Fed stubborn on inflation fight; recession likely by year-end, conference told

Financial markets will have to face the reality that the Federal Reserve will remain stubborn in its fight against inflation and there will likely be a recession by year-end, a panel of fixed-income managers from Capital Group, PIMCO and TCW Group said at the Morningstar Investment Conference on Wednesday.

In the panel titled "Don't Fight the Fed," Bryan Whalen, co-chief investment officer and portfolio manager at TCW, said "Don't think this is the Fed that you've come to kind of love for the last 10 years supporting your portfolio and your equity prices."

It's clear that the Fed will do everything it can to get inflation down to 2%, Mr. Whalen said.

"They are going to get there, they're going to bring down observed inflation and anchor inflation expectations," he said. "For the remaining part of the year, it's not about the Fed having to hike rates, it's more about how long are they going to stay there."

Mr. Whalen also said because the market is anticipating a 50- to 75-basis-point rate reduction in the federal funds rate by the end of the year, that's where the danger of volatility arises. He said rates will probably wind up holding steady for a long enough period of time to create the "right kind of demand destruction."

The panelists also criticized the Fed for waiting as long as it did to take action. Ritchie Tuazon, fixed-income portfolio manager at Capital Group, noted as late as 2021 that the Fed said "inflation was transitory."

That created the need for a faster, more aggressive response from the Fed to raise rates to slow down the economy. Some of the models justifying the pace of its rate actions are flawed, said Tiffany Wilding, managing director and economist at Pacific Investment Management Co.

"I would also just highlight in terms of the Fed, their models don't really capture non-linear events very well," Ms. Wilding said. "In the current environment, when you're pushing so hard on an economy … unemployment rates don't tend to go up in a linear fashion."

In terms of asset classes, when PIMCO models recession, Ms. Wilding said the firm finds that the inverted yield curve has historically tended to lead to a recession, and those are followed by equity price declines and then credit market stress.

"The labor market, it lags," Ms. Wilding said. "It does behave in a non-linear way, so (first) you see corporate profits really decelerate and productivity metrics start to retract. (We've) started to see that, and we are very focused on the WARN notices."

The Worker Adjustment and Retraining Notification, or WARN, Act of 1988 requires advance notice of certain mass layoffs.

When asked by Saraja Samant, manager research analyst at Morningstar and moderator of the panel, about the likelihood of a recession by the end of the year, Mr. Whalen said 90%, and Mr. Tuazon and Ms. Wilding each said 70%.