LIZ ANN SONDERS: I'm Liz Ann Sonders.

COLLIN MARTIN: And I'm Collin Martin.

LIZ ANN: And this is On Investing, an original podcast from Charles Schwab. Every week we analyze what's happening in the markets and discuss how it might affect your investments.

LIZ ANN: Well, hi, Collin. I'm glad to be back in the seat, so to speak. Nice to see you again after my couple weeks of vacation.

COLLIN: Yeah, good to see you again. Liz Ann, welcome back. I had a nice conversation last week. Kevin did a great job filling in, but it's always good to have the band back together.

LIZ ANN: Yeah, and I'm obviously very grateful to Kevin for stepping in in my absence. He always does a fantastic job, and you guys have a great rapport, so well done.

COLLIN: Yeah, it was nice. It's good to … they say variety is the spice of life, right? So maybe it's good to get new speakers. Let's move to the markets and, you know, may … I feel like there's a correlation. I don't know if my timing's right, but you're back, and we're seeing equities up. So maybe that's a good thing. We'll think about that next time you go on vacation. So I have some questions for you.

You know, we had equities, when I say equities, I'm usually looking more at the S&P 500®. They were trading in a … I don't know if it's a tight range, I'll defer to you, but a range for a few months, and now we finally moved up a little bit. So you know, I'm interested in what are the drivers and knowing that we're kind of wrapping up earnings season as well right now. So your thoughts on earnings and what's driving the recent move up?

LIZ ANN: I think it's because I went on vacation. And my prescription then for the market to continue to go up is maybe every other week I'll just be on vacation. So I'll run that by the higher-ups at Schwab and see what they think. But you know, there were two components to the question there, Collin. Market being up and having a nice rally again and earnings. And I think that's actually the reason why the market is doing so well. We've just had this extraordinary … I think it's our friend Ed Yardeni who's been using the FEMO acronym, kind of a version of FOMO, FOMO being fear of missing out, but FEMO is you know, what's the F? I'm trying to remember. I think it's fantastic earnings momentum. And that's what we're seeing. So we're not fully, fully through earnings season for the second quarter because we still have the retailers to come.

As a reminder, many retailers have a one-month-later end to their fiscal year. They typically end fiscal years in January. So each quarter end is a month later. And then you also have Nvidia, is obviously a bellwether for the market, yet to report. So these are not final, final numbers, but we're pretty close. And at the beginning of July and the lead into earnings season, the consensus expectation for the S&P was 24%. And we're now running at 51% and change. And we have never seen a parabolic ascent in earnings like we are seeing right now. The only other time in terms of rate-of-change that we have seen similar surges have all been coming out of recession. When you get that pop, when things start to recover, and the base effects of the quarter-over-quarter and year-over-year are going up against really, really depressed, you know, starter numbers. That is clearly not the case right now.

So this is unprecedented to see this kind of surge in a non-recession, post-recession recovery period of time. And it's obviously driven a lot by AI and the capital spending associated with that and the feeders that has into sectors other than just technology and communication services. It has feeders into materials, even utilities, into energy, into industrials. So that has allowed the improvement in earnings to be somewhat broad. I guess the only concern, which may not be imminent, is when you when you're seeing such a lofty number, it does raise the expectations bar and could establish a backdrop for the market where at some point the market starts to price in the inevitable inflection point, even if it's just due to base effects, where you just can't keep repeating that kind of growth rate. Because you're going up against these much stronger numbers a quarter from now, two quarters from now. So it's something to keep in the back of the mind.

But it has been extraordinary. The other thing to be mindful of, though, is even though there has been a lot of breadth and earnings, it is still fairly concentrated. So if you look at what the expectation is for 2026 compared to 2025, the top 10 contributors from an earnings growth perspective represents 65% of that increase in S&P earnings. And by the way, Nvidia is 18% just on its own. So there is still a concentration issue. But I think the latest surge in the market is this enthusiasm around earnings, around the ongoing spend associated with AI, which doesn't seem to be inflecting anytime soon. And you know, as has often been said, earnings are the mother's milk of stock prices. So that is the easiest explanation for why the market has done so well.

COLLIN: You beat me to it. I two I had two things I wanted to ask and you kind of teased him a little bit there. So let me … I have two follow ups here. So one, you mentioned it's all about expectations. So we've had, you know, we look at the earnings, earnings are strong, but it's always on to the next. And you mentioned that, was it 50% earnings growth? What was the number you said?

LIZ ANN: Fifty one percent is what's called the blended growth rate for second quarter. So it's all the companies that have already reported blended with those handful of companies that have yet to report.

COLLIN: So I'm not asking for specifics or anything like this, but what's the risk if earnings don't deliver such lofty … I mean, does the downside, I mean it does the math change a little bit because those expectations are so elevated right now?

LIZ ANN: Yeah, I think it is a risk. And I would probably put it at the top of the list of what might be considered known risks for the market. There's always the black swan kind of risks, but by nature of the descriptor, they're inherently unknowable. But I would put a sort of an aggregate disappointment. We're already seeing it at the individual stock level. Part of the reason why the KOSPI, the Korean stock market, had such a big drawdown was because it's heavily weighted in two stocks, Samsung and SK Hynix. And Samsung is a perfect example of a company that reported earnings comfortably above the consensus estimate, which is driven by the sell side of analysts. It's a published estimate. But it appeared to undershoot the buy side, money managers that follow the stocks as well. They don't publish estimates, but it represents sort of the whisper number or the hype number or the hope number.

And the fact that it seemed to come in below those expectations, the stock got crushed, and it led to this big downdraft in the index. So I think it is something that we need to be mindful of as a risk. We're seeing it at the individual stock level, stocks that have reported, even if they've reported better than expected numbers relative to the sell side, some of them have still gotten punished if they've undershot that, call it the whisper number.

COLLIN: So my second follow up, you mentioned the concentration in earnings and how the top 10 are making up a lot of the earnings growth. If we look at the other what, 490, I guess, if my math is right, are the earnings, you know, are they necessarily weak or are they OK? It's just not at the extreme numbers that we're hearing about for those highfliers.

LIZ ANN: Oh no, they're more than OK, certainly in terms of the energy sector. So the energy sector, which is not a big weight, cap-weight in the S&P 500, but it's got the strongest earnings growth for the second quarter, 143%. That compares to technology, which is, and if people could see the air quotes I'm doing, "only" 73%. Communication services is 115%. But then you've got consumer discretionary with 90%. You've got double-digit growth rates for nearly every sector, and only one sector with an estimate that is slightly negative. So there is breadth, but there's also still concentration.

And so, you know, the other force that at times has been a big driver of what the equity market will do, particularly on a day-to-day basis, if you get, you know, some sort of economic news is direction of yields. And that has come into play in terms of, at times, equity market volatility. So what are your thoughts lately on maybe the inflation data that we just got today, which as we're recording this, we only have CPI, Consumer Price Index, in hand. We've got the Producer Price Index yet to come, but give me your general thoughts on what you're seeing in the fixed income market and in particular the yield environment, either as it relates to inflation or other forces.

COLLIN: Yeah, we kind of think we're in this higher-for-longer. And I characterize it that way because there's a lot of uncertainty about what the Federal Reserve might or might not do over the next few months, where, you know, markets, the fed funds futures markets, still pricing in a rate hike by the end of this year. We're not there just yet. But whether or not the Fed hikes rates or not, we think rates are probably going to hold in a range, specifically on the short end, because the economy remains resilient. The labor market is, I'd say, relatively stable. You know, there's some ups and downs, but pretty good. So we're not expecting any cuts anytime soon either. So we think kind of steady short-term rates and same with the long end.

The way we're framing the Fed's outlook right now, I think we know there's some officials who are already in favor of a rate hike right now because we got three dissents at the last meeting in favor of a hike as opposed to a hold. I think the other voters are OK with the hold. And are very much on the lookout for something that suggests they should raise rates from here, whether that's, you know, hotter-than-expected inflation or a strengthening labor market, which can result in inflation down the road. And over the past few weeks, I'd say none of the data has given those officials who maybe are waiting for that nudge. I don't think they have that nudge right now. If we look at last week's jobs report on the weak side, so I think officials are saying, "OK, we don't need to worry too much about that pulling or pushing inflation higher." And then, as you mentioned, we got a, I'd say, a good CPI print this morning. The way I think in line is good. We don't want upside surprises, and we didn't get upside surprises. Now, the CPI is not the Fed's preferred measure. It's all part of the equation, but the Fed prefers the Personal Consumption Expenditures index, PCE. We get that in a few weeks. But usually we have a good idea after the CPI and PPI what that's going to look like. Just like with the CPI, I think upside surprises matter more than the reading itself these days. One thing I'd want to highlight is the difference between, you know, headline and then core inflation prints. A core inflation print strips out volatile food and energy prices. And because if we look at energy specifically, due to a supply shock like what we've seen, and this is a conversation that I had with Dr. Rich Clarida about the situation right now, the Fed can't do much about a supply shock. One, because it might just be a one-time increase, but also the Fed can't impact energy prices right now. It's focusing more on the demand side of the equation.

So we think whether or not the Fed hikes soon or not, short-term rates are probably going to stay kind of where they are right now. The two-year Treasury yield has been hovering a little bit above 4% for a while. We've upped our expected range for the 10-year Treasury to the 4.25% to 4.75% range, a little bit higher than what we were expecting previously, but it's really just on the premise of higher short-term rates than what we were expected just a few months ago, along with sticky inflation and fiscal concerns, which aren't going away anytime soon.

LIZ ANN: You know, and you mentioned Richard Clarida, who you didn't just have a conversation with recently. He is our guest this week. He's a friend of this podcast, so we're always happy when he agrees to come on. But tell the listeners a little bit more about him.

COLLIN: Yeah, so our guest this week, I was super excited to have the interview and conversation with him. It's Dr. Richard Clarida. He's a managing director in the New York office and PIMCO's global economic advisor. Prior to rejoining PIMCO in 2022, he was the firm's global strategic advisor from 2006 to 2018. He served as vice chairman of the Board of Governors of the U.S. Federal Reserve System from September 2018 to January 2022, which makes him an extremely interesting guest to give us insight into everything related to the Federal Reserve.

Dr. Clarida is also the C. Lowell Harris Professor of Economics and International Affairs at Columbia University. Prior to joining PIMCO in 2006, he was Assistant Secretary of the Treasury for Economic Policy, in which he served as Chief Economic Advisor to two U.S. Treasury secretaries. Earlier in his career, he was with Credit Suisse and Grossman Asset Management. He has 27 years of investment experience, holds a PhD and master's degree in economics from Harvard University, and he received an undergraduate degree with bronze tablet honors from the University of Illinois.

Hi, Rich. Thank you so much for joining our podcast.

RICH CLARIDA: Yeah, looking forward to it.

COLLIN: I have a lot of topics I want to discuss with you. I tend to keep it pretty high level. I figured we'll talk about the economy, maybe the state of monetary policy, maybe potential changes to the Federal Reserve looking ahead. But I figured I'd take a step back first and kind of talk about the Fed and your previous role there. Because I know for a lot of our listeners, a lot of our clients at Schwab, they hear about the Fed a lot, especially on a decision day, and I think we know that if the Fed hikes or lowers rates, that can have an impact on borrowing costs, interest rates, but there's a lot more that goes into it.

So can you give a brief overview of kind of what else Fed policy means for individuals across the country?

RICH: Well, sure, the Fed is a creation of Congress, the Federal Reserve Act of 1913. So the U.S. has had a central bank now for more than a hundred years. I think it's important for your listeners to know that even though we tend to focus on the Fed chair, the Warsh Fed or the Greenspan or Powell or Volcker Fed, the Fed, by design and by statute, is a committee, and so any decision to raise or lower rates is not something the chair can do on his own. And the committee has 12 members, and so you need seven of those 12 to vote for a policy change. Now, traditionally, the Fed's instrument to implement monetary policy is a short-term interest rate. Basically, think of a T-bill rate, a three-month T-bill rate. Technically, it's the rate that banks charge each other for overnight loans to other banks, but it very closely tracks the T-bill rate.

Now, very few people borrow at T-bill rates. If you buy a house, you have a 30-year mortgage. If you buy a car, you have a five-year car loan. A lot of companies in the corporate market borrow at 10 years. And so Fed policy is transmitted to consumers in terms of whether you pay for a car loan or a house through expectations about Fed policy over time. That's why even a small move in the interest rate today can have a big effect on longer-term interest rates if markets think that there will be more such moves in the in the future. Now, it's also the case that other factors determine auto loan rates or mortgage rates. And so the Fed is not the only game in town when it comes to those rates, but it's an important part of the equation.

COLLIN: Let's get right into current monetary policy. Because as it stands now in early August, the Federal Reserve has held rates steady since last December, but there's a lot of uncertainty around what the next step is, whether the Fed might hike later this year, whether they'll hold. It seems like a cut is unlikely. How do you view the current stance of monetary policy right now?

RICH: Well, you start with the reality that inflation has been above the Fed's target for five going on 6 years. The Fed has an inflation target of 2%. And inflation, of course, this year is above 2% and has been for some time. And so first and foremost, any discussion about Fed policy is what Fed policy is going to be needed over time to bring inflation down to that 2% target. Of course, inflation surged in 2021 and 2022. It got up to 9% on the CPI. By 2024, inflation had fallen back to what at PIMCO we call "two point something," say 2.5, 2.75. And under Powell, Chair Powell, the Fed was sufficiently confident that inflation was on its way back to the 2% target, that it could begin to adjust interest rates lower, as it did.

Importantly, as recently as March of this year, so five months ago, Fed officials thought that they would be cutting rates this year, and no official thought it would be appropriate to hike rates. You fast forward to the June meeting of the Fed, which was Kevin Warsh's first meeting as Fed chair. And in just three months' time, the sentiment on the committee had shifted. And you had nine folks who were in favor of hiking rates on the committee and only one in favor of cutting rates. So basically what happened between March and June, and the reason why there's a lot of uncertainty now, is that the U.S. inflation data got a lot worse.

In March, the Fed thought inflation this year would fall to 2.7%. In June, they thought it would increase to 3.3%. And so, part of the uncertainty about the Fed right now is uncertainty about where underlying inflation is. The way we measure inflation is clearly above the 2% target, but there are some factors that over time probably will reverse, energy prices being the best example. You know, tariffs, for example, probably pushed up prices last year, but tariffs aren't going to keep going up every year forever, and eventually that's going to wash out of the inflation data.

So part of the uncertainty is the Fed and others ascertaining what is the underlying rate of inflation. If it's close to 2%, maybe rate hikes aren't needed. If underlying inflation is at 3% or above, probably you do need some rate hikes. And so the Fed is sort of grappling with that issue right now. I think that's the best way to think about it.

The final thing I would say, of course, is there is a new Federal Reserve chairman, Kevin Warsh, who was sworn in in May of this year. He's presided over two meetings. and one thing I've observed in more than four decades as a Fed watcher is that typically there is some period of elevated market volatility when we do the handoff from one Fed chair to the next. We had it under Paul Volcker in the '80s, we had it under Alan Greenspan in the late '80s, certainly during my time with Jerome Powell in his first year. We had some market volatility after a meeting in which we hiked rates. And so I think most of this is to be expected as markets get a sense of what the Fed's approach to policy is going to be under Chairman Warsh.

COLLIN: You mentioned, you know, Warsh as new chair, and let's hold that. I want to come back to that with potential changes, but you talked a lot there about inflation, and inflation's still high. You mentioned some of those temporary impacts like tariffs or higher oil prices. But even when you look at, you know, so-called core inflation readings, it's still been elevated, albeit the trend was declining. What do you think is behind that?

RICH: Well, this is an important and long-standing debate in macroeconomics and monetary policy. How do you both measure the current pace of underlying inflation and forecast future inflation? The approach at the Fed, going back to the '90s at least, is to start by trying to look at measures of so-called core inflation to strip out volatile measures like food and energy prices.

And the reason why the Fed historically looked at core as a signal of underlying inflation is that core inflation historically does a better job at predicting future inflation than does headline. But it's a pretty crude way to filter the data because it mechanically throws out food and energy prices. I might add parenthetically, there's also a credibility issue in focusing on core inflation, in that for many people, food and energy prices are a very visible part of what they pay. You drive past the gas station every day, you go to the grocery store every week. You know, there are some, certainly not including me, there are some who argue that you should also filter out the price of rent and shelter.

I think if you do that, the Fed would really be risking its credibility because for many Americans, maybe 40% of the population rent, food, and energy is most of their expenditure budget, right? And so there are other methods that have been developed that are more statistically justified. One that you hear about sometimes, the so-called trimmed-mean measure of inflation, where you focus on throwing out extreme measures at both sides of the distribution. So in some months there'll be some category of prices that goes up 87% and there'll be some category of prices that falls 22%. And so you basically use a statistical procedure to trim those out. And so I think that the Fed right now, Chairman Warsh has said he's going to set up some task forces to look at the conduct of policy, and one of the task forces on inflation data and the inflation framework. So they may be looking at developing those as well.

COLLIN: I always think it's funny, and we look back a little bit over the past few years when you think about not just core inflation, but you mentioned throwing out other things. I think I always think it's funny when if you throw out all the high, you know, increases, you can get a number that you're comfortable with.

You mentioned, you know, inflation framework, and this is something that I wanted to bring up with one of the five task forces. And you already mentioned that the trimmed-mean inflation measures, let's say that becomes more of a factor into the Fed's decision-making and they start to look at more different measures of inflation, do you think that might have any near-term impacts on policy, or is that more of a longer-term thing?

RICH: Well, the honest answer is it will depend on the details. I personally think a good way to proceed would be for the Fed to be monitoring a suite of measures of underlying inflation, to continue to say that the target is to achieve a 2% rate of inflation in a particular price index, say the PCE price index, which is the current target, but to communicate that its assessment of underlying inflation will look at a broad range of measures, which certainly could and should include trimmed mean and other measures, but more broadly, I would argue that the Fed, in trying to ascertain underlying inflation, should not, and at least during my time as vice chair, did not focus exclusively just on inflation data.

The labor market's also incredibly important. Historically in the U.S., when we've seen sustained, say, three-to-five-year increases in inflation, they've always been associated with inflation and wages adjusted for productivity growth. And when we've seen sustained periods of disinflation, they've been associated with periods in which wage inflation adjusted for productivity growth has been declining. And so I do think it's important to broaden the aperture if you're looking at underlying inflation to include other macroeconomic variables other than simply price inflation itself.

And there are measures that do that, and certainly during my time as vice chair, I used to see those every month. But right now the focus, at least in the public's discussion of this, tends to focus pretty narrowly on underlying inflation measures that just look at price data.

COLLIN: I want to ask about the labor market, but one last question about inflation. This is something I've been thinking about. You mentioned supply shocks, and we hear a lot, you know a lot better than me, obviously, but you know, Fed officials, when you when you were there, you know, we often hear that supply shocks can kind of be looked through. And I'll say the "T word," transitory, but we don't need to get into that. But you can kind of look through supply shocks.

If we look over the past six years, it seems like we keep getting more and more supply shocks, whether it was the pandemic, Russia, Ukraine, you know, there's no shortage. Does that change anything if we're in this new kind of supply shock world?

RICH: Well, allow me to elaborate a little bit here. First and foremost, if you're in a credible inflation-targeting central bank, then first and foremost, you want to put in place a policy and an approach to policy that over time can be expected to move inflation back to 2% regardless of the shock. And it's not in general the case in academic models that you always look through supply shocks as a central bank and you always respond to demand shocks. The clearest case in which it oftentimes does make sense to look through a supply shock is if it is energy or cost related for reasons outside of your economy. So if there's war in the Middle East, as we saw in the 1970s and as we're seeing now, that mechanically is going to move up energy prices. And that mechanically is going to feed into headline inflation.

What would be the reason to look through that? If oil prices go from $50 to $100 and stay there, it pushes up prices, but then it doesn't increase ongoing inflation. And so because of lags in monetary policy, if you mechanically hike every time oil prices go up, by the time the rate hikes become effective, the inflation has disappeared. And so there is a case, given lags in policy, to look through some supply shocks, but not everywhere and not always. And in particular, another supply shock that people talk about a lot is a productivity shock. The economy, say, becomes more productive, or excitement about artificial intelligence leads people to revise up their view of future productivity growth.

There, the academic literature to which I contributed actually says you don't look through the supply shock. You actually, in fact, adjust rates upward today to anticipate the faster future productivity growth. And so there are certain supply shocks, in particular energy prices, and I think you can also make a case, a one-time increase in tariffs from 1% to 10% makes sense to look through because tariffs aren't going up every year forever, but it's not everywhere and always the case that central banks should look through supply shocks.

Another related point here is, and here's an example where I think policymakers and the economics profession don't do a very good job at explaining their thinking, for example, sometimes policymakers are not very good at explaining what they mean by, for example, transitory. I had some experience with that as vice chair in 2021, as did my colleagues on the FOMC. Historically, as was the case in the 2000s, and hypothetically could be the case now, is that you're in a period of robust global demand, and oil prices just move up and double and stay there for, say, a number of years.

That is going to put upward pressure on the price level, but it's not going to be an ongoing source of inflation, which is the percentage change in the price level. So you can have a permanent adverse supply shock that only has a transitory effect on inflation. You can also have a supply shock that reverses, that has a transitory effect on inflation. So I think, especially with supply shocks, policymakers would be better served to explain both what they're thinking about the nature of the shock, how long it will last, and also how they think it will then translate into higher or lower inflation.

Maybe the last thing I'll say here is that we need to remember that supply shocks can be favorable as well as unfavorable. Indeed, I and others have made the case that the global economy and the U.S. in particular benefited in the three decades between 1990 and 2020 from a very positive global supply shock, in the sense that you had a billion workers in China which entered the global labor force and put sustained downward pressure on traded goods prices.

That was a favorable supply shock. And that actually made monetary policy at the margin easier because every year goods prices were either flat or falling slightly, and that helped to offset services price inflation. And so that was both an enduring supply shock, and it was a favorable supply shock as well.

COLLIN: I love how you framed all that. Clearly the difference between price level and then change, I think it's really important for people to kind of differentiate between the two. But I love that last point about how it can have good or bad effects. It's not always bad. That's really great to hear. Let's go to the labor market. You seemed very excited before when I was ready to pivot there. I want to pivot there. You alluded before to productivity and wage gains. What are some other high-level thoughts you have on the labor market right now?

RICH: Well, let's start with the most important thing to get right about the labor market is, "Is the labor market data consistent with the economy operating at full employment?" And I think the answer is yes. The unemployment rate is low. The ratio of vacancies to unemployment is at a healthy level, about one to one. If you look at measures of wage inflation, they're running in the low threes. Now you might say, well, how can 3% plus wage inflation be consistent with a 2% inflation target? Because we have productivity growth that's running probably around 2%. And what's relevant for inflation is the difference between wage inflation and productivity growth.

In fact, I would argue that, if anything, the labor market in the U.S., if anything, is a force for some disinflation below the inflation target. So I think the labor market is in what Jay Powell referred to last year as a curious balance. In the last two years, job creation has been very sluggish. There was some excitement in April, May, and June because we got better employment data, but most of that got revised away. So over the last year, employment growth has been averaging somewhere under 50,000 jobs a month.

But on the other hand, unemployment is low. Also remember that, two years ago, there was a lot of speculation that when the incoming Trump administration would change enforcement of existing immigration laws, that that would lead to real scarcity in the labor market and be a factor pushing up wages and prices. We just haven't seen it. We have seen the reduction in immigration flows, clearly, and also a very sharp slowdown in the growth of the labor force, but that has not translated into higher wage inflation. And in part that's because we've also been benefiting from a sustained pickup in productivity growth.

Indeed, one thing that I do in my own efforts to track the economy is if you look at quarterly productivity data, it's incredibly noisy. I mean, you could get very discouraged very fast if you just look at quarter-to-quarter productivity numbers, but if you smooth them and look at say five- or 10-year averages, a pretty consistent and compelling story starts to emerge. And what you see in the post-World War II data, so now 70 plus, I guess 80 years, of course, yeah, 80 years of data. What you see is, on average, over those 80 years, productivity growth has been around 2%, but not in a straight line. You go through periods of booming productivity growth like we saw in the '50s and '60s, and like we saw in the '90s, and then you go through periods of disappointing productivity growth like in the 1970s.

And so productivity in the data tends to really evolve with these very long swings. And the good news for the U.S. economy is it looks like productivity growth bottomed out about a decade ago and has been moving consistently up and is now running about 2% over the last 10 years. And that's even before we begin to factor in in the future what AI and the deployment of AI more broadly throughout the economy may do to productivity. So I think the productivity outlook is positive. The labor market is in balance, and certainly the labor market is not now a source of price inflation.

COLLIN: I want to build on the productivity discussion you mentioned and the idea of the potential impact from AI. And there's this debate about well, one, what could the impact be on the labor market, short and long term, but also on the inflation side of the equation. One could argue that all the build-outs are causing inflation now to a degree, but may be disinflationary down the road. What are your thoughts on those?

RICH: That's our house view at PIMCO. When we're looking into the future, we try to look ahead out to five years. What we found is if you try to look ahead like 50 years, you get into discussions about levitating cars and going to Mars and stuff. So we try to look ahead five years. And our house view, as we highlighted in our secular forum this year, the essay is entitled "Rupture and Resilience" that you can find on the PIMCO website. Our house view is that near term, the build-out of data centers for training and inference of AI models is clearly putting some upper pressure on prices. Computing chip prices have gone up, both memory and processing chips, electricity prices are moving up because of the demands from data centers. And so that's clearly in the here-and-now. And indeed, Chairman Warsh himself has made reference to that recently. But we think that over the next three to five years, this relationship will begin to flip, and we'll begin to see potentially some pretty powerful disinflationary forces from AI, but not over the next several months or quarters. But the further out you go, we think the demand-supply balance is going to shift.

COLLIN: I want to circle back to some of the task forces we mentioned earlier. We already talked about potential changes to the inflation framework. One of the areas that Kevin Warsh is focusing on clearly is communications. And there's a lot of potential changes in the pipeline. So I'd love to hear if you have thoughts about maybe some changes that might seem more likely than others, and what are some pros and cons of some of the ideas that are out there right now?

RICH: OK, well what I'd like to highlight when we talk about communication by the Federal Reserve is distinguish between official committee communication about the committee's intent on policy versus the individual communication of the 19 members of the committee. And both are important, but they play different roles. And so what we've already seen under the Kevin Warsh Fed is elimination of formal forward guidance in the FOMC's written statement explaining its policy action. So at the June meeting, language that had been in the statement up through June, which was highlighting the committee's expectation for future policy, was eliminated. So that domain of forward guidance, which is the people who vote on raising or lowering rates are also voting on how to guide the markets, that has left the FOMC statement and may be gone for some time.

However, as I mentioned, when Congress created the Fed, and in particular when the Federal Reserve Act was amended in the 1930s, Congress was crystal clear in statute, in black and white, that decisions about interest rates or the balance sheet are decisions that must be made by a committee. And committees have 12 members, and each of those members can and will give interviews on CNBC. They'll post on social media. And so we are getting guidance by members of the FOMC committee; we are just not getting formal guidance voted on by the committee as a whole. And so I think one thing that markets and the Fed itself will be navigating in coming months and for maybe years is a regime in which we're getting signals about the intentions of individual policymakers, but we're not getting formal signals from the committee on which they participate.

It's perfectly possible, and indeed we've had evidence in the U.S., to conduct a very, very successful and credible monetary policy with zero forward guidance by the FOMC. Paul Volcker provided very little forward guidance during his time. Alan Greenspan was Fed chair for 19 years, and for probably 15 of those years did not provide any forward guidance. Indeed, Greenspan used to joke about his goal as a Fed chair was to provide as little guidance as possible.

We've gone through a period beginning in the mid-2000s and continuing really through this summer in which the Fed has relied more on forward guidance. In part, that emerged out of necessity following the global financial crisis, not only in the U.S. but around the world when interest rates were quite low. And so forward guidance was an important part of the toolkit when the Fed cannot be cutting rates, say, because interest rates are already close to zero. And so I think what I'd like for folks to take away is we're entering a period in which there will be different guidance by the Federal Reserve officials, but we're not going into a period in which there will be an absence of guidance. It'll just be the individual opinions of the voting members and not formal statements of the voting committee.

COLLIN: I love the way you summed that up because I think it's important … an important clarification where we're clearly hearing from other officials. It's not just the Kevin Warsh show. You mentioned before it's a committee. We have an idea about how each committee member is thinking. Some are more clear than others. So I like how it's not "OK, maybe forward guidance is no longer a thing, but different guidance." I also think it's funny to remember, you know, we go back and in, you know, after the financial crisis, how forward guidance has evolved where, you know, there was a calendar, there was a date that would be put in the statement, and it just shows that things change and …

RICH: That might be a good example of the different forms that forward guidance can take. You can also give forward guidance that's conditional on macroeconomic outcomes. In particular, during my time at the Fed in 2020, in September, in the dark days of the pandemic when millions had died and the economy was on its knees and there were no vaccines, the Powell Fed said, "We don't expect to hike rates until inflation returns to target and the labor market returns to full employment." So there was no calendar provided, but the liftoff was conditional on some observable macro outcomes.

COLLIN: Well, that's a great transition here. I want to ask you one more question. and it was on kind of the pandemic and post-pandemic response. You alluded to that they were dark times, and you and the rest of the committee had to make difficult decisions when you're thinking about the human toll. So looking back over that period, are there some lessons for either policymakers or investors?

Not that we'd expect another pandemic. Let's hope that doesn't happen, but if we get some sort of large economic downturn.

RICH: In my case, I've written and spoken extensively since I left the Fed on lessons I've learned individually. So maybe I can I can share some of those. First and foremost, both in '08 in the global financial crisis and 2020 and the global pandemic collapse, the Federal Reserve went all in, by which I mean not only did it cut rates, but it provided liquidity to financial markets. It actually backstopped lending outside of the banking system.

With regards to forward guidance, and I was writing this years ago before Kevin Warsh became chairman, I don't think that forward guidance is exempt from the laws of economics. I think in general there are costs as well as benefits. I think returns can diminish. And sometimes with regards to forward guidance, less is better than more. I would not rule it out, but it's part of the toolkit that you can choose or not to choose to use or not use.

With regards to the balance sheet, again, most of the Fed's balance sheet expansion occurred in periods of crisis, 2008 and '09, and in the Fed's case, 2020 and 2021. The reality of QE is that in the U.S. at least, quantitative easing, it's turned out to be very, very asymmetric. The balance sheet ramps up rapidly in crisis, and then in periods of recovery, it tends to decline very gradually. And I think there is a debate. I think Kevin Warsh has said for many years that he would be in favor of a smaller balance sheet. And I think that is something that the task forces, in addition to the task forces on communication, will address. So a lesson learned, yes, use QE if it's 2008 or 2020, but the Fed should have in place a robust framework that allows it to right-size its balance sheet more quickly than in the past it's been able to do.

COLLIN: Well thank you for joining me for this conversation. I learned a lot and I think our listeners are going to learn so much more about how all these things work together and what it might mean going forward. So thank you so much for joining.

RICH: Glad to be on again. Thank you.

LIZ ANN: So now it's closing time, and before we say goodbye every week, Collin, we ask each other to look ahead. So what is on your radar, and what do you think investors should be watching?

COLLIN: So there's two things that I'm looking at next week that are more in my fixed income wheelhouse as opposed to the general, you know, economic release. So I'm going to leave those to you. For me next week, on Monday, we get the TIC flows, Treasury International Capital. And we get those from June. And they're something we get every month. They come with a lag, and the Treasury reports, you know, holdings of U.S. securities. It's not just Treasuries. They include corporate bonds. They include equities. But it's really good to look at Treasury holdings and Treasury flows from foreign investors to see what demand looks like, to make sure demand's keeping up, to see who's buying or selling our Treasuries.

And not that we're expecting any sort of change with the June data or something that's out of the ordinary. You know, making headlines, of course, is Japan. And, you know, they hold … they are the largest foreign holder of U.S. Treasuries, and that's important because something that Kevin and I discussed last week, and it's in the news is the joint intervention with U.S. and Japan to help intervene in the currency market, the yen market. And there's a … I think a concern, I think it's safe to say that, with Japan being the largest holder of U.S. Treasuries, if they wanted a prolonged intervention, is there a risk that they would sell our Treasuries, which could put upward pressure on yields?

I think we'll see how everything plays out because there is a facility that Japan could use at the Fed, but we'll see. But anyway you slice it, the June release isn't going to signal much about the recent intervention. And then I'm also looking forward to the minutes from the July Federal Open Market Committee meeting. So the Fed meets, you know, eight times a year. Three weeks after each meeting, we get the minutes.

So it's a deeper dive into the conversation that officials are having. So we learn a little bit more from what the statement said and what from the press conference from Kevin Warsh said. And we're going to look into, you know, how robust of a discussion was there about potential rate hikes? Was there a discussion about the specific economic indicators that officials are focusing on? We think inflation's in the driver's seat, but maybe some more detail on how officials are maybe viewing the labor market right now. So that's what I'll be looking at. What about you, Liz Ann?

LIZ ANN: Well, we do get a decent amount of housing data out next week. First up is the National Association of Home Builders, the NAHB, what they call their Housing Market Index. It's sort of a broad index, and it gives you a flavor of what's going on in the housing market, and with yields having moved up and mortgage rates, I think that that data will probably garner a bit more attention than at times past.

And we also get housing starts and building permits. So those are key leading indicators, and we're not getting any major employment data next week, but I wanted to remind everybody that ADP, Automatic Data Processing as it used to be called, they now provide a weekly look into payrolls. It's not the same data gathering as what the Bureau of Labor Statistics does during the monthly jobs report, but it does actually survey companies and their payroll. So it's actually a pretty broad measure. And when we had the government shutdown, they opted to start to release that on a weekly basis.

And then, of course, we also get initial unemployment claims on a weekly basis. We also get industrial production and manufacturing production. I think those are key releases in an environment like this. And then lastly, we get the S&P Global version of the PMIs, the Purchasing Managers' Indexes. And those aren't as widely followed as the ISM versions. I think that should change because S&P Global actually surveys a larger number of companies, and it's a bit more global than ISM, which is more domestically oriented. So I pay as much attention to those as I do the ISM version, which I believe will come in the following week.

So that's it for us this week. Thanks as always for listening. As a reminder, you can keep up with us in real time all the time on social media. I'm @LizAnnSonders on X and LinkedIn.

COLLIN: I'm @CollinMartinCS on X and LinkedIn. It's Collin with two L's, and the CS is for Charles Schwab. And as always, you can find all of our written reports, which include lots of charts, tables, visuals, to add to our written commentary, you can find them at schwab.com/learn.

LIZ ANN: And if you've enjoyed the show, please consider leaving us a review on Apple Podcasts, a rating on Spotify, or feedback wherever you listen. And please tell a friend or more about the show. We always appreciate that. And we will be back with a new episode next week.

For important disclosures, see the show notes, or visit schwab.com/OnInvesting, where you can also find the transcript.