The message top corporate CFOs are sending directly to Fed presidents isn’t a bullish one


U.S. Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a meeting of the Federal Open Market Committee (FOMC) at the headquarters of the Federal Reserve on September 21, 2022 in Washington, DC.

Drew Angerer | Getty Images

The Federal Reserve is expected to pause or skip — depending on whichever term you prefer — its interest rate hikes at this week’s Federal Open Market Committee meeting after the most aggressive series of hikes since the 1980s. But it won’t be enough for the Fed to keep rates where they are now, at 5%, and then get right back to hiking in July if the central bank wants to avoid a potentially bad fate for the economy, according to several chief financial officers at major corporations.

CFOs on a CNBC CFO Council call on Tuesday morning who said they have recently spoken directly with Fed presidents in their regions, relayed the following message to the central bank: it’s not time to pause or skip, it’s time to stop.

This view coming from within corporations across the economy matches the results from the latest CNBC Fed Survey, released on Tuesday morning, which finds that while the markets see a 68% probability of a hike in July, 63% of survey respondents see no change and, in fact, think the Fed is at the end of its hiking cycle.

CFOs on the CNBC call, which is conducted under Chatham House rules to allow the executives to speak candidly, said they are seeing the signs in both consumer spending and credit strength to indicate the Fed rate hikes are not only working, but the evidence is in the data to suggest that lagging and more significant economic effects are coming.

Consumer weakness that began in Q1 has continued and there is concern from the C-suite that the actions taken by the Fed are not showing up fully in the CPI data yet, but will soon enough. The latest consumer price index released on Tuesday morning came in as expected, with inflation up 0.1% monthly, and at an annual rate of increase of 4%, the lowest it has been in two years. But core inflation rose 0.4% on the month and was still up 5.3% from a year ago, indicating that consumers are still under fire.

While food and energy prices are stripped out of core inflation to remove volatility, one CFO said the recent “dramatic” decline in energy prices will start to work its way into the core inflation index over time and that makes a pause at this FOMC meeting a smart move by the Fed, but likely not enough. The Fed remains focused on the labor market and cooling wage growth while raising unemployment as the key to bringing hot services inflation down. The CFO conceded that the “big anomaly” is still employment, which continues to be strong and which companies are “not seeing break in any measurable way.”

But the CFO said when he looks at an ISM Services index that is now trending down five months in a row, the only conclusion he can come to is, “That doesn’t happen typically unless we are in a recession. There is a chance we find out Q2 is a recession and we may not learn that until sometime deep into the third quarter. Services is in contraction territory we haven’t seen in a long time.”

“I shared with [a regional Fed president] that they should stop, not pause,” said another CFO on the call. “The drag effects are showing up. … Employment is dangerous to focus on.”

I see the possibility of two more hikes after June meeting, says Roger Ferguson

This consumer-focused CFO pointed to average transaction data from the grocery segment that had remained $53 year-over-year, showing the weakness in the lower-end consumer and subprime consumers being “way more impacted.” But the CFO said in the last few months average transaction value has been decelerating. “That’s the lag effect,” he said.

The consumer CFO said the message he delivered to a Fed president included his concern that one of the recent negative data points in what remains a strong labor market – the reduction in average hours worked – will become much more prominent if compounded by a top-end of the consumer market that falls off. Then, he informed the Fed, there will not be a mild recession but a moderate to severe one. “It could get very ugly next year,” he said.

After the regional banking crisis, the Fed’s own economists warned at the March FOMC meeting that a shallow recession is likely.

Among low-end consumers, 80% are back to pre-pandemic levels of credit delinquencies, but that has been rising. “The consumer is being smart,” the CFO said, but the Fed focus on bringing unemployment up can break the consumer. “I urge them to be cautious,” he said.

CFOs, as a rule, have been closer to a worse-case, if not worst-case, scenario view of Fed policy outcomes for the markets and economy in recent quarterly surveying of the CNBC CFO Council. And their view now is not reflected in recent stock market activity, with the Dow Jones Industrial Average higher for five consecutive days, the NASDAQ Composite pulling off sixth-consecutive positive weeks for the first time since November 2019, and all major indices above their 50-day and 200-day moving averages — until one considers that a quicker than expected end to interest rate hikes is bullish for equities.

“The bear market is officially over,” Bank of America equity strategist Savita Subramanian recently said, noting that the S&P 500 has risen 20% above its October 2022 low.

Some question the new bull market call based on how narrow market leadership has been — a handful of the largest tech stocks responsible for much of the rebound in market indexes — but the gains have spread in June to the majority, 425, of the stocks in the S&P 500.

Recession forecasts

The CNBC Fed Survey finds that for the third time in seven months, respondents have pushed ahead their forecast for when a recession will begin. In the latest survey, 54% predict a recession in the next 12 months, and the average start month is now November. That’s two months later than the prior survey and five months later than the prediction for a June start made earlier this year.  

But the slowdown in consumer spending has started to move from core to discretionary spending, said another consumer-focused CFO on the call, and that also led him to warn a regional Fed president about the risks of focusing too much on labor. “I gave this message to [a Fed president]: we can manage through this with unemployment below 4%.”

The Fed has forecast unemployment rising above 4% and peaking later this year, but has stated in recent FOMC statements that it watches lagging indicators closely and adjusts its policy accordingly.

The CFO said while the business world and the Fed agree on the importance of lag factors, where there is a disconnect now is how fast those lag factors work. Corporations, he said, are seeing the slowdown in consumer purchases flow through the economy, from purchase orders to warehouses and transportation and manufacturing. “The challenge is lag factors pushing unemployment well above 4%,” the CFO said. “The consumer is being very cautious and prudent and it’s just not being seen as much yet. … Three or four more months, at this point, could be enough of a slowdown to move the needle on unemployment,” the CFO said.

While one CFO in the manufacturing industry said he is not seeing signs of recession yet, he is confident that “if the Fed keeps raising they will push us into one, and Q4 seems pretty accurate.” And he expects the Fed to keep on raising rates after it skips this FOMC meeting, a move he says the Fed is making “more to appease Wall Street than to make an impact. … They will keep raising rates,” he added.

Fed insider on why more rate hikes are coming

A Fed that will soon return to more interest rate hikes is the view of several former Fed governors, including Randy Kroszner, who joined CFOs on the CNBC call to discuss the outlook with CNBC anchor Sara Eisen. “It is good inflation is coming down, both core and headline, but core is still quite elevated,” said Kroszner, who is a professor of economics at the University of Chicago Booth School of Business. He also noted that one of the Fed’s preferred measures, the personal consumption expenditures index, keeps coming in ahead of forecasts. “There are more rate hikes to come,” he said. “The markets may be a little confused by a hawkish skip: ‘If they don’t move, it’s dovish.’ But I think it is going to be a hawkish skip and they will use the word skip, not pause,” Kroszner said.

CFOs said the labor market remains tight and the wage gains, while slowing, have created a higher wage base that can’t be turned back. One CFO noted that margins are “razor thin, if not negative” as a result of labor costs.

This is one of the reasons Kroszner expects the Fed to continue to see the need for more interest rate increases.

“Whether in service or manufacturing, labor costs are an extraordinarily high fraction of costs and it feeds through the process and you need to move prices up to keep margins and that is what the Fed will be concerned about. We need evidence that labor is breaking,” Kroszner said.

Still, he agreed with CFOs that the big risk is that when labor breaks, it is often much more sharply than models forecast. “Models say unemployment moves up smoothly, but that never happens. It isn’t just one- or two-tenths of a percentage point,” Kroszner said. “It does not move like [the Fed] are forecasting. It really doesn’t happen.”

‘Double-whammy’ fears

The challenge, Kroszner said, can be summed up in the words of economist Milton Friedman, that there are “long and variable lags between changes in monetary policy and changes in the economy.”

“We’ve never seen a lag like this,” he said. “500 basis points [of rate increases in a year] and unemployment still near record low levels. No model would have forecast that.”

He believes rates may still rise as high as 6% if the labor market does not sufficiently weaken, but not much beyond that. By the fall, he says, we will know whether concerns about lags hitting the consumer were on target, “and the consumer is really getting into trouble,” he said.

Among wildcard factors, which he says include a mid-sized bank business model that is “broken” and will show up in earnings, is a U.S. housing market that could become worse very quickly if unemployment rises more sharply than expected. Kroszner cited the refinancing boom that occurred when homeowners were able to refinance at 2%-3%, which was equivalent to a big tax cut or fiscal stimulus payment. “For many households, it is a very large fraction of total expenditure,” he said. As long as those homeowners do not need to move, the housing economy is on stable footing. But if they lose a job and have to sell a house, the situation could change quickly.

“It’s the double whammy. Unemployment rate goes up and people have to sell homes and home prices, which have been pretty solid, turn. And you get the one-two punch of losing value in homes and wealth, as well as being unemployed. Hopefully, we avoid that, but I think the Fed is worried about that, but just doesn’t have the tools to tread so finely and make immaculate disinflation happen,” Kroszner said.

That feeling of being caught in a difficult situation with few good choices was summed up by one CFO on the call who said, “It would be better if we get the recession over with.”

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