Moody's Talks - Inside Economics - Bonus Episode: The Clock is Ticking on U.S. Budget Deal and Fed Tapering

Episode Date: October 12, 2021

The U.S. bond market is showing angst about the debt ceiling. While the debt ceiling will likely be raised, there is a history of waiting until the last minute. Ryan Sweet provides actionable insights to help you better manage your credit portfolio during this uncertain time.Episode's slides can be found here. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Thank you, everyone, for joining. There are going to be four parts to today's session. First, we'll take a look at the lay of the land in financial markets for corporate. Then I'll turn to some near-term concerns, including the Fed tapering, the rapidly approaching debt ceiling, and we'll discuss some metrics that are useful in assessing the amount of angst in financial markets, and one of them is the EBS. and I'll finish by discussing the economic and financial implications of reaching the debt ceiling. Don't worry, I'll still find a way to end on a positive note after going through that Armageddon scenario.

Before diving in, I want to give you the key takeaway, and that is the best times are behind us. Interest rates are set to rise, growth in the economy as peace, corporate and corporate profits, earnings growth is going to moderate, and defaults are going to rise. will be from very low levels. Even though these good times are behind us, conditions are going to still remain very favorable. It's the scarring from the pandemic recession. It appears to be very limited. And we're still in the early stages of what hopefully will be a long economic expansion.

So let's start with part one, delay of the land. There's a growing concern about the health of American corporate. corporate bond issue in this last year was very, very robust. It's very strong this year. Corporate leverage is rising. And all this is okay in an environment with low interest rates, and this is why one section of today's conversation is going to be about the prospect of, said, tapering, avoiding another taper canter because as interest rates rise,

that's going to put some pressure on corporations who finance the amount of debt that they've taken over the last couple of years. But there's plenty of reason for optimism, and that's what's being shown in the first chart. The stock market has rallied significantly since, you know, it's posed for pandemic lows. But along with that, corporate profits have also surged, and they've been much stronger than what we've seen,

overall with nominal GDP. And corporate profit margins remain very wide, and that's encouraging giving that we've had, we're in the midst of a period of transitory inflation. Consumer prices, producer prices, import prices have all accelerated quite noticely since the start of this year. But with corporate profit margins wide, companies can digest some of those higher input costs while patting some on to E.O. and the other thing with corporate profits being as strong as they are and interest rates still at historic lows,

that kind of justifies the valuations that you're seeing in the stock market, which kind of hopefully Ix inflates us from a near-term correction. Now, a correction worker at some point, on average, you know, a 10% decline in the stock market occurs once every two years. That's on average since the 1970s. If you've seen what's going on in equity markets recently, volatility is picked up, and a lot of that is attributed to monetary policy, not just by the Federal Reserve, but also internationally. Some to develop central banks are turning a little bit more hawkish, and that's, you know, leading markets if you start to price in a little bit more aggressive tightening cycle among central banks.

And then there's also the debt ceiling. But hopefully once we're on the side of the debt ceiling, with an economy that we forecast to grow, roughly 6% this year, 4% next year, and interest rates that are going to when we steadily rise, that's digestible for financial markets. Therefore, we anticipate still solid corporate earnings growth, profit growth, over than 5% next year, and that should keep financial market conditions very favorable

for the broader economy and also kind of ease or limit the amount of credit risk or predicate concerns among investors. This recession was unlike any that we've seen before. It was the deepest recession on record, but also the shortest. And that is a very unique combination. We avoided the depression. There's the three deeds of the depression.

There's the death which this recession met. There's the deflation aspect, which didn't occur. and duration. This was a very short recession, and it helped the short nature, along with a very aggressive policy response, limit the impact on defaults, delinquencies. You can see that in this chart here,

there was a disproportionate effect of the recession on investment grade in high yield. You can see the number of downgrade which is the blue bar jumps in 2020, but if you have to swim to see an increase in investment grades defaults. Now, downgrades did increase, but nowhere near what we saw during the financial crisis. There was an increase in high-yield defaults. But if you fast forward to this year, all these metrics have improved quite noticeably.

The number of downgrades is still less than the number of up, upgrade for high-yield investment grade. The number of defaults for investment grades in high-yield have both come down. And this is kind of the sweet spot of this credit cycle. Going forward, and this is what we'll start to see in the EDF data over the next 12 to 18 months, is that with a steady increase in interest rates, some slowing in the economic activity, a little bit tighter financial market conditions because they've been very, very loose over the last, year, year and a half, conditions are going to get a little tougher.

It doesn't mean that corporate bond issues going to fall off a cliff. It doesn't mean we're going to see significant increases in the number of investment grade or high-heal defaults. We're just going to be on the other side of the sweet spot, and conditions will get a little bit more challenging, but not seeing that you would weigh the red flag. So on the next slide, investors' perception of credit risk remains, you know, very good. There's not a lot of concern about creditors. You can see that in the high-eil corporate bond spread, which is the blue line on the left-hand scale.

It's very tight from historical perspectives. On average, the high-year-cold bond spread average is about 500 paces points. You know, we're right around 300 paces points currently. In the last week or so, there are some concerns about a Chinese developer. that rattle financial markets, but you have to squint to see the impact on U.S. high-eul corporate bonds growths, which I think is encouraging that this is being viewed more as an isolated event than something that's more systematic or could trigger some contagion effects.

What's keeping high-eel corporate bonds spreads is very tight, One is very low volatility in the stock market. Now, of course, that's notwithstanding in the last week or so. Volatility measured by the VIX is right around a statistical average, and that typically formsize of a very tight high-eo-corporate bond stress. The other factor that is helping keep corporate bonds rate is high-yield very tight, tighter than what we've seen historically, are rising energy prices. and there's a pretty strong correlation,

and there's a causal relationship between changes in global energy prices and high-yield corporate bonds price. So given this backdrop, these two key drivers, as long as volatility remains well-behaved, which it should once, you know, wrong the other side of the step-feeling,

and given our forecast for a very strong, global GDP growth this year, and next year, and the balance between supply demand favoring demand for oil, we expect a steady increase in global oil prices through the rest of this year, meets the next. Therefore, high-eil corporate bonds price should remain tight in the near term. Once we get into the second half of next year, we'll start to see high yield corporate bonds grab to begin to rise, and that's the contoram side with just, you know,

broader financial market condition. We have the 10-year treasury yield steadily rising. There's be more hints by the Federal Reserve that it's getting ready to raise the said fund rate for the first time. The other thing will probably get an early indication that high-eo corporate bonds spreads are going to start to decrease by looking at the U.S. one-year E.EF. And the EDS is, I apologize, to sort of lay this out earlier. The EDS is estimated default frequency. It's a very timely, it's a real-time measure of market risk.

business risk among corporates in the investor's assessment of credit risk. And this tracks the high-eal corporate bond spread pretty well. And you can see that you both are telling a very similar story. The one-year EDS is as low as the financial crisis, the same with high-year corporate bonds debt. But I will watch the see if the one-year EDS starts to take higher, then that would, you know, kind of foreshadow that we may be in the midst of some normalization in the high-year-old corporate bond market.

But given a backdrop of low interest rates, low volatility, a boatload of liquidity in the market at these corporate bonds spreads will mean very tight along with a low U.S. corporate corporate EDF for the near term. Now, one thing I'm going to keep in mind, please kind of ease this chart in the back of your mind because as we go forward and towards the end of the presentation, when we go through this Armigan scenario where the debt ceiling is reached, I'm going to bring the chart back, so just show you what would occur to both the high-yield corporate bond strike and the one-year EDF under that significant stress scenario.

Okay, so Section 2, and this is probably my favorite section. because anytime I can talk about the Fed, I'm a very happy individual. The 10-year Treasury yield has risen recently. You know, we're closer to 1.2%, not that long ago, several weeks ago. And the last time I checked earlier today, we're right around 1.5%. And this isn't the start of the tapered tension. I think the takeaway from this section is that markets are beginning to reassess their expected pass for interest rates and the tapering.

The Fed's going to avoid another tapered cancer. So the tapered tango, refresh your mind. It occurred in 2013 when Ben Bernanke, then Fed chair, hated that the Fed was going to start to reduce its balance sheet during a speech at Jackson Hole in August. that kind of really rattled financial markets because at the time, market and vice side policy with interest rate policy. So if the federal is going to begin to taper soon, that means higher interest rates are coming.

And then going forward over the next couple of months, the 10-year-charge of yield rose by roughly 100 basis points. And that's the so-called tapered tension. And leading up to this tapering process, there was still some concern. and Lincoln are concerns that we could see another response similar to 2013, which saw as 20-American conditions to tighten. But if you look at, to go back and look at the high-you-of-coker bond spread in the U.S. EDF, they continue to improve.

So that market makes about fed tapering and possible rate rates. That really never led through into broader capital market conditions. And I think that's a good lesson to remember, particularly. given that the Fed, and what I'm showing you here on this chart, is potential paths for the Fed's tapering of this $120 billion in monthly assets. The green, blue, dark blue, and orange are, pass it were, I assume, pre-September EFOLC meeting, and, you know, some paths were, you know, if the Fed wanted to go slow and steady, if they want to be more aggressive.

At the September meeting, we got a very clear indication of what the Fed plan is. Now, the timing when they start this is still a little bit unclear, but this tapering process is going to be more aggressive than I think the market anticipated. Before the FMC meeting, if you look at the U.S. Fed survey primary dealers, they were expecting $15 billion reduction in monthly asset purchases per EPLMD meeting.

Now, the Fed plan is an eight-month tapering process. They want this wrapped up by roughly mid-next year. So that means $16 billion per month, you know, probably starting in December. If you get a very strong employment number, a drop in the unemployment rate, stronger wage growth on Friday when we get the September data, then maybe a November tapering is on the table. But as of now, I think the Fed is one of these costs, just make sure we get through the debt ceiling, make sure there's not any concerns for a partial

government shutdown in early December, and then I think the Fed will follow through with tapering at the December meeting. But the key takeaway, no taper tantrum. Fed Chair Powell has divorced interest rate policy from balance sheet policy, and that has limited the increase in long-term rates, given that, you know, the Fed has. sent its advance notice that the tapering is coming. So what's driving long-term rates higher? This chart decomposes the 10-year treasury yield into its three main components.

The green line is inflation expectation. This is long-term inflation expectations, market-based measures. The blue line, the dark blue line, is the expected path real short-term rate. So another way of interpreting this is, you know, what's the expectation? effective path of the Fed's budget, adjusted for inflation. And then the light blue line is the term premium, and this is the extra compensation investors need to hold long-term rates versus short-term rates. And what's driven the 10-year treasury yield higher recently is an increase in the term

premium. And that is where the Fed's multi-asset purchase, that $120 billion in Treasury and mortgage-backed security. that's the primary way it lowers long-term rates is by depressing the term premium. Now that the Fed is signaled that they're going to start walking back from these purchases and dialing it back, you've seen the term premium starts to creep higher.

Still negative, which historically is normal when the Fed's doing quantitative easing, but it's climbing, and that's contributed roughly half of the increase in the 10-year treasury yield from its recent lows. The other thing that's driving it higher is markets are reassessing their expectations of the path of the Fed Fund rate. You can see that pretty clear in this slide. The dark blue line is the market-inplied pass for the Fed Fund rate out three years

that was in January of this year. The light blue line was the expectations before the last EFLNC meeting, and the green line is the current market pricing. And you can see just over time, gradually, gradually, higher their expectations of the amount of tightening that will occur during the upcoming tightening cycle now because the time when this begins the Fed's kind of divided you know roughly half FMC doesn't expect late 2022 the other half expects you know sometime in 2023 our baseline forecast is for the first rate hike to occur in early 2023 and we have

a more aggressive tightening cycle than that implied by market expectations. I think this is where we do get an adjustment in long-term rates more quickly than what's templed into our baseline, which is just a steady gradual increase in long-term rates over the next few years until they hit their equilibrium in an equilibrium senior tragedy loss by 3.75% to 4%. That increase should be orderly unless it, you know, markets suddenly reassess near the path of the Fed Fundrate. The path implied by markets currently is pretty benign.

You can see it's a little over 100 basis points in tightening over three years. Given the backdrop of very strong GDP growth, inflation that is going to decelerate back towards the Fed's target, but it may stick around a little bit longer given the global supply constraint. it's difficult to see how the Fed could raise or normalize industries along the path of what markets are expected. So in the end, you're likely going to continue to see markets ratchet up their expectations for the amount of tightening that will occur during the training cycle and how aggressive the Fed will be.

This sudden readjustment of market expectations that can speed into broader swingers for market. conditions, you can look back as the curious whether the market suddenly reassess their expectations for fed tightening, either tightening or suddenly expecting said rate cuts. And you can see the response in corporate bond spread in the EDF because particularly for those industries that are interest rate sensitive. So overall, higher rates are coming, but it's not the Fed funds rate is only likely that's going to really begin tightening monetary policy until the job market is back to full employment.

And economists, they throw out all these different parameters of what best measures full employment. And I think the best one is the prime age employment of population ratio. And an economy at full employment, that ratio is 80%. Currently, we're at 70%. And this kind of moves like a large iceberg. It doesn't improve rapidly over a few months. It takes time. But by this time, late next year, we should have an economy that is very, very close, if not at full employment.

And that's the last criteria that the Fed and check off and begin to acknowledge that they're going to start taking monetary policy. It's a – that communication is very important. around periods of changes in monetary policy and that's why you see financial market conditions you can see the EDF you know there's some wiggles around fed communication with regards to the typing cycle the other thing I wanted to point out is that the rise in the 10 year just a tenure treasure yield is justified what this chart is showing you is the actual tenure treasure yield which is the green line and the model implied tenure treasure yield the way I think of the

model applied 10-year-tresher yield is its economic fair value. So we modeled the 10-year treasury yields using five economic variables and use it as kind of a measure of, you know, is the 10-year treasury yield above what the economy is telling us to be or too low? And if you go back to the taper tension, you saw the 10-year treasury yield really jumped above, it's equilibrium value. Currently, it's still a little bit below. So there's some room for the 10-year treasury yields to rise.

Currently, the equilibrium 10-year treasury yields closer to 1.56, or about six stages points below what the equilibrium model would imply. But as you can see, we don't have a 10-year-t treasury that's way out of whack with the economy's underlying fundamentals. and that's another reason so far that I think we've avoided the tapered cancer. So this section we're going to turn. So it's mostly good news on the fed front. They're going to pull off tapering without a canterm. Next year, you know, our focus will start to shift,

and the market focus will start to shift towards the timing of the first rate hike. So there could be some, you know, hiccups here and there. You could see some responsive in corporate bond spread in the EDF around period where markets account is uncertain about the timing or the pace of tightening cycle. This section, we're going to focus more on something that is going to be a problem for the next couple of weeks. And we have to think about the unsinkable, and that's the debt ceiling. And so everyone's on the same page. We've seen this movie before, and I think why we haven't seen an enormous response in financial markets yet,

And we'll go through this dashboard shortly, is that they know how the movie ends, and that, you know, it's the 11th hour lawmakers will raise the death ceiling, and that will kind of remove this enormous weight on financial markets. And what this chart shows on you is just periods where the debt ceiling has been raised or suspended. And our working assumption is that the drop-dead date, we calculate it based on monthly treasury statements, is that the Charger will run out of cash right around October 18th. Now, Treasury Secretary Janet Allen warned that it could be a couple days earlier.

It could be, you know, October 16th. So they're right in line of, you know, what we're estimating. But that's going to be the period that, you know, everyone has circles. And looking back, at least historically, you know, markets begin to get a little bit more concerned the closer and closer we get to this drop debt date. And a good early warning indication is the one-year U.S. corporate EDS. Right now, that's sending a signal that's no significant concern yet. But, you know, we're still, you know, 10 days away, you know, leading up to the last few nasty

nasty debt ceiling flights, which were in 2011 and 2013, we had device. of governance. The one-year EDS did start to take up, you know, a few days before the drop dead date. Eventually, of course, the deceduling was raised, and then you saw, you know, a big-size release in financial markets, the one-year EDS fell out back down, volatility in the stock market to decrease, and things kind of, you know, returned to normal in many of those instances, except for when the European sovereign debt crisis stands to hit. So I'll make sure we leave enough time for questions, but this slide is just kind of reinforcing what our drop-ded date is and how we calculated.

We look at the projected treasury payments and tax receipts. If this drop-dead date can change, it could be sooner, it could be a little bit later. And that's why, you know, my little dashboard of gauging financial concern, financial markets concern, I think it is, helpful in assessing the amount of credit risk that is being perceived and angst in financial markets surrounding the prospects of the debt ceiling not being raised. There are economic costs of the debt ceiling, even though we all know it's going to get the increase, the political and economic costs are enormous. Therefore, I think lawmakers know that they need to raise the debt ceiling.

But even the battles, the arguments back and forth about the death scaling discussion that some lawmakers won't support raising it, that has economic costs. You know, we're already seeing that chink that normally occurs in the Treasury bill curve, and we're also seeing consumers respond. You know, they see the headlines, they read it in the newspaper, they see it on TV, these concerns about the debt ceiling. and you've seen consumer confidence respond. Now, a good chunk of this decline that you see in the blue line,

which is the Consumer Confidence Index in the University of Michigan, that's COVID-related. That coincided with the recent surge in daily confirmed COVID cases, and that really weighed heavily on measures of consumer confidence. So far, so good on this depth ceiling flight, if you look at Google trends and search intensity for government shutdown

or death ceiling, it hasn't really increased significantly. But when you see these spikes back in 2011, 2011, 2013, that was roughly a week before the death ceiling. So something to watch next week

is, is this registering in our consumer's mind? Are they really nervous? And sentiment, again, it's fragile, and it can shift very, very quickly. But, you know, as we're having our conversation today, so far, business confidence remains solid.

Consumer confidence got crushed by the recent wave of COVID-19, but it's showing signs of stabilizing, and it doesn't seem like the debt ceiling is having an enormous effect yet on the collective psyche. Where it is having some effect is in financial markets. Investors have taken notice. And what's showing you here is the learning from path experiences

here is the one-year EDF leading up to in years that we had these nasty debt ceiling flights in 2011 and 2013. If you do these rule increases in the blue line right around September in 2011,

even though we had a very significant debt ceiling flight in 2013 There wasn't a lot of indication. And, of course, this is the monthly average. So, you know, if you look at the daily, you'll see some, you know, volatility in the series. 2013 episode was worse than 2011 because it also coincided with a government shutdown. And that was the concern this time around is that we could have a repeat of that, you know,

a government shutdown that overlasts in a death feeling fight. Fortunately, Longman kicked a kick the can down the road. They didn't kick it too far. they have until December 3rd, I believe, to pass budget resolution where funds the government for the next fiscal year or there will be a partial government shutdown. But when you look at the EDF around instances of government shutdowns with a debt ceiling, government shutdowns without a debt ceiling, there's not an enormous amount of increase in the EDF. And that's a good leading indicator or signal that, you know, markets view these battles as temporary,

that they're going to get resolved, and there's no long-term damage to either financial markets or the economy from a parking government shutdown or a nasty test ceiling. Because, again, seeing back to the movie analogy, you know, we've all seen the movie before, you know, how it ends. but if there's any prospect that the ending of this movie is different, you will start to see an immediate response in our measures of our EDF measures, the Treasury Bill Kerr, Consumer competence, business competence, and investors sending it. It would be a sudden moment. You know, it could be similar to what you saw around TARC,

the Charbalt Active Release Program, if everyone recalls, you know, watching TV when they're voting, long-makers are voting whether or not to pass in the whole version of TARP. They turned it down and all help broke loose, the stock market plunge. You know, you got a sudden-tigning financial market condition. But that gave long ago their aha moment and they quickly reverse course in past TARP. We don't want to do that with the death ceiling because the economic cost would be much more significant. You could have a chart light moment if lawmakers temporarily reached the decimal for a day or two, and that would still have some economic costs.

You see it reflected in the EDS and the high-year-old corporate bonds threads, and there's nowhere to high really on the credit ladder. There will be a response throughout the corporate credit ladder. So the things we're looking at why I don't anticipate, you know, a, enormous increase this time around in either the EDS or the high-yield bond spread, all based on past experience, they seem to digest them fairly well. 2011, you see the high-yield corporate bond spread begins to increase, but all that increase is after the debt ceiling.

That's nothing debt ceiling related. That was more attributed to the Sloan and the European economy, concerns about stopping debt at that time around. Leading up to the debt ceiling, there was a very, very muted response. And I think that's what the most likely, scenario, baseline forecast is that you don't see a lot of movement in the EDF or a high-year font threat. But these past experiences, it doesn't mean that it will definitely be repeated.

You know, history doesn't always repeat itself. And if you do, you get to see indications that the one-year EDF is starting to move, that would raise a red flag. That's an early warning that this time may not be different and that we could have some more stress in the corporate credit markets, in financial markets, in the bond market than we've had experiences with the debt zone. One area that you're seeing a response is in the four-week treasury yield. Again, I'm comparing 2011-2013.

So far, the increase would be less than what we saw in either 2011 or 2013, and why the response in the forward-tresure yield in 2013 is much more significant than we're going to what we saw in 2011 is that in 2013 there was the government shutdown occurred before the debt ceiling. So you already had, you know, markets beginning of the price in, a government shutdown on top of, or coinciding with a debt ceiling increase that you needed. So you saw a much earlier response where, the more typical response was in 2011, you read three days out, you start to see a big increase in both. increase in the forward Treasury bill yields.

Currently, if you look at the Treasury goal maturing right around the drop dead date, October 16th, you know, 70 and 80, that's risen and it's higher than bills that are maturing either before the debt ceiling expiration or shortly after. And that normal kink in the Treasury bill curve is something that we would expect. You know, there's a little angst in the bottom market, not a ton. about the debt ceiling. So that is something we're keeping a close eye on. So, you know, as we draw up closer,

my checklist is, you know, watch the EDF, watch the Treasury Bill curve, the volatility in the VIX, the stock market investor sentiment, and also consumer sentences, because there's not just the financial cost of his banks around the debt zone. Consumers may begin to respond because the sentiment is fragile to collect the psyche typically is really, really important around the turning point.

And if we begin to be afraid because of the debt ceiling, then the next have economic implications. All right, so the next few sides are going to be much other than to share everyone, but we're going to hope for the best and forecast for the worst. So one scenario that we ran through our U.S. macro model is one where we have a, the government fails to raise the death ceiling, and it's not just a temporary one. I think there was one that occurred for a day back in the 1970s. This is more an extended one that lasts into November, so a little bit more, right around the month. The Treasury debt ceiling is abased.

So we ran that scenario through our macro model and an extended breach of the debt ceiling where it caused a recession very similar to the great recession. So that's roughly a 4% peak to trough to climb in GDP, a 6 million increase in the number of people unemployed, an unemployment rate near 9%, you know, significant is going to drop in equity prices.

And so we ran that through and I wanted to see what that would imply for the EDF and the high-yield corporate bond spread. We don't forecast the one-year EDF, but we'll come back to that in a second. The green line is the Armageddon scenario. So again, that's that extended breach of the death ceiling, and you see instantly there's a significant widening in the high-yield corporate bond spread. But that was slam the brakes on corporate bond issuance. That was, you know, instantly start raising credit concerns.

You know, typically when high-year-old corporate bonds rates increase, that kind of foreshadows, you know, more trouble ahead in the corporate bond market and increase, you know, concerns about credit risk. The blue line, what our baseline forecast is, and that's the most likely scenario. So the Armageddon scenario, that's out on the tail. That's something that we've got to think about, but it's not the most likely scenario. The most likely scenario is the blue line. But if we do breach the debt ceiling, this is the most – this is what the response

in the high-year corporate bond market would be. And based on its relationship with the one-year EDF, UF, you would see the UF-EDS almost triple what it is today. So right now, you know, it's low. But if we have a breach of the death, the only we're almost triple. So that's kind of putting everything into perspective. And, again, we'd like to see the EDF increase, you know, a little bit before the high-eo corporate bond spread would begin to raise the red flags or send sound the alarms.

And then I'll wrap up with this slide. Even though the last one focused on, you know, the high-eo corporate bond market, there's nowhere to a high if we preach the death ceiling for an extent of period of time. And this one is showing you the Moody's intermediate bond yield average. This is all investment grade. So you would see yields start to really increase if we preach the debt and increases death ceiling. Let me say, sorry, my daughter's going crazy. Again, just to reiterate that, you know, and this is what I promise here.

I end on a good note. even though there's potential for some angst and, you know, there could be some months along the road in financial markets over the next few weeks. Underlying economic conditions, financial market conditions are all still very favorable. You know, we'll start to see default rates begin to put up in one year. You start to see some increases in EDS among industries that are very sensitive to interest rates. But when you take a step back, conditions are still going to be very strong. We're in the early stages of what should be a long economic expansion. And I know we talked about some dark scenarios.

They're very unlikely. They're on the far tail of the distribution of possible outcomes. Our working assumption is that this is the same movie. You know, we know how it's going to end in the 11th hour, we'll raise the debt ceiling, and will avoid having to go down this very, very dark path, which I think lawmakers are very aware exists that the economic costs of now raising the debt ceiling are enormous, and the political costs are enormous.

And that's the most likely cattle for justifying them raising the debt filling. So we're past the best times, but the next few years there's still going to be very good times for corporates. The amount of liquidity in financial markets is a boltload. Leverage is a concern, but we're still going to be in a very low interest rate environment for the next couple of years. And unless interest rates adjust abruptly, there's not a lot of concern that the amount

with corporate debt that has increased recently is going to have any significant impact on EDFs or broader financial market conditions by extension the U.S. economy. So with that, I'd be more than happy to answer any of your questions. Great. Thanks, Ryan. We've had a couple of questions come in already, but please feel free to submit more through the TNA tool. Let's jump in. Okay, Ryan, so do any of your scenarios and outlook for debt and race take a view of

crowding out from government spending? It does. The model is designed in a way that it will factor in crowding out from, you know, stages fiscal stimulus. So our baseline forecast assumes roughly $2.5.3 trillion dollars in additional government spending. And that's broken up between infrastructure spending and then, you know, the Biden's build back better agenda. So we added all up to give about $3,000.

We likely might scale that back a little bit, just given what's going on in D.C. And the support, where the support lies for a bill is likely, you know, somewhere $8.3.5 and $3.5. So it makes just split a difference. But when we run that through our macro model, it does factor in, you know, what the impact on, crowding out

of private sector investment, what the impact on interest rates is going to be. So our models do capture that. So the baseline forecast that I showed you, the blue lines in each of the last two slides, does incorporate any adverse effects

of the significant increase in fiscal spending that is coming. Here's one about inflation. So I read the indicators, like inflation are not as transitory as initially thought, do you see data supporting that inflation is now more embedded than three or six

months ago? In question is a hot topic, and it's on everyone's mind. I'm still the view that it's transitory, and let me lay out why. If you look at the breadth of changes in consumer prices and producer prices, it's fairly narrow and it's isolated to areas that are tied to the reopening of the economy. which include lodging away from homes, so hotels and hotels, rental cars, you know, these are areas that got hit very hard by the pandemic, you know, where they shut down the economy.

Now that, you know, we're in the midst the later stages of the reopening of the economy, you see the price pressures there, you know, really emerged. But over the last months, it started to fade. The other area, which has contributed the most to the acceleration in consumer prices recently, are new and used car prices. And this is tied back to the global semiconductor shortage. And this is where we could see some lingering in inflationary pressures because global supply chains are still very, very disrupted. Recently we created a global supply chain stress index to the U.S. And it basically takes into consideration all measures of supply chain stress.

So supplier delivery times, container traffic, cost of shipping. And we just combine that, create an index, and it's showing no signs of easing. It's still extremely elevated. And that kind of lends support the idea that this transitory inflation could persist a little bit longer, but in the end, you know, as long as inflation gets back to the Fed's 2% of objectives, which likely will occur second half the next year, I think we'll look back and economists will judge its period as inflation, a transitory period of inflation. The key is really what I'm paying attention to are nominal wage growth, which is solid,

but it's not strong enough to set into motion a wage price spiral, which would be a necessary conditions to create inflation that is sustained around 4 or 5%. That's unlikely going to occur. And I'm also watching market-based measures of inflation expectations. So inflation swath, five-year-year-forward. Because as long as inflation expectations remain anchored, it's unlikely that this transitory period of inflation turns into anything worse. If you go back to the 1970s, early 1980s, when we had that period of statulation, which is high unemployment, high inflation, the reason that that occurs is the Fed ignored inflation expectations.

It became disanchored or unanchored, and that's kind of set in this wage price spiral that occurred at drove inflation to rates that we haven't seen in some time. So I know it's uncomfortable now. It's inflation cutting into people's spending power, but with corporate profit margins wide, meaning that they can absorb some of these higher input costs, inflation expectations anchors, nominal wage rates decent but not robust, and the fading effect of the reopening of the economy, along with hopefully some improvement in supply chains. And our baseline forecast is that, you know, the supply chain issues aren't completely,

resolved until, you know, at the earliest, mid-next year. So, you know, we could see some inflationary pressures linger into next year, but all told, we'll start to see more modest rates of inflation over the next six to nine months. What factors does the EDS include to make a forecast, then how accurate is it? So we don't directly forecast, the economics team. we don't forecast the EDF. However, that chart that showed you the relationship between the high middle corporate bond spread and the EDF, you can use that as, you can create a regression or an update the

forecast of the EDF. There is a very strong correlation and causal relationship between the two, and you can just back out a forecast for the EDF using the high-heel corporate bond spread. It's not perfect. but the relationship is strong enough where, you know, it gives you a good idea, you know, probably with not enormous confidence or rolling around, of projections for the one-year EF. Are Delta and COVID still important for the economic outlook? Unfortunately, yes.

The economy, I mean, even financial markets, both are tied to the hip with COVID. So with the Delta variant wave of recent confirmed cases, that really fit into the economy much more than we had anticipated. And as a result, we reduced our GDP growth forecasts for this year from 6.5% to 6%. And most of that is attributed to this wave of COVID-19. It had an impact on the job market, impacts to consumer spending, shifts of spending back towards goods away from services. reduce travel, a lot of a very high frequency data that, you know, pay attention to Google mobility, number of people passing through KSA checkpoints, all deteriorated, you know, in the midst of this wave of COVID-19.

So, unfortunately, it's on the other side of the pandemic. You know, the economy's near-term prospects are still tightly tied to the hip, with the pandemic. Okay, I think we'll end on this question. Do you think there will be a trillion dollar coin? This is a great question to end on. So I hesitate a little bit because if we get to the 11th hour and there are no signs that are the debts you're going to be raised, I think the Democrats and the Republicans will, if they're going back in the time,

forth, no one's going to bend. I think the Democrats know the economic and political costs of not raising the debt ceiling, and that's when they would go and pull a Hail Mary and print the trillion-dollar form. Now, I don't know

whose face they would put on it. I think that's what to be, but this platinum coin, this trillion dollar coin would give the last-dish effort to avoid this catapultamic event of not raising the debt zone. I don't think we'll get there.

I think, you know, we'll raise the death ceiling through, you know, their normal negotiations comes down to the last minute. But, you know, why that Armageddon scenario so far out on the tail end of the distribution is that there is that, you know, kind of hail-Mary of printing the trillion dollars coin just in case that deathdoing is not raised. I'd rather have a print of a trillion dollar going than breach the decimal.