Fed’s record on soft landing ‘not particularly good,’ strategist says

Wells Fargo CIO of Wealth & Investment Management Darrell Cronk joins Yahoo Finance Live to discuss signs of a recession during the Fed's interest rate hike cycle, inflation, and volatile markets.

Video transcript

- To mention, Jarod right there says, the market searching for a catalyst. I'm always learning from him. What is that potential catalyst that the markets are searching for, Darrell?

DARRELL CRONK: Good afternoon, Dave. So I think Jarod's exactly right. It's looking for a catalyst. I would say the two catalysts it's looking for is some reprieve in interest rates coming back down across the yield curve, which we're getting the last couple of days but more importantly, reprieve overall in the rate of inflation. I think specifically today they were very focused on Chair Powell's testimony in front of the Senate, which I actually thought was a little more hawkish than he was yesterday in front of the House.

So you know he was very outspoken on this idea of unconditional movement of inflation back down, which basically means he's willing to-- he and the Fed is willing to sacrifice unemployment and ultimately growth to bring that rate of inflation back down to the Fed's target.

- So then, Darrell, all this talk about a soft or even a softish landing, does that appear now to go out of the window based on what Powell is now saying?

DARRELL CRONK: I think he's finally confirming what everybody has known or I think most people have known for quite some time. If you look at the last 11 tightening cycles of the Fed they've only ever been able to soft land the economy three of the last 11. The last one was 1994. It had some unique circumstances to it.

So their history is just not particularly good here as far as being able to soften land economy, and particularly when they're going to make as aggressive of moves as they are and then couple that with quantitative tightening or shrinking of the Fed's balance sheet or [INAUDIBLE] portfolio simultaneously. The odds are just not in their favor that they can soft land this thing in a world where you already have decelerating economic growth and decelerating earnings growth.

- Darrell, what are some of the key levels that you're watching because there was lots of talk about 3,800 on the S&P. We obviously fell through that level when the S&P fell into bear market territory. So what's that what's that next level, the key resistance level that you're keeping an eye on?

DARRELL CRONK: Yeah, I think, well if you want to talk key support levels, I think 3600 is the key support, next major key support level. If we were to breach that with any conviction, then I think we probably move down to somewhere around 3400 to 3500. Below that, it takes you down to the 3200 to 3400 level, which is pre-COVID, kind of takes us full circle back there again. If you look at an average recession and bear market put together you're talking peak to trough decline of 33%. So if you use the January 3 high, that would represent a level of about 3250 on an average peak to trough decline of 33%.

So there are some really key support levels. To your earlier point though, I think it's important one. What might be as important as the resistance level, just any attempts to rally back to even the 2050 or certainly the 200, day which is a long ways away. Resistance levels have been met with failing into that resistance and selling. And they've been pretty meek attempts at this point with no real breadth or breadth thrust conviction.

- There were a couple of guests here yesterday, including Jim Paulson said, he's seeing data that the Fed is doing its job, that it is working. He's looking had a 50 point hike in July and a potential pause after that. What do you see coming?

DARRELL CRONK: Well, I think that might be a little optimistic. I mean, if you take Fed Governor Bowman out today, who was speaking same time Chair Powell was testifying, she was saying that another 75 basis points are in the cards for July. We think the Fed funds rate has to go to 3.25 to 3.50 And that's consistent with what Powell and the rest of the Fed governors are saying, which is they want the short side of the yield curve, in essence Fed funds, real rates to be positive.

The short side is the only place where they're not positive today, which would mean you'd have to take it up above the 3% handle by year end. We think they'll have to ultimately take Fed funds to 4% to arrest this latest bout of inflation. So I just, I can't believe that the Fed stops after 50 basis points after the next move. And the only reason it would, in my humble opinion, is if you had some kind of a liquidity shock or crisis where the Fed had to pull back to deal with that in the near term.

- So then if we take a look at what's happening with the bond yields then, what is that signaling to you and how should people be positioning their portfolios based on some of these signals you're watching?

DARRELL CRONK: Well, I think defense has to be the order of the day and continues to be the order of the day. It's interesting we're only between 5 and 6 basis points away from reinverting the 2 to 10 or 10 to 2 year spread, which is often your precursor to signaling recession. So there's a lot of look to see if it's time to buy duration out on the long side of the curve. Because obviously if the curve is going to continue to flatten or invert, owning duration could make some sense here.

I think the mistake on the bond side of thing is to go down the credit stack and buy lower quality credit in this type of environment, which is either late stage or next stage type of recessionary environment. So I would stay away from lower tier quality credit. We think it's a little early to buy duration yet. And then on the equity side you still have to play defense by lowering your equity exposure and kind of barbelling defensive sectors with, maybe energy is the only cyclical one you'd want to own with earnest there.