‘Expect that reflation without the inflation’: Strategist

Garrett Melson, Portfolio Strategist, Natixis Investment Managers Solutions, joins Yahoo Finance Live to discuss the outlook on the market amid FOMC news and inflation concerns.

Video Transcript

ALEXIS CHRISTOFOUROS: And I want to stick with the markets now and the Fed and bring in Garrett Melson. He is portfolio strategist at Natixis Investment Managers Solution. Garrett, good to see you. So we all want to know, has anything changed for you in the way you approach your portfolio after the Fed's decision yesterday, basically being very clear and transparent about the fact that they want to raise interest rates at least twice by the end of 2023?

GARRETT MELSON: Yeah. That's a great question. And honestly, there are a couple elements to the release yesterday in the presser that kind of made us go, huh, that's kind of interesting, not quite what we expected. Certainly, I'd say consensus coming into the meeting yesterday had shifted more hawkish. And so I push back in a way that the meeting and the news was actually more hawkish than expected.

And I think you're actually seeing some of that news today or some of that in the price action today. This expectation that we're going to see two hikes-- or that we are, excuse me, going to see two hikes in 2023, well, that was already largely priced into markets. Markets already expecting more hikes than the Fed had signaled earlier on.

And so I think it's kind of interesting that you've seen the Fed really, in some people's eyes, moving away from that new framework in some of the details here. And I'd push back against that. I really don't think much has actually changed in their reaction function.

It's simply just a byproduct of the fact that some of the downside risks have materially dissipated. And naturally, that simply skews the forecast higher here. So I think that's really all we're seeing is just downside risks have started to alleviate. That shifts everything higher here. But I would point to the dots in 2023. There is significant dispersion there. And there's still quite a few that are really hovering around that lower bound. I'd say that's probably more representative of the governors and the voting members. I don't think this really changes the reaction function significantly and, as a result, really doesn't change our viewpoint moving forward in the markets.

KRISTIN MYERS: Garrett, I want to ask you about what the Fed said on inflation. They did raise their inflation expectations to more than 3%. Now, someone we were talking with just yesterday really disagreed on the picture that the Fed is painting right now on inflation. He was saying that he views inflation to be much higher, to be running much hotter than the Fed has been portraying. Where do you stand on this inflation narrative? Is the Fed potentially getting it wrong, at least on this picture they're painting about where they see inflation going?

GARRETT MELSON: Right. Well, it's obviously a pretty important question. And I'd say the updated projections yesterday certainly backs up the idea that the Fed expects a lot of these pressures to be transitory. If you look at the longer-term expectations for inflation, it didn't really move a whole lot.

Essentially, what we got in those expectations was simply a mark to market. So it's simple math I mean, if the expectations and projections ignored the sizable prints we had this year, that would be somewhat of a communications issue, right? And then kind of looking through the data when the Fed has told the markets they're even more data-dependent--

So I think this certainly backs up the thesis that a lot of these pressures we're seeing currently are transitory. And that's certainly the camp that we fall in as well. If you look at those line items, what's really driving some of those eye-watering month over month numbers, do you really expect used car prices to continue rising at a 10% clip every single month? Is it really surprising that areas of the economy where consumers are spending more are seeing prices move higher? I'd say that's really not all that surprising.

So structurally, if you kind of look through all that noise and some of the outliers, we're just not seeing signs of a structural shift higher in persistent inflation. And I think the Fed certainly reaffirmed that in some of the expectations on the longer end in SEP yesterday.

ALEXIS CHRISTOFOUROS: I want to ask you about your tactic, I guess, when it comes to rising inflation and how you might be hedging against inflation. There are some who are saying that investors should be looking to buy shares in companies with a long maturity of debt as an effective hedge against inflation.

We know that companies issued debt at an astounding rate through COVID-19. Much of it of course, was necessary to build up funds that they needed. But do you think that that's an effective way to hedge against inflation?

GARRETT MELSON: Yeah, it certainly is because obviously, with higher rates of inflation, that kind of deflates the debt burden for some of these companies. I'd actually take a slightly different tack. And I'm not quite so sure the narrative is really inflation as much as reflation. And I know those two ideas really get lumped together quite a bit.

But I think it's something what we've been talking about quite a bit with clients this year is to kind of expect that reflation without the inflation. And so you do certainly see a resurgence in growth. But again, it comes back to some of those structural elements of inflation.

I just don't see the signs there. I certainly do see a recovery in growth and expect relatively robust levels of growth through the back half of this year and into next year. And ultimately, if we are wrong with those expectations, some of these transitory inflation pressures turns out to be a little bit more persistent than we expect, well, I'd also argue that simply having that overweight to equities is probably going to be a pretty reasonable inflation hedge.

If you think about just simply the revenue picture, it tends to be nominal in basis. And that will continue to have some upward pressure as a result of some of these inflationary pressures. So I'd question really the idea in general about some of these inflationary fears. But I think just in general, an equity overweight in our portfolios, which is how we're currently positioned, really does make, still, a lot of sense, even amid that backdrop where some inflation pressures maybe don't turn out to be quite as transitory.

ALEXIS CHRISTOFOUROS: All right. Time will tell for sure. Garrett Melson, portfolio strategist at Natixis Investment Managers Solution, thanks for being with us.