Episode 2

May 18, 2021

Three inflation and rates questions for Rich

Steve sits down with Rich Familetti, CIO of Total Return Fixed Income at SLC Management, to discuss all things inflation and rates.

Steve: This is “Three in Five - an SLC management podcast.” Hi everyone thanks for tuning in I’m Steve Peacher, President of SLC Management, and this is “Three and Five”, in which we ask three relevant questions to experts across our platform. Today I’m speaking with Rich Familetti who's the Chief Investment Officer of our Total Return Fixed Income team. Thanks for joining, Rich.

Rich: Thanks Steve, thanks for having me.

Steve: Okay Rich first question: there's a lot of talk about inflation. Warren Buffett recently commented that he thought inflation was “red hot,” and that they were finding that consumers were accepting price increases across their various businesses. So Rich, as a fixed income investor, how are you thinking about inflation in the short term and long term?

Rich: The big question is the long term. I’ll throw in a couple of numbers in terms of expectations. Coming up Unit Labor costs are expected to rise 4.2%1, CPI is expected to rise 3.6%2 and PPI 5.8%3. So, expectations are high. And the big question is around how persistent inflation will be. We think inflation will persist and I’ll give you a number of reasons. We've seen industrial commodity prices rise very aggressively, that hasn't all been passed through to the consumer yet. Food commodity prices, the CRB food index is up 38%4 in the last in the last year and a half. Corn is starting to look like a cryptocurrency. Inflation expectations by companies and individuals will start to become important, right, and so how expectations can drive further inflation. And so, to the extent that these things continue to play out inflation and the risk of inflation can continue to grow. Another couple of data points: labor force participation has been very slow to recover5, so expect wage inflation. And supply chains are stretched6. I think I’ll give you one quote, this quote, this is from the CEO of Colgate-Palmolive, Noel Wallace. He said “Straight price increases will continue to be an important element, as we look back at the back half of the year.” He said, “I anticipate that you will see more price increases across the sector given headwinds that everyone has faced in the space.” And we've heard similar things from Apple from Coca-Cola, Kimberly Clark. A number of companies expect higher prices in the future.

Steve: Okay, I like crypto-corn, that's going to be the new thing. So interest rates are obviously up in response to inflation expectations and a strong economy. Today to 10 year’s around 1.56%.7 So Rich, what is your outlook for rates? Do you think treasury yields will be higher or lower a year from now?

Rich: Yeah so, clients ask us about a rate expectations quite often, and we always start out by pointing out that we de-emphasize interest rate anticipation. So, here's our rate call and we are always right, of course, since we don't have to bet on it. We think we're in a bear market. For bonds, two and a half percent three and a half percent, easily possible for the 10 year note over the next 12 months. The combination of fiscal stimulus, stronger growth, positive public health outcomes. All we all expect that to lead to higher rates. I’ll say this, there was a term from the 90s, “the bond market vigilantes.” And so don't be surprised if the bond market vigilantes show up. I have another quote, this is an interesting one. I'll tell you who it was after I after I say it. “I used to think that if there was reincarnation I’d want to come back as the President or the Pope, or as a 400 baseball hitter. But now I would like to come back as the bond market, you can intimidate everybody.” That's James Carville, who worked for Bill Clinton back in the 90s, forcing the government to reduce deficits. If you can remember, interest rates rose to almost 300 basis points in a year. Would not be the least bit surprised given all the things going on to see something like that again.

Steve: Okay I love the quote. You know the market hasn't really had to focus on Fed rate increases for last few years. Treasury Secretary Yellen made headlines the other day when she indicated that rates might have to rise to avoid an overheating economy. So my question is, what do you think the Fed will need to see before they start raising rates or tapering bond purchases and when do you think that's going to happen?

Rich: It will be a race between inflation and full employment and while keeping in mind those bond vigilantes. Right so, to the extent that inflation continues to rise and becomes a political issue for people's wallets, that can start to drive the Fed. We still expect that until they see what in their view is full employment, which may not happen for another year, that they won't start to raise rates. The other interesting question around the Fed is not just when they start raising rates, but how much and how quickly. And given everything we've talked about so far it's entirely possible that expectation could increase quite quickly.

Steve: Okay that's great. I got one more bonus question. Rich I know you're a fan of live music, which has obviously been curtailed since the start of the pandemic. And my question is what's one of the best performances that you remember prior to Covid and attended?

Rich: Well, I’ll mention a couple but I’ll start by saying this: Saturday March 7th, 2020 was the last live show I attended, it was at a venue in Brooklyn and it was so crowded – wall to wall people – that I’m frankly surprised it didn't contract Covid. The band was Destroyer. Prior to that and I saw a number of bands – Jeff Tweedy from Wilco, which I highly recommend. Squeeze, which you might be familiar with, that's a band from the 80s. I saw a band called Barrence Whitfield and the Savages, Steve I know you like blues and if they ever come around to Boston I highly recommend it. And then the only other thing I’d add is all last summer’s concerts were cancelled and so we're so we're very hopeful about seeing Green Day and Rage Against the Machine and a German heavy metal band called Rammstein.

Steve: Okay, I love it well, hopefully we're close to seeing those concerts ramp back up. So thanks Rich and thanks to everyone for listening in.

Rich: Thank you.

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1 https://www.cnbc.com/2021/03/04/us-productivity-q4-2020.html#:~:text=Unit%20labor%20costs%20%E2%80%94%20the%20price,pace%20that%20was%20initially%20estimated

2 https://www.bls.gov/news.release/archives/cpi_05102019.pdf

3 https://www.bls.gov/news.release/ppi.nr0.htm

4 https://tradingeconomics.com/commodity/crb

5 https://www.pewresearch.org/fact-tank/2021/04/14/u-s-labor-market-inches-back-from-the-covid-19-shock-but-recovery-is-far-from-complete/

6 https://www.cnbc.com/2021/04/15/supply-chain-slowdown-hits-at-key-pillars-of-economy-and-will-likely-get-worse-dan-yergin.html

7 https://www.marketwatch.com/investing/bond/tmubmusd10y?countrycode=bx