small caps because we think the world has changed years and years ago, maybe in the eighties, if you look at the Russell 2000, something like 15% of the index was unprofitable. Today it's close to 40% is unprofitable. So hopefully all our listeners would agree. Yeah, that change, that's a big change. But you saw it yesterday. You saw that trade sell, large caps, buy small caps. I didn't look at it here today, Gary, if that trade continues.
(48:47):
But our analysis, we went back over eight cycles, back to 1984, rate cutting cycles. And lo and behold, that's a short-term trade. Small caps outperformed large caps, short-term, call it six months, twelve, twenty four months. Large caps the winner. So we're not traders my whole career. It's a trader. You got to make a lot of decisions and you better get 'em all right, not one of 'em. Right? So we're not doing that trade. We're looking inside our sectors that would be defensive, interest rate sensitive, whether that would be utilities, real estate, things along that line. And some of those sectors are relatively small in the s and p 500. They don't really move the needle. But that's what we're really looking at is emerging markets, the weak dollar, low interest rates. And that has performed well, obviously in the last 12 months, outperforming domestic stocks. But those are things that we continue to do the analysis on and think about what interest rate sensitive areas of the markets, is there an opportunity?
Gary Siegel (50:03):
Well, that concludes our leaders event. I'd like to thank everyone for tuning in, and a special thanks to my guest, KC Mathews, executive vice president and chief market strategist at Commerce Trust. KC, always a pleasure.
KC Mathews (50:17):
Thank you, Gary.
