'This impulse of inflation... is going to be much higher than the Fed and market participants are expecting right now': Strategist

Investment Strategist at ClearBridge Investments, Jeff Schulze, joined Yahoo Finance Live to break down what investors can expect from the FOMC meeting this week and what to keep an eye out for.

Video transcript

SEANA SMITH: We want to bring in Jeff Schulze. He's Investment Strategist at ClearBridge Investments. And Jeff, when you take a look at the market's reaction today, I think investors are trying to figure out where we stand in this inflation debate. Because we have some conflicting signals when it comes to the latest data. We had the PPI report that came out this morning, showing a 6.6% increase on an annual basis.

Yet, when you take a look at the price of lumber, that has really sunk over the last several trading days. And we know lumber prices have really been so central to this inflation debate recently. Where do you stand just in terms of the data that we're getting and whether or not the inflation pressure will be transitory?

JEFF SCHULZE: I do think that the inflation pressure is going to be transitory. And a microcosm of that is lumber, right. You had a lot of demand for housing, created a situation where lumber prices increased dramatically. There wasn't a lot of supply. But now you're seeing demand destruction. And you're seeing supply come back online. So ultimately, I think a lot of these global bottlenecks are going to be alleviated as more and more countries reach herd immunity, and we get back to normalcy sometime in the fall maybe even early part of the winter.

But I do think that this impulse of inflation, although transitory, is going to be much higher than the Fed and market participants are expecting right now. So I'm expecting some more hotter inflation data. But ultimately, I think those pressures ease as we get into 2022.

ADAM SHAPIRO: So if I'm an investor listening to the discussion Jeff, I'm curious. Because we're getting projections and we'll get the dot plot stuff from the Fed tomorrow. We'll have great GDP, perhaps, projections this year. But then we go back to the old normal and nothing better than 2.2% as soon as 2023. As an investor, should that be something I should be leery of?

JEFF SCHULZE: You shouldn't. 2.2% is a little bit higher than what we've had in recent history. But we're just going back to the pre-2014 norms for inflation. I think this FOMC meeting is going to be really important, though. You did mention that. I think that's probably the most watched event of the week. And I think the Fed is going to start talking about talking about tapering.

But I think Powell in the press conference is going to reiterate that this is just getting the ball moving forward about the tightening process. They have nowhere come close to reaching their mandate for employment, likely going to be August or maybe even September before they're comfortable laying out a path of tapering that will start likely next year. But, again, even though inflation is higher than what we've had here recently, I think we're going to see disinflation over the next couple of years because of the abundance of labor market slack.

SEANA SMITH: Jeff, any concern from you that the Fed will be a little bit too slow to act on that?

JEFF SCHULZE: Well, the Fed has said specifically that they're going to wait to see the whites of the eyes of inflation before they're going to move, right. They want to see the unemployment rate at pre-COVID levels. And they want to see sustainable 2% inflation. And sustainable is really the key here. So they're purposely going to be behind the curve, which is automatically going to create an overshoot of inflation.

But if you look at forward-looking market pricing of inflation, they see an overshoot over the next five years. But more importantly, from 2026 to 2031, the market is pricing inflation coming back closer to that 2% level. So the market sees this overshoot. They're pricing it. But they do think that the Fed is going to be credible when the time comes.

ADAM SHAPIRO: Jeff, can you follow up on what you said about disinflation because of the labor market slack? Because the expectation is lots of people will be coming back into the labor market when the unemployment benefits, the extended benefits, expire in September. But what did you mean by disinflation in relation to that labor market slack?

JEFF SCHULZE: So we did an analysis going back 65 years. And we looked in both high inflationary regimes and low inflationary regimes. In the beginning of an economic cycle for the first three or four years, you see disinflation. You see inflation coming down because of the abundance of labor market slack. And I know, at this point, we have a labor shortage. You have record job openings. But unfortunately, you just don't have the bodies to fill those jobs.

But I think this labor bottleneck is going to be alleviated over the next month or two. There's a lot of people that aren't in the labor market because they're scared of getting COVID. But we're likely going to hit herd immunity by July 4th, that will reintroduce those individuals. Obviously, parents were home because of the irregular school system. Schools are going to be back to normal here. We're in the summertime, should draw those people back into the labor market.

And finally, 25 states are ending the federal unemployment benefits. And that's going to come due in the beginning part of July, which will free up about 4 million individuals. So we're not going to get a view of that until the July print of the jobs report. So we could see some higher inflation and the wage growth over the next month and a half. But, again, I think that this dissipates as we move later into the summer.

SEANA SMITH: So, Jeff, investors who want to put money to work right now, where should they look?

JEFF SCHULZE: I think that the 10 Year Treasury is in the process of bottoming. I think it's going to rise as we move through the reopening. I think inflation expectations are firming and going to be moving higher. And that's going to be a nice tailwind to the value slash cyclical complex. So I think value cyclicals are going to do well over the next, call it, 3 to 5 months, at which point it may be a good opportunity to look over at growth and defensives. But we're just not there quite yet.

SEANA SMITH: All right, Jeff, always great to hear your perspective. Jeff Schulze, Investment Strategist at ClearBridge Investments.