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The Federal Reserve keeping rates unchanged, but the FOMC acknowledging some softness in the labor market. Joining us now, Greg Dako, EY Chief Economist and Jeff Klingelhofer, Co-head of Investments and portfolio manager at Thornburg Investment Management. Greg, I want to get to you first here and thank you both for joining us. Um, let's talk about this new balance of risks here. In addition to the jolts report, we also got ADP this morning, and again, both showing, you know, under the surface, some signs of labor market weakening. Do you think that the Fed is acknowledging that enough?

I think this is still a bit of a two shy of a wink wink in terms of a potential rate cut in September. Uh, the Fed remains in my opinion too data dependent and backward looking in that regard. Uh, you've heard me talk this talk about this in the past, but um, I still feel like we should have more of a forward-looking perspective. If you look at the totality of data, you're seeing employment gains slow, you're seeing the unemployment rate tick up, you're seeing the jolt report as you were referring to indicating slower quits, slower hiring, slower job openings, overall the labor market is slowing and inflation continues to move towards 2%. So we're in the environment that would require uh, the Fed to start recalibrating monetary policy. I think it's pretty simple for Fed policymakers, but they're still erring on the side of caution being in my opinion way too backward looking in their assessment of economic conditions.

Now Jeff, as I, as I read your notes to us, I think you're a little more comfortable with the Fed maybe slow walking its process as we get towards, um, September. And I guess as we've seen the markets, you know, really aggressively decide September is going to be it, the Fed, and we'll see how Powell kind of handles that in the next 15 minutes or so. But I'm just curious how you see the landscape, um, and kind of what you think the Fed not only should be doing here, but really needs to do, um, to keep the economy either in the place that it wants to be or perhaps, um, you know, doesn't risk it, uh, getting into vulnerable situation.

Yeah, I mean, as I read the Fed statement, I think the Fed did exactly what they were supposed to do today. The market is a little bit too ebullient in terms of its belief that we are 100% priced for a move in September. And the reality is there are better balance of risks. Inflation is coming down, but it's not this immaculate disinflation story. It's coming alongside with a weakening economy. My, my, my main contention is the Fed shouldn't be necessarily forward-looking because nobody has a crystal ball. I think the goal of monetary policy is to cushion a cycle, but not try to engineer a cycle. The reality is the job market remains relatively strong, although weaker than it has been, and inflation remains elevated above its own 2% inflation mandate. So I think the Fed is appropriately on hold here. And, and I hope that what we see from Chairman Powell in the press conference is doubling down on needing to see more data that they are absolutely moving towards that 2% inflation objective. And I think we remain a relatively far ways away from having true confidence.

Um, Greg, game it out for me. What would it look like if the Fed did nothing the rest of the year? I mean, you know, obviously there's changing economic conditions, yada, yada, yada, but if you had to say today and game it out what that would look like, what would you see?

Well I think if we forward, uh, fast forward to the end of the year or potentially next year, uh, we're going to be in an environment where you're going to see ongoing disinflation and a rebalance labor market for which any further weakness, uh, would portend to slower income growth and a potential more significant pullback in consumer spending activity. You're already seeing businesses become more cautious, you're seeing signs of a slowdown in economic activity. If you have a higher for longer scenario where the Fed does not start to ease monetary policy, you're going to see a tightening of financial conditions. Combine that with an environment where there's increased focus on the fiscal situation in the US with elevated levels of debt, high interest debt payments, that could portend to a negative feedback cycle where interest rates actually rise further from here, and that leads to a more pronounced pullback in private sector activity. I really believe that the Fed needs to be much more forward looking, and I wouldn't be surprised that Fed Chair Powell in his introductory remarks talks about that greater confidence in the move towards 2%, and perhaps even signals in his press conference responses that there is openness for potential rate cut in September.

You know, Jeff, given I think where the markets saw the Fed headed, uh, really we came on the air, we're talking about like the action today is in video. So looking at that rotation, looking at what's happened, um, kind of in the Nasdaq and elsewhere, I'm curious how you've looked at, you know, not just the reaction to Powell or to the Fed statement today, which was not much of reaction, but what we've seen in markets over the last couple of weeks, I think investors start to really grapple with this next phase of the cycle. And we can debate all day whether they should go now, November, et cetera, et cetera, but we've seen markets really start to change their behavior. I'm curious how you've thought about that.

Yeah, I, I, I don't think it's really connected to the cutting cycle or potential cutting cycle of the Federal Reserve. I really think it's just markets got far too ahead of themselves of pricing in the significant growth runway of AI. And what we've told clients for some time is absolutely AI is very likely to change the world, but it's not going to change the world today. And I think over earnings reports and companies we talk to, what we're, we haven't seen is a transition from the build out to actual use cases. And so the risk to that is maybe the build out is a little bit slower and some of those estimates of forward growth have to come down. But on the flip side of that rotation is the significant move we've seen in small cap stocks, and that is premised on a belief from markets that the underlying economy remains incredibly, incredibly strong because it's small caps that should sell off, should face the most pain if the economy truly does weaken. And so I think the Fed is really, it's the uncertainty. It's the uncertainty of if we're heading into any potential slowdown, how deep that slowdown will be, also and if inflation continues to come down and the Fed should stay pat, but that underlying rotation, we the markets are paid to take forward-looking views. I think the Fed isn't.

All right, we'll leave it there. Jeff, Greg, thank you both for the time on this Fed day.