KATHY JONES: I'm Kathy Jones.

LIZ ANN SONDERS: And I'm Liz Ann Sonders.

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

LIZ ANN: So Kathy, finally we hit the day everybody's been waiting for, the Fed cutting rates and going 50 basis points after four years. So what's your first reaction? What was the reaction on the part of the bond market in particular?

KATHY: First of all, my reaction was, "Thank goodness that's out of the way," because we've been beating this this horse to death for weeks on end. I think the 50 basis points as Powell sort of laid out the case in the press conference, and as I looked at some of the economic projections, is really based on the deterioration in the labor market since the last meeting in July. So it strikes me that it was very likely that the decision in July was a close one, maybe closer than we had thought between starting to cut and not cutting. And this one might have been really just catching up with what they thought was probably something they should have done in July but held off because they weren't sure. But he really emphasized both in the statement and his comments that it looks like they have a lot of confidence in inflation continuing to come down, but that the deterioration in the labor market was such that it was time to address that with policy, which we've heard before from various Fed officials. So not too surprising. 

The updates to the projections on the dot plot. So the Fed lowered the upper bound of the Fed funds rate target range from 5.5% to 5%, which was 50 basis points. The dot plot where the Fed members lay out their projections implies another 50 basis points by the end of this year. So probably two cuts of 25 each and then another 100 basis points next year. And, you know, all that considered, the market is already pricing all that in. So when I look at what they're saying, what they're saying is, "Yeah, inflation is doing what it's supposed to do. We're feeling good about that. But the unemployment rate has gone up. Job growth is slowing down. And we are hoping to circumvent a deeper decline in job growth by starting to cut rates now." So the bond market actually ended up selling off initially. It rallied. Then it sold off a bit. I think a lot of the reaction has to do with positioning. You know, people came into this expecting a pretty much a pretty good size rate cut and a dovish kind of messaging. And then it's a "buy the rumor, sell the fact" sort of reaction. Now we go back to waiting on the economic data. So all things considered, not as big a reaction as you might have anticipated with all the chatter ahead of time.

So what about you, Liz Ann? What's your take? I noticed that you updated your article, which is really popular, "Panic Is Not a Strategy." Were you anticipating maybe something disturbing?

LIZ ANN: Not necessarily, and remember, I guess the subtitle of that is, you know, "Panic Is Not a Strategy, Nor Is Greed." So there have been times where I've updated that, and I first wrote it back in 2008 for obvious reasons, with the panic being more of the emphasis at the time. But I've updated it in the past when we've gotten to really, really frothy market environments where you want to sort of sound the warning a little bit on the greed side of the panic-to-greed equation. Just, you know, we've had some volatility since mid-July, and a lot of it is around Fed policy and uncertainty thereof until maybe today, at least for now. So it just seemed like a good time to update it. 

You know, I thought interesting was the use of the word "recalibration," and I wonder whether that's going to be a word that we hear, you know, used in the banter much like "transitory" was in the early part of the surge in inflation, but, you know, much like you talked about the initial reaction on the part of the fixed income market and maybe some "buy on the rumor, sell on the news," clearly that's what we saw in the equity market too. In the immediate aftermath of the announcement at 2:00 p.m. Eastern Time, stocks just ripped, but throughout the course of Powell's press conference and even after that, into the close, you saw a pretty significant sell-off. You did see some resilience maintain in the part of small caps and equal weight. And I still think that that rotation away from some of the prior leaders and opportunities for investors in the equal-weight space down the cap spectrum, although we would still suggest staying up in quality, I think that trade has legs. And clearly in the last month or so as the market was anticipating a start to rate cuts, though uncertainty with regard to how much the first one would be, you've seen those interest sensitive areas of the market perform best, areas like rates and financials and utilities doing well, and that's in the lead in. I'm not sure if we're going to see that same kind of momentum now that the Fed has sort of started down this path. I think it was an internal meeting—it wasn't a discussion you and I had on this podcast—but we were chatting and kind of giggling the other day about the possibility that if they went 25, it would be considered or called a hawkish cut, and if they went 50, it would be dovish or vice versa. And there are some saying that this was hawkish. I'm not so sure I necessarily believe that. Fifty basis points out of the blocks and then another 50 anticipated throughout the end of this year. I'll remind people that the Fed did 50 basis points at the September FOMC meeting in 2007. That is not me suggesting that what's ahead of us now is similar to what was ahead of us then, but that's a pretty meaningful move to make coming out of the blocks.

KATHY: Yeah, I agree with you there, but to tell you the truth, again, we're starting at a high level, right? So when you think about it, starting at the upper bound at 5.5%, going down 50 basis points, not that big a deal, if you ask me, with the unemployment rate rising. 

LIZ ANN: Well, that's the recalibration. 

KATHY: Right.

LIZ ANN: I think that's the reason for, yeah, the use of that word.

KATHY: Yeah, and I think you're right. The Fed has a way of repeating their favorite words over and over again, until we are repeating it for them. So we can look forward to that.

LIZ ANN: Well, we are really lucky this week to have a guest who is not only a returning guest for us on this show, but she is really in high demand these days.

KATHY: That's right, Liz Ann. I had a chance to sit down with Claudia Sahm this week and get her take on things. We did have her on a couple of months ago, and yeah, I felt very fortunate to have her on Fed week since she knows a lot about the Fed, having been a former economist for the Federal Reserve and a former economist for the White House Council of Economic Advisors. Claudia Sahm is the chief economist for New Century Advisors. She's a regular guest on Bloomberg News, CNBC, MSNBC, and many other places.

You've probably seen her, certainly heard from her. She is the founder of her own advisory firm, SAHM Consulting, S-A-H-M. And you can keep up with her on her newsletter called Stay-at-Home Macro, which, by the way, matches up with the letters in her last name. And you can subscribe to that for free at stayathomemacro.substack.com. We'll link it in the show notes.

KATHY: Claudia Sahm, thanks for being here. It's your second appearance on our podcast, and we're thrilled to have you back.

CLAUDIA SAHM: I'm thrilled to be back.

KATHY: I'm going to jump right in and acknowledge that we're taping this ahead of the FOMC meeting. So all comments come with a little bit of a warning signal that we don't yet know what they're going to do—which in and of itself is newsworthy because for years we've had a pretty good idea what the Fed is going to do well before they hold their meeting and make an announcement.

But you know, I'm going to ask the question this way that everyone's talking about—the 25-basis-points versus 50-basis-points cut is the question that's raging, right? But if you could choose—if you were a voting member of the FOMC—which would it be? And then, how much does it really matter?

CLAUDIA: A 50-basis-point cut to begin this easing cycle is the right way to go, in my opinion. We can just look at the data. We don't even have to do the forecast to kind of think about where we're headed. And the federal funds rate is still above 5%. It's been at that peak for a little over a year. And in the period the Fed has raised the federal funds rate, we've seen a lot of progress on inflation. And most recently—and what's important, I think, in getting across the finish line to a larger cut to start out with—is we've seen some softening in the labor market conditions that you want to get ahead of.

Now I have also been one that I felt like the Fed had a case to cut in July. So this is not a new theme for me that I think they need to get going with the normalization of the interest rate. I think, unfortunately, we know more about the labor market that has some warning flags—not free fall—but just some warning flags that they have held rates in a more restrictive place than necessary and need to get moving. In terms of, "does it matter?"—you know, a quarter percentage point, the difference between 25 versus 50—like at a point in time, that is not material for the U.S. economy and where we're headed through the rest of the cycle. And yet where the Fed begins this easing cycle will tell us a lot about how they, not just are thinking about the economy, how they're thinking about their job, how they are prepared to respond to labor market conditions in particular. I mean, inflation, I think, is absolutely still on their radar and should be. And at the end of the day, actions speak louder than words.

What the Fed chooses to do at this point to start off their easing cycle will tell us a lot about their principles, more than any words that could come out of Chair Powell's mouth on Wednesday or any dots that could show up in the summary of economic projection. So it is consequential. And yet at the end of the day, we should … none of us should pretend that the Federal Reserve is the master of the universe here. Where interest rates go over the next few years, they will respond to—as they should—the economic conditions.

So unfortunately with this cycle, the wild ride is not over. It has become much calmer than in its initial stages. And I expect us to still have bumps along the road and continue to see events, both policy events and economic events, that sit outside of our historical record. Right? So there'll be a lot of questions.

KATHY: I like the fact that you're using the driving metaphor, because that's one of Powell's favorite metaphors—you know, driving on a foggy road, bumps in the road, speed, destination—all those things have been used to describe the Fed setting policy, which I think is really appropriate.

But I guess one of the questions that comes to mind is, speaking to you—especially since you're famous for the Sahm Rule, the recession indicator that's based on the unemployment rate—how are you seeing the labor market right now?

CLAUDIA: I see a labor market that is still in pretty good shape, but it's headed in the wrong direction. Despite the fact that the indicator that bears my name is signaling a recession right now—so the increased unemployment rate has been large enough to trigger the so-called Sahm Rule—I don't see us in a recession right now.

Looking broadly at the economic data, we still have a lot of growth. We have consumer spending. We have jobs being added. Not as fast, but they're being added. So we don't have the hallmarks of being in a recession right now—and frankly, not one being imminent. We do not need a recession as a reason to cut rates. Inflation is moving well down towards 2% target, and we still have a very high federal funds rate. So it is time for the Fed to join the rest of the economic data and start normalizing—getting back to something that is more appropriate for being on the growth path—when, you know, things are back to normal.

KATHY: So yeah, so that begs the question—and this is another debate that's kind of raging among economists, not so much on social media or in the business news—but what is the terminal rate in your view? I've heard prominent economists say that they think terminal rates should be probably 4%, maybe even a little bit higher, because the economy has so much resilience. And I've heard others say, "No, no, it's probably 2%." Where are you thinking the terminal rate will be for this cycle?

CLAUDIA: Right, and when thinking about the terminal rate, it wouldn't necessarily be the interest rate right at this moment—you know, it's kind of where we come to rest—because I think there are some special factors still affecting the U.S. economy right now that we're working through that come out of the kind of post-pandemic era. But I see a pretty good case for the neutral rate. So where the fed funds rate kind of sits—doesn't push up, push down on the economy—to be fairly close to where those estimates were before the pandemic. And that's, you know, running in the high kind of 2% space. I'm not convinced that we've had, you know, big structural changes, though that may be the case. I think productivity—if that sticks with us—that'd be a good reason that the terminal rate would be a little bit higher. My impression is that there's probably about 2 percentage points to go down on the federal funds rate before we really get into this, "Are we close to the right?" And it also, you know … it's a good guiding post, and yet it's one of those numbers that you need to have a sense of and yet not take too seriously because it moves around. It's very hard to estimate. But you know, it's important to keep in our current conversations about policy rate decisions at the Fed to keep in mind where the level of the federal funds rate is right now. And it is high, and we need to keep having this discussion. And the discussion about the terminal rate will become more and more important as we move closer to it. 50 basis points, even if they go, quote unquote, "go big" on Wednesday, that is not a big jump to the terminal rate. We're just moving in that direction.

KATHY: Yeah, one of the points we've been making is that when you have an upper bound at 5.5, and you have inflation at roughly 2.5, you have a very high level of real interest rates. And that is having a big impact on the economy. And there's lags. But I did a little informal survey of some small businesses the last couple of days, and I can tell you they're all eagerly awaiting a rate cut because their financing costs have been so high for the past year, year and a half, and it's really hurting. I think similar story for a lot of consumers on their credit cards, car loans, those kinds of things. We're starting to see some real impact there. So I would agree with you. There's just lots of room here for the Fed to move. And why not go big and go 50? But, you know, we'll have to see what the mindset is of a collective group.

Do you have any thoughts on why it's always a unanimous vote these days? It's been a very long time since we've had a dissent at all. Is this just the modus operandi now of the Fed—that they don't want to make a move, especially initiate a change in the direction without everyone on board?

CLAUDIA: So dissents are not unprecedented. They certainly have happened over time. They've happened over during part of, you know, as Powell has been chair, there have also been dissents. So it's not that they don't happen, but it is true that both historically and more recently, it's an institution that tends to want to build a consensus. And you will even see particularly an external consensus. There are times in the transcripts—you can look back—like when the Federal Reserve under Chair Yellen went to do their first rate increase, and Governor Dan Tarullo at the time did not agree with it. And as you can see in the transcripts, he's pushing back. And in the end, he's like, "I'm going to vote with to give Yellen her vote." Right? So there are times where we learn six years later that the external presentation of consensus was much stronger than the internal presentation.

I mean, I think we can also tell from listening to Fed officials now that they speak a lot in public—speak their mind—there's a lot of disagreement. Disagreement is very healthy, and yet it doesn't often get reflected in the vote. Now on some level, that's fine if the outcome is the same. If the central tendency was to go for a certain action, and building the consensus, it just, you know, it kind of looks nice. This is how the Fed wants to present. If that building a consensus stands in the way of making a decision that needs to be made, well then that's problematic. And of course, that's hard for us. It would even be impossible really for us to figure out in real time.

Making a big decision, something akin to the 50-basis-point cut—pairing that with dissents—it would soften the decision itself to make clear that, you know, "We went forward with this, but there was enough pushback that it was registered publicly, and that's something that was important." So there, I suspect if a bigger decision, you might see it come with dissents. But it is—it's an extra lever. Like it is a piece of information, whether it's consensus or not. I'm not a huge fan of the "need to always have the consensus" vote. I think that can endanger good policy. I am very heartened when I see a lot of robust disagreement across officials in public. So I know they have different views. However they do the official votes, that's just the way the Fed does it.

KATHY: Yeah, I think we see a lot of the differences of opinion in the dot plot as well, right? We see some significant outliers, particularly in this cycle. It's the dispersion of the dots has been enormous with the last time, I think, a couple of dots were still pointing to the potential for rate hikes. So it is another way to communicate that they're not all on the same page all the time about things.

I want to ask you since, you know, much of the Sahm Rule had to do with, "Oh, we're in a recession, and we should have those fiscal levers working." This cycle, obviously very different because we had such major fiscal stimulus coming in—you know, the pandemic and kind of coming into this cycle, so to speak. And now we're looking towards an election—and I'm not going to ask you about your political choices—but I do know that we have some policy proposals that could potentially have an impact on the economy, such as tariffs. What is your thinking on that? What is your thinking on how some of these potential policy choices could impact the outlook?

CLAUDIA: One of the challenges right now as an economist trying to think about this is the policy proposals are still in their campaign election version. Right? And so the details matter in terms of the effects on the economy. They certainly matter whether they're good ideas or bad ideas in terms of economic effects. And we really don't have all the pieces to the puzzle right now.

The other important part of details is the actual constellation of who's elected, right? So it's not just about the president—it's also about Congress—because at the end of the day, say legislation has to go through Congress, all of those different outcomes in the election are going to have an effect on those details. So I think there's still a lot to watch and pay attention to. There are certainly some areas that could be potential red flags, at least in the economic space. You know, there's a lot of discussions about tariffs. I mean, there have been tariffs put in place both under former President Trump and under the Biden-Harris administration. And so there's concerns about that if you think about inflation.

And we've certainly learned from the last three years that people get very upset about inflation. And so that anytime you have another inflationary risk coming through, even if it has some other non-economic justifications—also very cognizant of any proposals with immigration—I think, you know, the process certainly can be improved in many ways. But it's becoming pretty clear that the immigration into the country in the recent years was an important piece of solving labor shortages that were putting a lot of pressure on inflation. Again, to undo—just in that economic lens—to undo that would be a real problem. 

And, you know, we have bigger demographic issues going forward that immigration is important. And then to highlight, there's also good policies, because, you know, some that come on both sides with the candidates. I think the child tax credit—that was something I worked on previously when I was helping with advising Congress during the pandemic. And I think that's an excellent policy—and one, again, that can help do a lot to not just help the children who receive the benefits, but, you know, supporting families with children and, you know, again, to keep growing that labor market and to have the demographics. So there are elements of policies out there that I think are important. Again, the details will matter, and the people will matter.

KATHY: If I were sitting at the Fed—or you were sitting at the Fed as a voting member—would you be hesitant to go big because of the uncertainty around the future policies? Or would you just address what is it today? How do you think that question is resonating with the Fed right now? Are they just saying, "Look, we're here right now. This is how we're going to set policy, and we'll tackle that when it comes down the road," or will they look forward and say, "Boy, there's a lot of risk around fiscal policy that I might have to take into consideration"?

CLAUDIA: Right, so having worked at the Fed on the forecast, I can speak about this just kind of in the staff and in the input perspective on this. It is absolutely important for monetary policymakers to consider fiscal policy when they do their rate decisions. Not to influence it, just you got to kind of … the Fed works around the edges, right? So they need to have an understanding of the landscape of the economy and where it's likely headed.

As fiscal policy becomes likely—so it really takes some shape, has some details—then it starts to be integrated into the forecast. Then it starts to be integrated more into at least the discussions of the rate policy—then the officials can decide as they want to. But we're at this stage again where the details are so uncertain. Even if we knew one candidate were going to be elected, their platform is sufficiently unspecific that you wouldn't, you know, really be able to sit down and come up with a setting. So at this point, Fed officials, it is highly unlikely that they are playing the three-dimensional chess of what does policy look like in mid-2025. They've got enough on their hands. And also because we are just at the beginning of this easing cycle, right? Those economic policies, whatever they are into the future, there is plenty of time for them to have an effect on what the Fed decides. It's just, it's not the decisions this week or this year even, but you know, something that will come into play later. And absolutely, some of these policies would be in play for their considerations, particularly around probably inflation.

KATHY: Yeah, yeah, OK, so it's a down-the-road-still kind of consideration. So we thankfully can put that off and wait for all those policy decisions to finally formulate into something we can actually try to assess.

I'm going to ask you just this—I always find this interesting—what are people not thinking about that you think, you know, they should be thinking about when it comes to the Fed and policy, the economy? What questions are we not asking, or what things are we not paying attention to?

CLAUDIA: So the labor market's gotten a lot of attention in the last couple months. I think that's appropriate. It should have a lot of attention. And a big argument among us about is it a recession here? Is it coming or not? And I think these are all fine. And I mean, I have a recession indicator, so obviously I think it's important to understand recession.

There is an aspect that I have been really puzzled with, and I think it ties back into more of these echoes of the pandemic. But in terms of when we think about what's good policymaking—like looking at, "Well in the history, the Fed's done this or that"—I think is fairly irrelevant for right now, just because this has been quite different. And right now, the most troubling statistic in the U.S. labor market is the hiring rate. It has fallen back to levels that are close to 2014 when the unemployment rate was 6%. So like the labor market was not as good in 2014, and that's where our hiring rate is. And yet we have layoff rates at almost all-time lows. And we have consumer spending—looks great, and this looks … that hiring rate being as low as it is, is going to continue to cause problems. We're going to keep seeing unemployment rate move up. We're going to keep seeing the payrolls slow down—not maybe dramatically, because we haven't big layoffs—but it's a real problem. 

And so when I look at something like that, that tension—which is causing some real problems, particularly for anybody trying to find work—what's going on? And we spend a lot of time discussing the Fed, and I think that's appropriate. They have levers to pull, and it's not clear to me that that's all about interest rates, right? Because it's an odd constellation of low layoffs but low hiring. So trying to figure out what is behind that, and then is this an uncertainty, say, around the election that's going to resolve itself? Is it, we just need people like me to stop having recession indicators that are scaring individuals? I'm not sure what the answer is, but to me, that hiring rate is a big problem. And one of the reasons I think the Fed should go bigger is to help move the needle on the labor market. But I'm not entirely convinced that's all there. So to me, I'm very big on whatever the biggest problem is, even if we've talked about it ad nauseam, that's where the effort should be put into trying to figure it out.

KATHY: Yeah, I can foresee some PhDs working on this cycle and focusing on details like that. But it has been, I think, a big shift. Just anecdotally, we're hearing from recent college graduates, high school graduates, etc., that finding work is much more difficult for this year's class than it was last year, or the year before, or the year before that. And so it is a worrying situation when that happens. So yeah, we'll have to see how it all plays out. Like you say, maybe it's just Claudia Sahm warning everybody about a recession, and they're all holding back. So we'll circle back with you and see if you're the culprit or not. But I kind of doubt it. I kind of doubt it.

Well, with that, I really appreciate your time today. Again, I know you're busy. Everybody wants to interview you. So really thrilled that you were able to find the time to come back and speak with us.

CLAUDIA: Great, well, thanks for having me back. I appreciate it.

LIZ ANN: Well, always great to hear from Claudia Sahm herself. So beyond all this Fed chatter, Kathy, what are you going to be watching out for next week?

KATHY: Well, you know, we always have the weekly jobless claims numbers. And I think given the focus on the job market, that's probably going to be the main thing that I'm interested in, along with the kind of the usual commentary that's going to come out from Fed officials now that the quiet period is over. Once the meeting ends, they start talking again. And I think we'll get some more depth of understanding of how the meeting went, what the factors were that played into it. So those are the main things for me. What about you, Liz Ann? What's on your radar for next week?

LIZ ANN: Well, speaking of the Fed, and maybe in light of stronger than expected Empire data[1] that we got, you've got, think, four regional Fed data points out next week: Chicago, Philly, Richmond, and Kansas City. We'll have to see whether it corroborates some of the strength that we saw in Empire. We also have S&P Global's version of the PMIs. They're not quite watched as widely as ISM, but if they diverge, sometimes that can be market moving. So ISM, by the way, is the Institute for Supply Management. And then really important these days is a lot of the housing data. So we get a whole bunch of different metrics on home prices as well as home sales. 

We've got both consumer confidence and consumer sentiment coming out. Conference Board puts out consumer confidence, and University of Michigan puts out consumer sentiment, and one tidbit that is worth noting, and more important maybe when there's big divergences between the two, consumer confidence, based on the questions asked, tends to key more off of what's going on in the labor market, whereas consumer sentiment tends to key off more what's going on in the inflation data. So always keep that in mind with those two readings. And then we also get personal income and spending and an update to GDP and then PCE, the Fed's preferred measure of inflation. So we got a busy week next week.

KATHY: No break, no rest for the weary here.

LIZ ANN: Well, that's it for us this week. Thanks as always for listening. And as always, you can keep up with us in real time on social media. I'm @LizAnnSonders on X and LinkedIn. I am not active on Facebook. I am not active on Instagram. So if you think you see something from me, it's an imposter. So keep that in mind.

KATHY: And I'm @KathyJones, Kathy with a K, on X and LinkedIn. And if you've enjoyed the show, we'd really appreciate it if you'd leave us a review on Apple Podcasts or rating on Spotify or feedback wherever you listen. You can also follow us for free in your favorite podcasting app.

LIZ ANN: And next week I will be speaking with Doug Ramsey of the Leuthold Group, so stay tuned for that, and we will talk to you next Friday.

KATHY: For important disclosures, see the show notes or visit schwab.com/OnInvesting.

[1] Empire State Manufacturing Survey, monthly survey of manufacturers in New York State conducted by the Federal Reserve Bank of New York. https://www.newyorkfed.org/survey/empire/empiresurvey_overview