COLLIN MARTIN: I'm Collin Martin.

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

COLLIN: 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, hello Collin. Busy day as we're recording this. We are recording this very shortly after the Federal Open Market Committee, or FOMC meeting, where the Fed voted to raise interest rates. And it's the first rate hike that we have seen since 2023. It was 25 basis points, which was what expected, and there were no dissents, which may be a little bit of a surprise.

So for listeners who haven't been tracking the Fed's every move like we have, Collin, maybe start by giving us some context here. Explain the why behind and maybe what some of your takeaways were, whether it was from the statement or the dots plot or the summary of economic projections or Powell's somewhat abbreviated… Powell, listen to me.

COLLIN: Powell.

LIZ ANN: Powell. Warsh's. Kevin Warsh's abbreviated press conference.

COLLIN: Well, you mentioned, you know, the listeners who aren't paying attention, I applaud you because it's hard to watch or listen or read any sort of financial media without hearing about the Fed these days. So I'm glad that today happened and now we can talk about it. But of course that means we'll just look ahead to the next meeting. So you asked about the why. I think that's always important. So to recap what you just said, Liz Ann, the Fed raised interest rates by a quarter of a percentage point today, 25 basis points.

The why is because inflation's just too high. I mean, that's really the simple reason. The Federal Reserve has a dual mandate of maximum employment, which is the labor market, and price stability, which is inflation or price changes. And if we take a step back and just look at the economic environment we're in right now, the economy remains resilient. In fact, Warsh talked about it and actually said strengthening, not just strong, but "strengthening" economy. The labor market is pretty stable and the unemployment rate's actually been declining. So you can kind of check that side of the dual mandate. But inflation's just too high. So an adjustment seems necessary. And that's the why, but we can look at some specifics over the past few weeks as to as to why they did it now.

And if we go back to the speech that Warsh gave at the end of August, it was a little bit more hawkish, meaning he was more on the side of potential rate hikes coming where he mentioned that underlying trends in inflation haven't meaningfully improved. And he doubled down on that today. And notably he talked about kind of speed being the issue of… not so much that inflation is re-accelerating or that they're worried that they won't ever get to the Fed's 2% target, but that it was just taking a really long time. We're past the five-year mark of most of the key inflation indicators being above target.

And the statement that comes out with the decision, it suggested that where it said that this decision will help for a "timelier" return to the 2% target. I thought that was interesting. We don't see that language too often. You mentioned the dot plot, Liz Ann, and some economic projections. So at every other meeting, the Fed comes out with their updated summary of economic projections where each of the committee members, both voters and non-voters, project where they see the economy growing, gross domestic product, or GDP over the next few years, the unemployment rate, and inflation as measured by PCE, the Personal Consumption Expenditures indices, both on a headline and a core basis. Core excludes volatile food and energy prices. There weren't major upgrades there. They were kind of as expected, slightly stronger growth, slightly higher inflation. But only a little bit relative to June.

But more importantly, the core PCE projection doesn't even have the Fed hitting their target in 2028. You know, and that and that's a problem. So I mean maybe that sums up the hike right here that if they're not expecting to hit their target for two plus years, then a hike seems appropriate. And then with those projections, each official, with the exception of Kevin Warsh, because he chooses not to submit these projections, they project where they see… or where they project Fed policy to be at the next few years. So the end of this year and the end of 2027 through 2029. And they moved up a little bit. So in addition to the hike today, the projection going forward is pricing in another hike this year. Projection, of course. We can't take that as a guarantee or anything like that. That's a point-in-time projection from each committee member.

And if we look ahead to 2027, for example, the projection in 2027 does not project, the median dot does not project another rate hike, but there was more of a hawkish bias there, where 8 of the dots did project one additional hike next year. It wasn't enough to move the median, but it was hawkish nonetheless. I think it was a lot more hawkish than the markets or other investors were expecting.

And one final thing, and then I'll pass it to you, Liz Ann, to kind of hear your thoughts. In the press conference, Kevin Warsh said when he talked about the hike, he said that the committee removed a dose of accommodation. So, you know, one, that's kind of a callback that maybe the cuts last year were not necessary, but it suggests or maybe it's more definitive than a suggestion that monetary policy is in fact accommodative and not restrictive. And if it's still accommodative, and this is just removing some of that accommodation, that's I think why we saw those dots projecting another hike or two suggesting that this isn't just a one-and-done. So what are your quick thoughts?

LIZ ANN: Well, we obviously saw a negative reaction by stocks in the somewhat immediate aftermath of the press conference. And that shouldn't come as a surprise given the move back up above 5% on the 10-year, and as a reminder, the 10-year yield tends to be the yield that matters most to the equity market in terms of driver up and down or and or volatility. I also think that the market has been struggling not just with the move up in yields, but the fact that a lot of this inflation, forward-looking risk, current unacceptable levels of inflation, there's been so much discussion about it being mostly supply driven.

In fact, one of the questions by reporters during the press conference with Warsh was about the Strait of Hormuz and, you know, 25-basis-point rate hike is not going to open the Strait of Hormuz. And he talked about the fact that there are ripple effects associated with inflation. But it's also the case that yes, most of the inflation increase and the stickiness of inflation, particularly in the aftermath of the start of the war with Iran, has been supply-side driven. But there's a demand side component of this, too.

AI is a piece of that with massive capex, and that's putting upward pressure on prices that feeds back into consumer prices, a lot of discussion about many of the consumer-tech companies raising prices. You've also got the latest NFIB survey, which is the National Federation of Independent Business. That's a small business survey. And one of the questions asked on a monthly basis is, "What's your single most important problem?" And what's at the top of the list right now is labor supply. So there's even a little bit of a labor component.

Not quite to the point where we could call this a wage-price spiral, in fact, not even close to that, but there is a little bit of a labor component. And that's where the Fed can have an impact, is it can bring demand down. And there's no shortage of strong economic data, including what we got today, as we're taping this, which was much stronger than expected retail sales pretty much across the components therein. And even the control group, which is the portion of retail sales that feeds directly into GDP caused the Atlanta Fed GDP Now, which they track on a day-to-day basis as data comes in. And it's the reason why they call it "GDP Now" is it's important to note that it's not a forecast by the Atlanta Fed. It's a "nowcast," meaning that as data comes in throughout the course of the quarter, it gets fed into this model and then it spits out basically the run rate for GDP.

And that just moved up from, you know, a few days ago from 4.4% to 5.1%. And that's a real GDP number, already inflation adjusted, which means nominal growth is a lot hotter than that. So that's why I think you haven't seen maybe more turmoil in the equity market where we're at about a… I think from the intraday low today in the aftermath of the FOMC meeting, the S&P I think was down about 3.7 or 3.8% from the mid-August high. And I think that's because, you know, a 5% 10-year yield is reflective of what's going on in the economy from a nominal growth standpoint, from an inflation standpoint, from a Fed expectations standpoint. And it's been somewhat orderly. I think were it to become more disorderly or you were to see a big spike in volatility in Treasuries, then I think we could see maybe something a little bit more meaningful in the equity market.

In the meantime, you're seeing a little bit of a lift to the more defensive areas, some of the classically cyclical areas of the market exclusive of AI driven areas have been under a little bit of pressure and that's what you would expect as well. So there was not a lot that was terribly surprising to me coming out of the meeting today.

COLLIN: On the equity reaction, I can point to the Treasury market and I think what caught the markets off guard, when you look at the 2-year Treasury yield jumped pretty sharply, about 4.74% right now following the meeting and the press conference, because this was a little bit more hawkish than expected. So the idea that the Fed might hike a little bit more. Do you think that's the main driver of the drop in equity prices? Where we had this idea that yields were high-ish but also reflective of a pretty strong economy. But if now the Fed has to be more aggressive than we or the markets thought, that, you know, discount rates matter and that's actually having more of an impact now.

LIZ ANN: Yeah, and it flattened the yield curve a little bit. Banks really got hit and that tends to be a leading indicator for the economy broadly, but specifically the consumer part of the economy. So yeah, the market is a forward-looking mechanism. It has a reaction function as we all learn on a day-to-day basis in the aftermath of any kind of economic reading or inflation reading, but it's also still a forward-looking mechanism. So I think that's what it's pricing in.

COLLIN: You know what I found pretty surprising is… maybe not so surprising now that I see the full picture, but it's not what I expected, the move up in the 10-year Treasury yield. Not recently, but specifically following the meeting and the press conference. So the 10-year Treasury yield has been over 5% now for a couple of days. It's been bouncing around that 5% level. And I actually thought that a Fed hike could bring yields down a little bit, for two reasons.

Because when the Fed raises interest rates, it can help keep inflation expectations anchored. But then also it can show and support the idea of Fed credibility. Now, I've been in the camp that the Fed has not lost credibility, had not lost credibility, but I think there was a risk if they didn't hike or didn't make it clear that they were going to hike to really bring inflation down, then we'd have a credibility issue. And they followed through on that. So that's great. That was a success. But what we're seeing is the 10-year Treasury yield is now up a little bit. So at its low today on Wednesday, it touched 4.94%. Now it's close to 5.02%. So up about eight basis points from the intraday low.

And that could be because Warsh kind of… he talked about some of those drivers. He talked about the economy being strong and strengthening. That I think… that's a key driver of where yields are right now. If the Fed is neutral or below neutral and the economy's growing, you should see a positively sloped yield curve and 5% shouldn't be out of the ordinary. He also mentioned, you know, how much competition there is for capital with, you know, corporate bond issuance and hyperscalers. And those things probably aren't going away. So the if the economy's doing OK, you mentioned the strong GDP Now from the Atlanta Fed. if we're still seeing a lot of AI build out, inflation's still sticky, our fiscal concerns aren't going away anytime soon.

LIZ ANN: You don't think so? They're not going to just miraculously go away.

COLLIN: You know, define soon. But no that's a good question, Liz Ann. So I don't think that's a big driver of the recent move up lately. If you look at the 10-year Treasury yield, it has moved up pretty sharply over the past few weeks. It's not like collectively the world woke up and said, "Whoa…

LIZ ANN: We have a lot of debt.

COLLIN: "…the U.S. has, you know, $40 trillion in debt. We know that." So that's actually not a big near-term driver, but it's something I worry about, that over time we need to kind of attract those marginal buyers.

LIZ ANN: And you know, the other thing, I've seen a couple of articles recently, including from some television commentators about…. that it would be a mistake for the Fed to raise interest rates because it would put further pressure on lower-end consumers, which is where that's the low-end of the K-shape that we have talked about ad nauseum on this program and in writings that we have done.

But the reality is that for lower-income consumers and many small businesses, their borrowing rate is not tied to the Fed funds rate. Their borrowing rate is tied to longer-term yields like the 10-year. So back to where we started this conversation, I think that, and you mentioned it, if the Fed had not raised rates today, not only would it have been a credibility problem, but you might have seen the 10-year yield go up even more, with the bond market's message being "You might have to hike even further later, inflation isn't under control. Why are you not acting?" So that potentially would have done more damage to those that borrow not at the very short end.

COLLIN: And that's a great point to kind of differentiate what the Fed influences and what it doesn't necessarily influence, at least in a direct fashion. So the Fed funds rate is an overnight rate. So it directly influences, you know, Treasury bill yields or the yields offered on short-term CDs, you know, of a few months. The yields income paid on money market funds tend to be influenced by the Fed. But if you're a borrower, it's things like home equity lines of credit, credit card rates, auto loans or more on the short end, but not necessarily mortgage rates. And to get mortgage rates down, and they're very high right now because they're tied to, you know, the 10- and 30-year Treasury yields, we need to see inflation come down. So it sounds counterintuitive, but raising rates can bring down inflation, can bring down inflation expectations, and over time, not necessarily in the in the here and now, but over time can help bring mortgage rates down. So it can be a good thing.

LIZ ANN: That's enough Fed talk for now. But we're going to have a lot more of it over the next few months, no doubt. But what else is on your radar in the near term, Collin? Look ahead to next week. What matters… what matters most? What reports are you keeping a close eye on?

COLLIN: Yeah. So we will get a number of Fed speakers over the next week. So as we approach every Fed meeting, Fed committee members go in a blackout period, a communications blackout period where they're not allowed to comment on monetary policy, and that expires later this week. So once that opens up, the floodgates open up and you start to hear from each you know, voter or non-voter, but the voters are important to hear from about their why. Now in this case, there might not be too much to hear because it was a unanimous vote, as we've talked about, which I think was pretty interesting, unanimous vote. So we know that inflation is still an issue, but we can get more nuanced takes from each committee member about maybe indicators they're looking at, and for them, what might be considered progress, right?

What are benchmarks they're looking at where they might be more comfortable that policy is no longer accommodative, maybe it's now restrictive, and what indicators on the labor-market front or inflation front that they'll be paying attention to. So that'll be important. There's a lot of stuff on the economic calendar, nothing too market moving. You know, we have some of your favorites, S&P Global's Purchasing Managers Indexes, the PMIs. I know you like talking about them, but we'll get those, which is a good preliminary look at September.

We also get the University of Michigan sentiment indicators and inflation expectations, as well as a few regional Fed District Bank surveys on the activity side. One thing I'll plug, Liz Ann, following this is… our team will be publishing an updated article next week, specifically on kind of what next for the Fed and Treasury markets, given this more hawkish pivot. So if you're looking for more insights or charts or visuals next week, our team will be publishing an update there. So Liz Ann, what about you? What will you be paying attention to?

LIZ ANN: All of those things. I think the jobs data now becomes in focus again. So we don't get a… we don't have a big jobs report next week, but we get the ADP weekly data and initial unemployment claims just to see whether the pickup that we saw in payrolls is carrying through to other labor-market data. I also wanted to just touch on the S&P global version of the Purchasing Managers Indexes.

We touched on that before, but I just wanted to highlight a couple of the methodological differences between the two and why I don't dismiss S&P Global's and I look at it just as carefully as I do those that come out from the ISM. So S&P Global actually surveys a larger number of companies. It's 1200 companies versus I think it's 800 for ISM. So it is a little bit more representative, in terms of U.S. manufacturing. ISM also attributes the various variables with this all the same weighting. Their attribution is sort of equal, where S&P global has more of a weighted effect, so a little bit more granular. And in addition, ISM, the surveys are based on data from just purchasing and supply executives where S&P Global, their survey also goes to a broader spectrum of job titles, including CEOs and CFOs. So you get a little bit of a more robust flavor.

ISM has a longer track record, a longer history of doing this survey, but I would say that S&P Global is growing in importance because it actually has done a little bit better a job at providing kind of real-time signals and a little bit less noise and that helps to just figure out whether you're at an inflection point or not. So I just wanted to be a little more specific given that I've mentioned that a few times.

LIZ ANN: Well, Collin, that's it for this episode. And to our listeners, thanks always for tuning in. We really do appreciate it. And if you don't want to wait a week until the next episode, you can always keep up with us in real time on social media. I am @LizAnnSonders on X and LinkedIn. Still have lots of imposters. Please make sure you are following the real me.

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

LIZ ANN: And also, to our listeners out there, did you know that word of mouth is the number one way people discover new podcasts? It's certainly the way I have typically discovered new podcasts. So we would love if you would tell a friend about On Investing or any of Schwab's podcasts.

And if you want to go the extra mile, please consider leaving us a review on Apple Podcasts, a rating on Spotify, or feedback wherever you get your pods. And we will be back with a new episode next week.

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