Kathy Jones on Inflation: ‘The Worst Is Behind Us’

Episode Summary

Executive Summary: In this episode of The Longview, Kathy Jones, Chief Fixed Income Strategist at Schwab, discusses the current macroeconomic environment, the role of bonds in portfolios, and the outlook for inflation, interest rates, and the economy. She argues that the 60-40 portfolio is not dead, as higher yields now provide a cushion, and that the worst of inflation is behind us. Jones advises investors to focus on long-term trends and avoid reacting to short-term noise, while noting that an inverted yield curve likely signals a mild recession in 2024. She also covers fiscal policy, the Fed's credibility, and key indicators to watch.

Main Topics: Macroeconomic Factors in Investment Planning (Priority: 5/5): Discussion on how to incorporate macroeconomic trends into financial plans without overreacting to short-term events. Jones advises awareness but not reaction. The 60-40 Portfolio and Bond Market Outlook (Priority: 5/5): Analysis of whether the 60-40 portfolio is dead. Jones argues it's not, as higher yields now provide income and diversification, unlike last year's unique environment. Inflation and Fed Policy (Priority: 5/5): Examination of inflation drivers, the Fed's response, and the disconnect between market expectations and Fed hawkishness. Jones believes inflation is easing and the Fed may over-tighten. Yield Curve Inversion and Recession Risk (Priority: 4/5): Discussion on the inverted yield curve as a recession signal. Jones expects a mild recession in 2024, citing historical patterns and weakening consumer spending. Consumer Health and Spending (Priority: 4/5): Analysis of consumer balance sheets, pandemic savings depletion, and credit indicators. Jones notes that lower-income consumers are more vulnerable. Housing Market and Affordability (Priority: 3/5): Discussion on housing market slowdown, affordability issues, and the need for price adjustments if mortgage rates remain high. Fiscal Policy and Debt Sustainability (Priority: 3/5): Examination of federal deficit, debt sustainability, and Social Security. Jones sees no imminent crisis but notes long-term challenges.

Key Arguments: The 60-40 portfolio is not dead; higher yields now provide income and diversification, unlike last year's unique environment. The worst of inflation is behind us due to supply-demand rebalancing and central bank tightening. The inverted yield curve likely signals a mild recession in 2024, as historical patterns suggest. The Fed may over-tighten to regain credibility, despite market expectations of low long-term inflation. Consumer pandemic savings are largely depleted, especially for lower-income households, increasing vulnerability. Housing prices need to adjust downward if mortgage rates remain high to restore affordability. Fiscal policy was too aggressive during the pandemic, contributing to inflation, but the Fed can address it.

Data Points: Long-term inflation expectations (TIPS market): 2% to 2.5% - Implied in Treasury inflation-protected securities market. University of Michigan 5-10 year inflation outlook: 3% - Consumer sentiment survey. Historical recession timing after Fed funds rate peak: 8 to 15 months - Typical lag before recession begins. Mortgage rate comparison: 3% vs. current higher rates - Jones notes that mortgage rates would need to fall to 3% to avoid housing price declines. Fed funds rate increase magnitude: 5 times - Small businesses' financing costs have increased fivefold.

Pivotal Quotes: "I think the worst is behind us. I do think we'll have our moments of nervousness ahead of us. But when you have this much tightening and this much determination on the part of major central banks around the world to bring inflation down, I think they'll succeed." — Kathy Jones: On the inflation outlook and central bank effectiveness. "I'm a big fan of believing what the market tells me, having been in the market for a long time. And the bond market is pretty smart. So I tend to think the inverted yield curve will indeed lead to a recession at some stage of the game." — Kathy Jones: On the yield curve inversion as a recession indicator. "I think the risk is that they overdo it to try to maintain or regain some confidence that they believe has been lost." — Kathy Jones: On the Fed's potential to over-tighten due to credibility concerns.

Implications: Investors should maintain a balanced portfolio (e.g., 60-40) as bonds now offer attractive yields and diversification. Expect a mild recession in 2024, but avoid overreacting to short-term macro noise. Focus on long-term trends and consumer health indicators like hours worked and credit card defaults.