Why the Fed's GDP Forecast Is Catching Our Attention

CHRIS VERSACE: Good afternoon, Action Alerts Plus members. Chris Versace and Bob Lang here. After much anticipation and speculation, we finally heard from the fed post September monetary policy meeting. The central bank moved as expected raising rates by 75 basis points. But it also sharply lowered its GDP forecast for this year, trimmed the one for next year, and signaled it expects to quickly get monetary policy into an area that's rather restrictive compared to where it is even after this meeting.

Bob, let's break it down. Market reaction, what did you think to how the market quickly reacted to what Powell had to say, the statement, and the economic projection?

BOB LANG: Well, it's the rosey price action prior to the meeting concluding, Chris. And futures were up about almost 1%. And then they dropped sharply and then rallied more than 1%. And ever since then, as Powell was talking in the press conference, the futures started to drop sharply and considerably. Now we're down more than 1 and 1/2% today. I think that secondary response to the meeting is probably a lot more meaningful than the first response.

Now we had a lot of short covering going on, a lot of people who were out of position and trying to catch up and buy stuff and get long. I think that they're going to not be feeling really good tomorrow when they wake up and see their P&L is the negative. But still, I think that I'm actually, you know what? We talked about this, Chris. I'm actually very happy with what the chairman said and what the committee is doing.

Because I think in the long run, and we're talking '24, '25, the out years, this is going to put the economy in a much better footing as long as they're focused in on stamping out inflation.

CHRIS VERSACE: So I agree, although I'd also say that's a long way to go to get there. But I think the read we had going into this, that the fed is going to have to go bigger for longer served us rather well. But having said that though, I think I was a little caught off guard by how clear Powell was by saying that the fed is only now starting to enter a restrictive area in terms of monetary policy, and that it has much more to go, and it's going to get there rather quickly. Was there anything that Powell said, Bob, that you heard during his press conference that kind of added or surprised to what you were thinking?

BOB LANG: Well, I think that the fact that the chairman was a lot more emphatic about wanting to keep rates higher for longer. He was very adamant about it and said, you know what? Under no uncertain terms that the fed is going to hit to that restrictive level, which according to the dot plot, was changed up to about 4 and 1/2% on the funds rate. And keeping rates higher for longer. So clearly, they have not been looking at the small drops or slightly flat lines in the month over month readings on the CPI. They're not looking at that. What they're looking at is the year over year inflation numbers, which are just too hot.

So what is it-- let's just project out and say, what is it going to take to get inflation down? You're going to have to see quite a few months of negative CPI and negative PPI to get that inflation down. And it's going to take months, and months, and months for that to happen.

CHRIS VERSACE: I agree with that. I do think that the biggest number that changed in the dot plot, some people focus in on that GDP cut, which was pretty hefty for 2022. But the idea that the fed fund rates is going to be close to 4.4% exiting the year, that's extremely different than when the market was thinking of very recently. I think the expectation had kind of started to move up to around 4%. And even before that, it was still hovering around 3.75 a couple weeks ago.

So I do think we're going to see a continued reset in expectations work for a number of things, including GDP, as well as earnings expectations. But the one question I have for the fed, Bob, is this. If you're going to continue to raise interest rates to fight inflation at the pace you're indicating, do you think that maybe that 1.2% in GDP forecast for 2023 might be a little, I hate to use words from the past, a little exuberant?

BOB LANG: I would say so. And frankly, they've been guiding us a little bit too optimistically on GDP for the past several quarters. And they've had to reduce, as you said, reduce their annual GDP growth for 2022 down to a negligible 0.2. And frankly, we were just talking about before we went on air here, Chris, that I think that that's a little bit too rosy. When you think about the fact that the first half of the year already has baked in two negative readings in GDP, how are you going to get there?

And then we just talked this morning that Cleveland-- I'm sorry, Atlanta fed GDP now came in and reduced their projections for Q3, which is ending next Friday to 0.5. So when you add it all up, when you do the math, are they expecting at least probably a 2% reading or more on GDP growth in the fourth quarter when you've been talking endlessly about how analyst estimates for earnings have been coming down? And even the companies are starting to take their numbers down.

So I don't-- honestly, I can't square how they have come up with even that number. But as you said earlier today, have you ever seen a fed forecasting a negative GDP or a recession? And the answer is no.

CHRIS VERSACE: Yeah, that's exactly right. So let's get to the real meat here, Bob. From a portfolio perspective, I don't think we're going to change anything. We've been on the prudent path. I think that expectation resetting is going to keep us there. What do you think?

BOB LANG: Yeah, I'm telling you right now. What we've been talking about lately is lower levels on the S&P 500. And I think that what we've-- we've been adamant about keeping lots of cash and keeping the-- trimming some things off the portfolio, and keeping the inverse ETFs there. We're going to still do that. But I do think that down the road here, Chris, in the very short term, we're going to get that retest of those June lows. And we're going to see if there are any buyers can step up there. And what is that? That's down to 3640. Well, today, what are we, about 3820 right now in the S&P 500?

That's not too far down. It's about less than 5% just to come back down to that area that many people had expected that that's going to be-- that's going to hold. That's not going to get retested again. But you know what? We've been discussing it and saying that, you know what? Let's be careful. Because that is an area where if we break down below there, we're talking about even lower levels, let's call it the pre-COVID highs. 3393 on the S&P 500. So we're talking about another 14% down from current levels.

CHRIS VERSACE: Well said, Bob. I totally agree. And members, thanks for joining us. We'll be back with you with the regular daily rundown tomorrow.