Inflation: The Fed is ‘between a rock and a hard place right now,’ strategist says

Drew Matus, MetLife Investment Management chief market strategist, sits down with Yahoo Finance Live to discuss how market sell-offs could impact the Fed's interest rate hike cycle, inflation, the labor market, and the outlook on the market's volatility.

Video transcript

SEANA SMITH: We have about 45 minutes to go until the closing bell. And you're looking at another day of selling, all three of the major averages in the red as the S&P enters a bear market. Nine of the 11 S&P sectors moving to the downside. Consumer discretionary the worst performer, with XLY off just over 3%.

We want to talk about what all this means here what Drew Matus. He's MetLife Investment Management chief market strategist. It's great to see you. When you take a look at what an awful week it has been, the S&P sinking into a bear market, absolutely brutal selloff, Drew, how do you think this plays into the Fed's calculus? Do you think it will prompt the Fed to change its policy?

DREW MATUS: I think eventually, it will. They're between a rock and a hard place right now. They can either accept sharply slowing growth or leaving inflation where it is. But the question really becomes, with inflation, at least, what can the Fed do about it? Your last guest was talking about supply chain issues and disruptions there.

And a lot of the inflation that we're seeing is actually because of supply chain issues that the Fed can't readily solve, and even though they seem like they're going to try. And I think that's what's gotten people a little bit nervous, is this idea that the Fed thinks they can do something that a lot of people don't believe they can do.

RACHELLE AKUFFO: And Drew, a lot of people are wondering, are we just going to start feeling this pain still through the end of '22, or will we really see the repercussions start showing up in 2023? What are you keeping an eye on?

DREW MATUS: Well, I'm keeping an eye on job openings. And I'm keeping an eye on margins. Because the way I view the world is that what happens is, firms begin to see margins contract. Those firms then react to margin contraction by reducing hiring and reducing investment. Maybe not immediately, but at least their plans for hiring and investment begin to come down. And so all of this works with a lag.

Firms identify that their margins are compressing a little bit. Firms try to figure out what to do about that. Firms identify expense management, investments, job opening cuts, et cetera, as a way to kind of maintain their margins by reducing expenses. And that translates into lower employment growth going forward. But it's not going to be something that happens this month. It's going to be something that the decision-making process starts this month and ends up happening later in the year and probably most impacting early 2023.

SEANA SMITH: So, Drew, what does all this, then, mean for the odds of a recession?

DREW MATUS: Well, the odds of a recession if the Fed keeps trying to hike interest rates in the context or against the backdrop of financial market stress, it probably means that you end up thinking that a recession is increasingly likely, as you get further and further into 2023. By that point, monetary policy works with the lags. All the rate hikes they've done so far actually haven't affected the economy directly yet. They're going to directly affect the economy about 9 to 12, 15 months from when they actually occurred.

And that should be around the same time where firms are making those adjustments to maintain their margins. So just as you're beginning to see maybe job openings come down a little bit, you'll also begin to see the real effect on the economy of interest rate increases. And so this is one of the quirky aspects of monetary policy, is, they're hiking rates to contain inflation that they really can't control. And by doing so and by being aggressive about it, they might actually negatively impact the economy at a time when the Fed might actually want to be providing a little bit of support, instead.

RACHELLE AKUFFO: And obviously, we know that the Fed has its laser focus on bringing down inflation without really keeping an eye on what's happening with the equity markets, but as you say, that's going to end up with job losses and other things. How aggressive, then, will the Fed need to be at this point, if they are sort of pricing in some of those expectations?

DREW MATUS: Well, I think they've been pretty clear they're going to go another 50 at the next meeting. And then I think kind of all bets are off because I think you are going to begin to see some reduction in job openings. You're going to begin to see more complaints about margins.

And as you see those complaints, what you're going to see is the equity market respond to that. And none of those are good for long-term equity market activity. Consumers are already stressed because of inflation. They're stressed because of shortages, right? It's one thing to say you have to pay more for an item. It's another thing to not even be able to find the item in the first place, right?

So it's kind of the macroeconomic way of saying, your money's no good here. It's the ultimate devaluation of the currency. You go into a store and you want to buy something, and you actually can't find what you want to buy. In that case, the price for that good is effectively infinite.

SEANA SMITH: Drew, what about the wild swings that we've seen? And taking a look at the NASDAQ right now, still off just over 2%. But we've seen these 1 and 1/2% to 2% swings. It almost seems like daily recently. Should we brace for this type of volatility to continue?

DREW MATUS: I think volatility is a natural consequence of the fact that most people don't know how to price a lot of what's occurring. And by that, I mean, you know, how do you-- right now, everyone's guessing that the Fed is more concerned about inflation than growth. But that could change, right? And so but we don't know the probability of that changing. There's a geopolitical component. There's a food price component. There's a shortages component. There's supply chain components.

And sometimes, things just get too complex for the markets to actually effectively deal with. And that's when you see this kind of movement back and forth, because it really depends on who showed up for work that day and whether or not they had a desire or a plan that they wanted to implement for investing the money that they're entrusted with.

RACHELLE AKUFFO: Certainly, thank you for breaking all that down for us. Drew Matus there, MetLife Investment Management chief market strategist. Thank you.