Fed: 'There’s a lot of tension and friction' between full employment and inflation, UBS analyst says

Stuart Kaiser, UBS Head of Equity Derivatives Research, joins Yahoo Finance Live to discuss the balancing act that the Federal Reserve must navigate when it comes to the areas of achieving full employment and mitigating inflation as needed.

Video transcript

SEANA SMITH: We want to continue the conversation on what we're seeing play out in the markets. For that, we want to bring in Stuart Kaiser. He's UBS head of Equity Derivatives Research. And Stuart, it's been a pretty eventful past 24 hours or 36 hours, I guess you can say, for the market. We got the reappointment of Fed Chair Jay Powell. It looked like the markets, initially at least, were excited about that. Today, we're looking at some selling when you take a look at the S&P and NASDAQ. What are you-- where do you think the markets are headed between now and the end of the year?

STUART KAISER: Yeah, good afternoon. Thanks for having me on. I mean, I think you all hit on it pretty well, which is post the FOMC announcement, you've had a strong performance of banks and, you know, some pretty strong headwinds from large cap tech. And I think, ultimately, that large cap tech trade is going to probably determine the rest of the way the year plays out, just in the sense that it's the market leadership, and the market leadership has been fairly narrow for the last couple of months.

And I think initially, the markets were happy with the FOMC decision in the sense that it was sort of a continuity play, to some degree. But then rates started to rise, and a lot of folks read negative rates as negative for big cap tech. So I think, you know, the trade-off we're going to have here is that, you know, tech has been market leadership. It's obviously a strong earnings growth and free cash flow engine for US equities. But if you believe it's going to come under pressure from higher yields, then you end up with kind of a difficult kind of catch-22.

So I think our base case is the market should be relatively clear into yearend. You know, we think a lot of folks have had a good year so far and just sort of want to get through 2021, which I think most people would agree has been a pretty high level of difficulty, investment environment. So that would be the base case. But, you know, the fact is you've got another inflation print coming up. You've got another FOMC meeting. And you've had rates rising. And I think those would be the risks to what our base case view is.

ADAM SHAPIRO: Stuart, the good news is getting through 2021. The bad news is we've got to get through 2022. So, with the reappointment of Jay Powell, yeah, we get the stability and all of those issues. But what kind of pressure is there going to be? Because the board is going to change in 2022. And where as investors should we pay attention? Right now, as you've pointed out, it's all on this full employment mandate. But is that going to shift?

STUART KAISER: You know, hey, Adam, it's good to see you again. I would say, look, we do think the early part of next year is going to put, you know, the Fed and, frankly, investors in a little bit of a tough situation in the sense that we don't see inflation peaking out probably till the end of the first quarter. So you've got another three to four months of what are going to be very high numbers on the inflation side.

And for a lot of investors at the beginning of the year, if you're looking out for the balance of 2022, you're probably going to be expecting some sequential slowing in both economic and earnings growth. So that combination of kind of higher inflation and slowing economic growth is going to be difficult. And, you know, likely, the markets are going to try to pressure the Fed if you start to see inflation, you know-- or continue to see inflation printing at the level as it is. So I would tend to agree with you.

I think early 2022, there's a lot to work out, both from a growth and inflation perspective. And, you know, again, ultimately, the Fed is going to be questioned on that. I think in the last FOMC press conference, there was a number of questions related to, you know, the idea that the Fed is trying to get to full employment. But if they're generating inflation, is that inflation negative for a larger share of the population, you know, than the employment mandate is helping?

So, you know, I would agree with you. I think there's a lot of tension and friction there. And I think early next year, you know, that friction should come to a head to some degree.

KARINA MITCHELL: How important do you think it is that this decision about the next Fed chair came before the next FOMC meeting? And then I wonder about wage growth. Is that something that they're looking very closely at? Are they worried about it?

STUART KAISER: I think it's important that they got the decision done earlier rather than later. I mean, this was not a deadline that snuck up on them, you know, so it's good to see that they addressed it and didn't kind of let it run into the FOMC meeting because, you know, to your point, I think it would have been a little awkward if this decision hadn't have been made, and you had a press conference, and the Fed needed to make any decisions or changes. So I think it's important just to get that out of the way.

In terms of wages, you know, I think they-- I would imagine they're concerned about it, especially from the perspective that real wage growth has been negative. So you're trying to create jobs to get to full employment. But those jobs have negative real wage growth because of high inflation. So I would imagine they're definitely paying attention to that.

To be completely honest with you, though, I think corporate America probably pays a little bit more attention to wage inflation than the Fed does because the Fed tries to look at things holistically. So I think for your typical equity investor and for your typical, just, you know, American who is sort of earning wages and paying for things, you know, wage inflation might be a little bit higher priority than it might necessarily be for the Fed. But it's certainly still, like, a tier one consideration for the Fed, I would say.

SEANA SMITH: Stuart Kaiser, always great to speak with you. UBS's head of Equity Derivatives Research, happy Thanksgiving. We look forward to having you back here on Yahoo Finance.