Fed's rate hike outlook 'warrants some caution' from consumers in near-term: Strategist

Invesco Global Market Strategist Brian Levitt joins Yahoo Finance Live to discuss the state of U.S. consumers amid retail earnings, while also examining the impacts from the Fed's rate hike outlook and ongoing debt ceiling negotiations.

Video transcript

SEANA SMITH: Let's talk a little bit more about the state of the consumer and the retail sector at large. For that, we want to bring in Bryan Levitt, Invesco Global market strategist. Brian, it's great to see you again. So consumers are trading down. We also see people pulling back on their spending, spending moderating a bit. What does this mean then for the market?

BRIAN LEVITT: It's actually a good sign. I mean, it's sort of paradoxical. If we saw the consumer that was still shopping at a clip that they were shopping in during the early days of COVID or into 2021, it would be far more problematic. Remember, precisely, what the Federal Reserve has been trying to do is slow down this economy. In essence, make people feel a little bit less wealthy. They've been successful at that. And as a result, the consumer is moderating. And the economy is slowing. But that's precisely what the Federal Reserve needed to do in what was a very high inflation environment.

AKIKO FUJITA: Yeah. And there are questions about what that next step is from the Fed. But if we bring the conversation back to the consumer based on the retail earnings we've gotten, the data that we've gotten so far, from an investment standpoint, who do you think is best positioned to ride out this wave right now?

BRIAN LEVITT: Well, in the near term, you'd want to be a little bit more defensive. And so the, you know, a company like Walmart that you were talking about, where, you know, consumers can come in and take advantage of Walmart's labels or can, you know, take advantage of lower costs. That's where you'd want to be in a more defensive contractionary environment.

But what investors should also recognize is that the sector that leads out of the economic soft patch or the recession is consumer discretionary. And so while we're not there yet, typically that happens following policy tightening, a shift in the Fed's approach, where we're not ready to call the recovery and the new economic cycle. We will be there over the next months and perhaps as early as within 2023.

So, you know, investors should start to be thinking ahead about what the peak in inflation, the peak in policy tightening looks like, and think about those cyclical sectors that tend to outperform in the early stages of a news cycle.

SEANA SMITH: Brian, between now and then, though, do you expect some of the pressure that we are-- that we have seen on consumer discretionary to that-- for that story to continue then, at least in the near term?

BRIAN LEVITT: Yeah. You'll need a-- you'll need a cyclical impulse on that. I mean, we're still waiting to see the lagged effects of all of this policy tightening now. The economy has been resilient. But we haven't necessarily-- we've never historically gotten through this much tightening without a further slowdown. So the near term warrants some caution.

But-- but my point is to say that there's another side of this. While you're hitting the guideposts to the end of a cycle, that also suggests you start looking ahead to what the next cycle will look like.

AKIKO FUJITA: We've got just under a month to go until the next FOMC meeting. We did get some Fed speak this morning. Dallas Fed President Lorie Logan speaking about the upcoming plan, saying, quote, "After raising the target range for the federal funds rate at each of the last 10 FOMC meetings, we've made some progress. The data in coming weeks could yet show that it is appropriate to skip a meeting. As of today, though, we aren't there just yet."

And specifically, she talked about the core preferred inflation data PCE. That coming in a little hotter than expected. Now, we're still looking at the CME Fed probability currently at 64% chance of no hike. Where do you stand on that?

BRIAN LEVITT: I mean, I'm certainly hoping that there's not a rate hike. I would like to see what the lagged effect of all of this policy tightening is going to mean on the economy. I mean, these probabilities have not necessarily been right throughout this whole cycle. So it is possible that we could see another rate hike. I mean, look at what the two-year rate is doing today.

The good news, though, is that the move in the two-year today has not corresponded with a sell-off in the S&P 500. So the market is recognizes that, you know, we're either at the end of the tightening cycle or perhaps another one to go. But-- but this is a market that is gearing up or getting ready for a period of greater policy clarity, something that we haven't had, quite frankly, since the fall of 2021.

SEANA SMITH: Brian, what about if we do get another rate hike in June? What will that do then to some of the regional banks, some of the stress that we've already seen play out within the financials?

BRIAN LEVITT: Yeah. I mean, it's not great. I mean, these-- the financial accidents that occur at the end of every tightening cycle only tend to end with a shift in policy and the Federal Reserve working to normalize the yield curve, whether they're actually easing or just using the power of the mic to suggest easing in the future. So this is the first instance that I can think of where you've had the financial accident at the end of policy tightening and the Federal Reserve kept raising rates. In all the other instances, the Federal Reserve was easing by now.

And so that's a bit of a challenge. It continues to be a challenge for the regional banks. Now, you know, the good news is the quality of assets on bank balance sheets look quite good. It's really more of the confidence issue, the whole to maturity issue on those quality assets, as we've all been talking about. So this will shift as rates start to come down as the Fed normalizes the yield curve.

You know, I hope we're sooner than that rather than later. But I'm not sure the Fed is answering my phone calls these days.

AKIKO FUJITA: There's another X factor that's kind of hanging over the market right now. And that is the debate over the debt ceiling. Vice President Kamala Harris speaking today virtually to community leaders about the dangers of a potential debt default. Take a listen to what she had to say. And I'm going to get your reaction on the other side.

KAMALA HARRIS: A default could trigger a recession, stop military paychecks, and raise interest rates for years to come. And turn mortgage rates into a situation where they would actually go up. Credit card payments would go up, and small business loans would be more expensive. It would also reduce the amount of money in your retirement accounts. So for an average American close to retirement, their 401(K) could lose over $20,000 hard-earned dollars. And the default would also put at risk programs that millions of Americans rely on, including Social Security and Medicare.

AKIKO FUJITA: We have seen the administration sort of message this doomsday scenario the closer we get to that x date, which is June 1, as we know it right now. The market doesn't seem to be reacting significantly to that. How do you or where do you place the risk of a default in the long list of risks that the market's facing?

BRIAN LEVITT: I still have it at a low probability. I mean, I always adhere to the words of Winston Churchill, whether or not he said it or not, which is Americans always do the right thing, but only after exhausting all of their options. So this is a negotiation and we're working through that negotiation right now. I mean, the Biden administration had initially said that they're not going to negotiate. They want a clean increase in the debt ceiling, which was always going to be a nonstarter for the House. And now, we're in that negotiation phase.

And you know, like much like the Obama administration in 2011, there's going to have to be something that the Biden administration gives, some type of budget caps, or spending reductions over the next 10 years. I believe that this will get done. I'm not surprised to hear the vice president talk about it in such a scary way. I mean, that's obviously to try and garner support from voters and from Americans to ask their representatives to raise the debt ceiling. But ultimately, I would expect much like in past years, this will pass without incident.

SEANA SMITH: So Brian, what should investors do right now, those that are worried about it, should they stay on the sidelines? Or are you still seeing some opportunity now?

BRIAN LEVITT: Yeah. I mean, I wouldn't be sitting on the sideline because of the debt ceiling. I think that, you know, we'll see that hopefully pass without incident within the next week or two. I think what a lot of investors are doing right now is going into money markets. And money markets look very attractive. You can get a yield of 5% with, you know, no real historical volatility. Why wouldn't you want to do that?

Well, I would just tell investors to go back and look at any time money markets seemed this attractive. It's happened in times like '82, and 2000, 2006, when you had an inverted yield curve. In actuality, in hindsight, peak in-- a peak in interest in money markets suggested that you wanted to go longer with regards to bonds, because you wanted to lock in the yields. And you wanted to start thinking about taking on risk over the next month, because typically, a spike in money market assets is a harbinger that the S&P 500 has or will form a bottom.

So I think that the near term, if you're very tactical, the market still says quality defensive. I'm OK with that. But I'm also a FOMO guy socially and with investing. I don't want to miss out. And I do believe over the next couple of years, which almost always happens after Fed tightening, the markets will do very well.

AKIKO FUJITA: I can assure you, you're not the only one with FOMO. Brian, always good to have you on this show. Brian Levitt, Invesco Global market strategist, appreciate the time today.