Moody's Talks - Inside Economics - Bonus Episode: U.S. Economic Outlook Q&A

Episode Date: February 22, 2023

Mark, Cris, and Marisa answer questions from their recent U.S. Economic Outlook webinar where they discussed that the economy will struggle in 2023 with halting growth and higher unemployment. Recession is a serious threat, but the Moody's Analytics baseline forecast-the most-likely outlook-holds that the economy will avoid a downturn.Full episode transcriptFollow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight 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.

Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and this is a special bonus podcast. We did a webinar on the outlook for the economy a couple weeks ago. Got a ton of questions. I mean, when I say a ton, at least several hundred questions, I think they were trying to remember. I think there was 17, 1,800 people on the webinar, lots of questions. And we taped a Q&A, myself, Chris Doridis, the Deputy Chief Economist of Marist. of Dean Natale, a senior economist, and responded to those cues and thought, hey, this might be a pretty good podcast. People might be interested in this. If our clients are asking these questions, our listeners to the podcast are probably doing the same thing. So here it is. I hope you enjoy it.

I hope you find out some value. And let us know. So here we go. Hello, everyone. I'm Mark Sandy, the chief economist of Moody's Analytics. and I'm joined by my two colleagues that were in the webinar earlier this week. Chris DeReedys. Chris is the Deputy Chief Economist.

Hey, Chris. Hey, Mark. And Marissa D. Natali. Marissa keeps the trains on the tracks and also participated in the webinar earlier this week. This purpose of this conversation is to go over the blizzard of questions we received on the webinar. We answered a lot of the questions in the webinar. So we won't reprise that, but there are a lot of other questions that we didn't get to, and we'll do that here. And the way we're going to do this is we kind of categorize the questions that people ask, and we're going to talk about them in those categories.

And I'm going to ask first, Chris, a question around housing and mortgage markets. And I should say this is kind of in no order of particular importance. So I don't mean to say this is the most important kind of thing that we're talking about here, but just to get to the conversation going. We're going to talk about housing and mortgage finance. Chris, the question that many people asked was how we have a correction in our baseline forecast, a house price correction. Yep.

Down based on our repeat sales, Moody's Analytics, repeat sales index, down peak to trough. I'm rounding, but 10% ish. And that prices rose 40% from the start of the pandemic to the peak last summer. They're down maybe a percent or two since then. And we're expecting all in when it's all sudden done by the end of 24 going into 25, the prices will be down nationwide by about 10%. So we're going to retrace one fourth of the price increase that occurred earlier in the pandemic. And the question is, well, why 10%, you know, what's the logic behind?

that. And why not something more severe? Why won't we experience a crash, which no hard definition of a crash, but if you use the financial crisis as a gauge, prices were down, say, 25%-ish, depending on the price index. That would be, in my nomenclature, a crash. So why not down 25 in the baseline? Right. It's a crack at that. Sure. And it's a good question because we did go up 40% over or two years, which was much more than we actually did during the housing boom. So if you just extend the analogy, you would expect, why not retrace most of that? And I think it comes down to supply and demand factors in the housing market today relative to what we saw back then, right? So we still have a very large housing deficit. There's more demand for housing today than the actual

supply. So in order to get an actual sharp decline in pricing, you would expect that demand would have to pull back significantly. And we just don't see that. We see that there are many young adults in particular are still living at home who want to buy a home or rent a home. They're just not able to. If prices start to correct just a little bit, though, provided the labor market holds up,

you would expect some of them coming in to provide support. All right. So that's one factor. The other factor, perhaps you can classify this bit more on the supply side in terms of existing homeowners, they're actually in a much more solid financial condition than they were back during the housing bust. Homeowners today have much more equity in their home. Mortgage standards have been very tight, so they've had to come up with large down payments.

If they were getting a mortgage, they have to be super qualified. There are no liar loans. There are no exploding arms, right? So we have more traditional fixed rate mortgages at this point locked in at very low interest rates. So there's no real impetus for existing homeowners to default on their mortgage, or I should say there's less impetus for them to default on their mortgages. And you really need a steady stream of foreclosures to really cause prices to fall dramatically, at least in the short run.

So for those reasons, I'd say the likelihood that we actually see a very sharp correction is pretty low unless we get hit by some other shock and unemployment goes up to 10%. that's a different story, then you will get that type of foreclosure activity. So our forecast, why it's 5, 10% peak to trough decline, it's really more of a gradual adjustment period here. We got ahead of ourselves when it came to prices over the last couple of years because low interest rates, juice demand. But there's no, again, there's no real need to sell.

So it's going to take some time for the prices to adjust gradually to a point where incomes and how long prices are better aligned. So that's the nature of the forecast. But it does assume that lots of things continue to work in the economy when it comes to labor market and incomes. Good, good. So a correction, but not a crash. Yeah.

Correct. Yeah. In the baseline, the baseline is a soft economy, the job market essentially going sideways, unemployment moving up a bit, but not a recession. If we had a recession, kind of a typical, kind of in terms of severity and length, then the price declines would be more significant than that, right? That's right. I'd even argue that it would actually have to be a pretty substantial recession because of that imbalance in supply and demand. The other thing that makes today so different is that just the demographics are very different. We have a very large number of young adults looking for homes that we didn't have back in the housing bust. So you'd actually need unemployment to rise substantially, in my opinion, to get that type of

real significant decline in home prices. Got it, got it. Related question, turning to mortgage credit quality. So obviously, if you're in a declining house price environment with rising unemployment, that would suggest more credit problems, more delinquency default. But the question is, we haven't seen that yet so far. I mean, unemployment's very low. Layoffs are non-existent.

Yeah, house price has kind of gone flat here down to a little bit, but people have built up a boatload of equity. Why are we seeing mortgage delinquency rates tick higher here? And, you know, when I, the data I look at would be the data that we bank from Equifax, the Credit Bureau, which is a census of all the mortgage loans outstanding. And I was just looking at that through the month of January, and you are starting to see a tick up in delinquency. Did you want to comment on that? Why are we seeing any pickup at all in delinquency here despite the better conditions, the good conditions? Yeah, it's a great question. And we saw, you're right, in Equifax, you can see we just had the MBA delinquency rate series come out today as we're

recorded. That also showed some uptick here. And when I think about it, a couple reasons. One is just normalization, right? In some sense, we had artificially depressed the delinquencies, with moratorium, with stimulus check, right, made it easier for folks to make, make their payments. They didn't have to make their payments for a while. They didn't have to make student loan payments, right? So there were reasons why the delinquency rate was depressed during the pandemic, which was beyond normal, right? That wasn't equilibrium. So you take off some of those supports, and naturally you're going to come back up to some increase in delinquencies.

And, of course, people go delinquent on their mortgage for a variety of reasons. is not just unemployment necessarily. There are other life events, other things that happen that cause people to be unable to make payments and actually go into foreclosure. So that's part of it. I do think that even within the homeowner community, you have a lot of variation in terms of demographics, you have folks higher income, obviously, but you do have folks at the lower income end of the distribution, and they are running out of their savings.

as we talked about on the webinar, right? So even if their jobs are plenty, they are facing financial pressures due to high inflation, right? So unfortunately, there are reasons why folks are going delinquent. The delinquencies are ticking up, right? So that's definitely something to monitor, but they're still low relative to prior to the pandemic. So again, at this point, I still see this more as normalization. Even prior to the pandemic, delinquency rate was very low. So I'm not terribly worried quite yet. Let's talk in a couple months if we continue to see this rise very dramatically. But something to keep your eye on, but I wouldn't overreact at this point to the trend.

Yeah, correct me if I'm wrong, but most of the, I think, tick up and delinquency has been for FHA loans, right? It's still not significant degree for Fannie Freddie loans or non-conformal loans. Do I have that right? That's right. So FHA, which do tend to skew lower in terms of income and credit. So that kind of makes sense. And I'm sure if you dig into even the conforming, you would see that pattern as well. Right. So again, it seems all going according to script in terms of what you would expect in a normalized economy. Yeah. Okay. There was also a question that we put into this housing block around rents. You know, I made a point to say that rents. has gone flat to down here in recent months, given that we're getting more supply, as supply chains ease, a lot more multifamily units are getting completed. And we still have a lot of units, a record number of units in the pipeline going to completion, that will get completed over the next year or so.

So more supply and demand has been hit by the previous surge in rents, rents surged with house prices. and the rents are so high now that people can't even afford those. And so we're getting what economists called demand destruction. You know, people can't form household. So it's less demand, more supply rents are weakened. And that's really key to the outlook for inflation, because particularly consumer price inflation, because a third of the CPI index is the cost of housing services,

which are tied back to rents. But the question was, well, when I look at the CPI for housing services, rents, you know, rent of shelter, I don't see the slowing that, you know, Mark talked about. Do you want to comment on that just to square the circle there for people, you know, the link between market rents that we're observing now and the CPI for housing services? Sure. So to keep it simple, it really comes down to whether you're looking at rents across the entire housing stock, the entire rental market, including people who are already in their leases, right?

They're not facing rent adjustments month to month. They're facing rent adjustments once a year. So you want to measure how rents are moving across the entire housing market. Or do you want to focus on how rents for new units, new units that are coming online for rental, how those rent prices are moving? So the CPI, Consumer Price Index, is looking across the entire market, trying to account for the cost of shelter in the economy overall, right? So it includes a lot of rents that are not moving month to month.

Most of the room are actually locked in. So it takes time for any type of adjustment on the new lease side to actually make its way into that broader index. Right. So what you were referring to is that data that looks at changes in asking rents or effective rents on new leases, right? And that clearly is slowing and is actually negative or declining in certain markets. So that's the distinction, right? Yep. Okay. Very good. Okay, let me hand the baton to you, Chris, because I think you're going to ask Marissa some questions around the job in labor, the job market and wages and jobs and all those kinds of things. So take it away. Yeah, there were lots of questions related to jobs and wages, as you can imagine. That's a pretty big part of our topic and the outlook right now.

You know, we really didn't touch much on the January jobs report. And so we did have a question. or two here related to that report, which showed this tremendous job growth. And I get the question to you, Marissa, is, well, do you believe that? Do you expect that to get revised? What do you think is the right number or the number that will be, it will be revised too? That's a great question because it was such an outlier, right? It showed that in January, over half a million jobs were added on that. And we were expecting something, you know, a little north of 230, 240, something like that, as where most economists. It was almost double what people were expected. I think Chris was at 180, if I recall correctly. So I'm just pointing that out.

Some economists, right, were even further off. We're talking about the revisions, though. Let's see. We are talking about the revisions. Okay, so we'll come back in a year and we'll see how you did. Yeah, I mean, so like all economic data, the employment data get revised multiple times, right? So there's a first release, there'll be two more revisions in the next two months, and then we have these annual benchmark revisions, which actually were just released in January benchmarking the March 22 data. So you get all kinds of revisions, first of all. So yes, it will definitely be revised. The question is to what extent it will be revised. There's, I mean, I think there's a few clues,

that it could be overstating certainly job growth. I mean, one, it's just so far out of bounds of what we've seen from month to month. So, you know, what would have happened in January to make all of a sudden the labor market turn on a dime so suddenly. One was it was much warmer in many parts of the country, particularly in the Northeast and the Midwest, than it has been for past January's. that introduces all kinds of seasonal problems when the BLS tries to seasonally adjust the data. So things like construction, right, where any sort of industry that happens outside, you usually see a big drop in employment in January.

And if you don't get that big drop because it's warm, it pushes up the job number. Other things like retail, which had been really weak in December, but it had been stronger in the fall. That could be off because perhaps not as many people were let go after holiday hiring surge as they normally are. Another thing that I was looking at was the number of people out sick obviously has been extremely elevated each January since COVID began. This January, it was almost back to normal, surprisingly, despite the fact that everyone I know is sick. if you look at the past two January's in 2020, 2021, 2022, this January 23, it was almost back to like a pre-COVID level of people that were not working because they were sick. So I think there's, again, some seasonal adjustment, perhaps issues going on with trying to account for patterns in recent years.

The other clue, and I think this is another question, you maybe were going to ask me in it, but it's along these lines. is another clue we have is that this, as I mentioned, this benchmark revision for March of 2022 was released. And that showed that showed that actually more jobs were created between April 21 and March 22 than the BLS was first estimating. But there's been more recent data from the quarterly census of employment and wages that goes through June of 2020, to that suggests that at least between March and June, job growth looks like it was overstated by BLS and that there will be downward revisions during that period. So we could have entered a week period. It could have been relegated to last summer.

This was after the Russian invasion of Ukraine in late February. This is when inflation really started to take off, right? It doubled between like March, the pace of inflation doubled between March and April. alone. So it could have been sort of a summertime weakness, but it could also be suggestive that just kind of all of 2022 might be overstated a bit. So that's a very long-winded way of saying, yeah, it's going to get revised likely down. Okay. Down, down a lot? Do you think that there's still underlying strength? Absolutely. I do. I think all these other indicators that we have have on the job market point to the fact that the job market is still quite strong, right?

Pretty much everything else that you can point to shows that it's strong. So I don't think it's going to look like job losses by any means. But I don't think that half a million jobs a month is our underlying pace of job growth. I think it's probably about half that. Okay, okay. I guess related to that and also key to the Fed's outlook, is wage growth. And what are your thoughts?

The question was on what are your thoughts or expectations for wage growth in 2023 and 2024? So wage growth right now by a bunch of different metrics is running at about 5% year over year. And we think by the end of this year, by the end of 2023, it's going to be about 4%, or maybe just under 4%. So we're going to come down a little bit.

The Fed would like to see wage growth. as measured by the ECI at about three and a half percent. So even by the end of this year, we're still going to be a bit above the feds target when they look at wage growth, which is really key to them because that goes to growth in prices of core services. You know, the biggest input cost of core services is labor. And so if wage growth is very, very strong, then companies are more likely to raise their prices to offset that. that strong increase in wages. So by the end of the year, we think we get down to around 4%. It continues to slowly decelerate through about the third quarter of 2024. And that's about the point when it

hits three and a half percent. So you're looking at probably middle of 2024 before we get to that three and a half percent mark. But we have seen evidence in recent months just since the fall through the data that we're getting now, that wage growth does seem to be cooling off a bit by all different metrics. So the ECI, the Atlanta Fed's wage tracker, even average hourly earnings, which we always have some caveats about. But nevertheless, the trends are kind of all going in the same way, which looks like wage growth is cooling. Okay. So our forecast calls for a cooling labor market. We actually have some increase in unemployment, cooling wages. last question for you is this going to impact or how will it impact the upper income versus lower

income earners out there, right? Where would you expect to see more of the job losses or more of the weakness in wages, let's say? Well, so the wages that got really, really juiced during, let's say the summer of 2021, 2022 is sort of peak wage growth time and wages peaked, I believe, in July of 22. The industries that saw the fastest wage growth were among the lower earning industries. So it was industries like leisure hospitality and retail and to a lesser degree health care where we saw the fastest wage growth. And that's because these were the industries that were, you know, hurting the most for workers initially. They lost the most jobs and laid off the most workers during the pandemic and then trying to very quickly rehire all those people

and finding out that not all those people were around anymore and available for work. And so wage growth, the poster child would be leisure hospitality. This is bars and restaurants and hotels. Wage growth peaked at about 12% year over year during the summer. And that has come way down. I mean, now it's just a little bit above average. I think the last time I looked it was like six or seven percent. So in terms of growth in wages, I think it is going to be sort of the lower end of the income spectrum that's going to see the most marked kind of drop off in growth in wages. I think if we look at the coming year and what industries are likely to slow the most or even lose jobs, those are going to be really the interest rate sensitive segments of the economy.

So we haven't seen it yet. We haven't seen construction job losses, but we expect at some point this will happen as the housing market continues to slow or bottom out. There's a lot of, maybe you disagree, there's a lot of strength on the multifamily side that could offset what's happening on the residential side. But nevertheless, I think we'd agree we would see a slowdown at least in jobs there. And then we already are seeing, we've heard about a lot of high profile layoff announcements in tech and financial services.

And you do see that in the job numbers already. So if you look at information services, that broad industry lost jobs in both January and December. So and those tend to be higher paid industries. And again, those are the more interest rate sensitive segments. So I think those higher paid industries are going to probably face a lot of maybe near-term pain with rising rates. longer term, if we were to fall into a broad-based recession and consumer spending pulls back, then it's going to be pretty ubiquitous throughout all of these categories. But the most marked slowing in wages should be leisure hospitality, retail, these industries

that saw really fast wage growth. Oh, great. I'll then pass the baton to you, Marissa. Okay. She's going to pepper me, I understand, right? I am going to pepper you with questions, a variety. So let's start with some questions around federal fiscal policy and the debt and what's going on with the debt limit. So you talked about this and we highlighted it as maybe the major risk for 2023.

Can you talk about that a little more? What two things? What's the drop dead date for the debt ceiling? And two, where do you place the probability of the U.S. government actually defaulting on its debt? So to the first question, we don't know for sure because that depends on the X date, the date at when the Treasury won't have enough cash on hand to pay all its bills in a timely way. Someone's not going to get paid on time. That's the X date is unknown because it depends on revenues and expenditures over time that are very uncertain. We don't, particularly the April tax payments.

The Treasury has an idea about how much they're going to receive. tax payments, but they don't know exactly how much and exactly when they're going to receive those payments. So it's uncertain. CBO, the Congressional Budget Office, the nonpartisan agency that does the budgeting for the federal government came out with a report yesterday. It was actually a pretty good report. Yesterday would be the 15th of February. And they said it would be sometime between July, and I think October. We are doing our, we are doing our own work. In fact, to be more specific, Bernard Yaros, you know, our colleague, a good colleague who follows us very carefully, looks at spending day by day, revenues day by day, goes back, you know, looks at this period

last year to see what is happening to determine what's going to happen going forward, is coalescing around the August 8th as the exact day at which the Treasury will breach the limit. He's going to update my birthday. Oh, is it really? There you go. Yeah. What a gift. It'll go down in infamy, for sure.

But that can change, and we'll see. Bernard will continually update that X date as we go forward here. One thing that might happen is if it is August 8th, Congress and administration might agree to a temporary suspension of the debt limit to make it coincide with the next fiscal year budget. Because that's the other thing that has to happen by the end of September is a passing of the budget to keep the government funded to keep it open. So they might kick the can a little bit down the road to the end of September

and say, we're going to solve both these problems at the same time, do something about the debt limit, but also pass a budget to keep the government open. And that would be my guess as to what they do. So the X state would actually get kicked down this. September 30th, that would be my guess. You know, if they don't suspend or increase the debt on it by that point in time, and Treasury doesn't pay someone on time, whether that be, you know, Social Security recipient, the military bondholder or Treasury bondholder or just the electric bill, that, in my view,

is a default. The government has defaulted. And I think that would be the fodder for what I would call a tarp moment when stock prices fall, chaos in the fixed income markets, the bond market. It would be a mess. And would, like in all likelihood, undermine our baseline forecast of no recession. We would almost certainly go into recession at that point. In terms of the probabilities of that actually happening for the government to actually breach the limit and not pay someone on time. It's low, but I'd say it feels higher than it has at any point in time in the 30 years that I've been following debt limit battles. Even the 2011, folks recall in 2011 we had a pretty very ugly debt limit battle that ended in a downgraded U.S. government debt by

S&P, standard importers, and the U.S. lost its AAA rating according to S&P, not Moody's. Moody's still has the AAA, but according to S&P. And that was pretty messy, but this feels like it could be messier, just given the very vexed politics and the fact that the House of the House is controlled by Republicans, but by a very thin majority five seats. And of course, the Speaker of the House McCarthy is there.

It seems to have his support is very tenuous. and the change in the rules make it such that, you know, it's going to make it very difficult for them to come to some kind of consensus on what to do and actually execute on it in a timely way. So having said all of that, our baseline is that they will get it together by the ex-state, sign on the dotted line, pass a piece of legislation, and life goes on.

But, you know, I would say there's a non-zero probability, probably, you know, in the single digits that, you know, they either, they breach it either because it was intentional or more likely it was just a mistake. You know, they couldn't get it together in time to pass that legislation. So, you know, a single digit kind of probability at that point. And if you look at our risk matrix, which, you know, Chris went through in detail in the webinar, you can see that it is a low probability event, but if it happens, it's a big deal. It's a big problem for the economy. Yeah, yeah.

On a related note, and this is a question we get a lot. What are the longer run macroeconomic consequences of continuing to rack up debt, which is now what the statutory limits, what, 31 trillion, something like this? So longer run, is this a problem for the U.S.? Yeah, I think it is. I don't think it's a problem for the here and now. I mean, it's not an issue for next quarter or next year, but if policy doesn't change, and again, you can go back to that CBO paper that was released yesterday on the 15th, they do a long-term forecast for the economy in the budget. You can see that the government's debt load rises from just under 100% currently to I think it's 110 percentage points by 10 years from now. It rises about a percentage point

per annum. I might not have that exactly right, but that gives you orders of magnitude. The thing that really is pernicious, though, is the increase in interest expense on the debt. And if you look at that as a share of GDP, right now it's low. It's about two and a half percent of GDP, maybe even a little bit lower than that. But that's going to rise about a percentage point, you know, in the coming decade. So we'll go from two and a half to three and a half, and then the next decade, three and a half to four and a half. And at some point, you know, we're going to be spending more on interest expense than we are on, let's say, the military. And, you know, that doesn't make a whole lot of sense. I don't think people aren't very comfortable

with that. Wouldn't be very comfortable with that. So I do think we need to, address our long-term fiscal issues. And the first thing we need to make sure that we do, I think, is if there's any legislation that would cut taxes or increase spending, it needs to be paid for by tax increases or other spending cuts so that it's deficit, any legislation is deficit neutral, you know, at least deficit neutral going forward. You know, and to some degree, the Inflation Reduction Act, that was the last piece of legislation passed in the last Congress in the Biden administration, that satisfied that rule. In fact, it will lower the budget deficit in, in subsequent decades. In the first decade, first 10 years of that, of that, of the, of that, after that legislation,

it's, it's budget neutral, might reduce the deficit a little bit, 10-year cumulative deficit a little bit, but if you go out the second 10 years and the third 10 years, it lowers a deficit. So if we can do something like that with new pieces of legislation, then I think we'll be okay. One other point, if the borrowing costs of the government, the interest rate they pay, the average interest rate across all the debt, is less than the nominal growth rate in the economy, then you can run deficits. It's that sustainable because your debt to GDP ratio won't rise. It's a just a budget, you know, it's a product of budget math.

If, and, you know, since the financial crisis up until now, that's been the case. You know, so-called R, the interest rate on the debt has been less than G, the nominal growth rate of the economy. So that gave us a lot of so-called fiscal space. We could use, you know, we could borrow aggressively and help get us, navigate through the pandemic and get to the other side of that and, you know, not be in a dire situation. But now interest rates are higher. R is higher, like the 10-year treasury yield is now close to 4%. And G is probably about 4%. That's nominal potential growth rate of the economy. So we're getting pretty close to R equals G. And if R rises above G, then we can't run

deficit. You can't run deficits. I mean, then debt will become unsustainable. So we're getting to a place where we really do need to think about, you know, our long run fiscal situation. I'll say one last thing about all this and to tie it all together. I don't think, though, we can get the political, we'll generate the political will to do anything substantive about this until interest expenses, the share of GDP is measurably higher, until a lawmaker can tell the population, the electorate, look, you know, if we don't do something, we're going to be paying more to Chinese bondholders, Japanese bondholders.

Saudi bondholders, British bondholders, then we're paying to defend ourselves around the world in our military budget. So once that happens, once the interest expense is high enough that someone can connect those dots for people, I think that's when we will make a change. In fact, that's what we did back in the 90s. If you go back to the 1990s, the last time we really addressed our long-term fiscal situation, that's when interest expense was 6, 7% of GDP. and that was Clinton, Bob Rubin, who was the Treasury Secretary at the time, could, you know, generate the political will to pass the kind of legislation they needed to address that. And we ended up by the end of the 1990s with a surplus. You may remember the, I think the last year we had an actual surplus was 2000, Y2K, something like that. You know, a lot of other factors contributed to that, but the fiscal discipline was very important. So my point is, I don't think we're going to really do, I don't, I'm not counting on lawmakers doing anything of substance here.

maybe not doing any more damage, but nothing of substance to address this problem until, you know, they can connect the dots for the electorate, and that's going to require interest expense being a lot higher as a share of GDP. Okay. That was a good thing. Yeah. No, that was great. And I think that answered all the questions sort of on the fiscal side. Oh, good, good. Do you want me to take the baton?

Yeah. Why don't you take the baton, and then I'll come back to you later. Okay. very good uh so chris you're up again and i think we're going to talk about inflation and we've got a bevy of questions around inflation and i'll start you off with an easy one you know what's behind this high inflation what is the cause of the high inflation that we're suffering right now well um let's see you have a demand exceeding supply right in it in uh foundationally We still have the high oil prices, high gas prices, right, still certainly relative to where they were a year ago.

Right. So that's still a factor here in terms of the overall inflation that we're feeling as well as that then feeding into food prices. But then as the Fed has highlighted, right, we are certainly focused more on the service side of the price spectrum as well. and we are getting those housing costs that we referred to earlier, still continuing to put upward pressure on prices overall. And that's just going to take time to work its way through, given the lags between rents and home prices. And beyond that, we have concerns about the service sector X housing, right?

So some of those high wages that Mercer referred to, right, continue to put some upward pressure. we have at the core it's been the supply chain issues that have kept prices high over the last few months those are continuing to fade but they're not gone entirely yet and so that's that's certainly part of the equation as well well can i just the way i frame it and just tell me what you think is it's apparently not the way i frame it no no no it's just to make it you know you there's a lot of moving parts here, right? And you're the way you answered it. You talked about each of the moving parts a little bit. But most fundamentally, in my mind, it's the pandemic and the Russian invasion,

that the pandemic scrambled supply chains, scrambled labor markets. Still to this day, we're suffering from that. I mean, new vehicle prices have yet, they're still going up, you know, because of supply chain issues, limiting production globally and creating shortages. And the Russian invasion caused oil prices to jump, ag prices to jump, and that's still filtering through. And it was the combination of those two things, those two shocks to the supply side of the economy that kind of came to the conflated and then drove up inflation expectations. And that's when inflation kind of metastasized got into wage demands and wage growth. And that then broadened out the inflationary pressures to the service side of the economy where there's a lot of labor-intensive action. health care, hospitality, that kind of thing. So at core, if you, like if we didn't have the,

if we had just had the pandemic, I suspect we would not have been talking about inflation in 2022, but we had the pandemic. And then we had the Russian invasion. And then we were, that's all we were talking about is inflation because of those two shocks. Now, there is a, there's, you know, the, the idea that, you know, demand has been all juiced up by fiscal support, you know, and at this point, we're talking about the American Rescue Plan, which was passed in March of 2021, which is now 18 months, you know, plus in the rearview mirror. And I would argue that, yes, that certainly helped to lift demand and inflation back in the spring, summer of 2021. But that's long gone in terms of its impact on the economy, in terms of lifting inflation.

This is mostly about just adjusting to the, you know, the, you know, the, you know, the, you the continued fall out from these two massive supply shocks. So how would you, how would you, what do you think? Yeah, no, I think that's most of it. I don't want to discount demand entirely, though, or even a substantial amount. Not only the fiscal supports you talked about, but there have been some behavioral shifts in demand throughout this period as well, right? So early on, pandemic, we all chase goods and that causes prices to rise.

And then afterwards, we all chase services and that's causing prices. Right. So there is, the demand side of it is certainly driving inflation as well. But I would say that's the pandemic. That goes back to the shock. Yeah, yeah. But it affects demand and supply. You're saying, you know, it's the pandemic.

Yeah. So, okay. It's the pandemic. But I think often we think of the pen or many think of the pandemic from the supply side only. Yeah. The supply chain's got scrambled. That's why we can't get all the goods.

What we wanted. Right. Well, but we also want more good. We wanted more good. than we wanted previously. Right, right. Okay. That was the easy one? Well, I actually was sarcastic.

That was sarcasm. That was sick of all right. Here's another one. This is not so easy. It goes to the Inflation Reduction Act. That's the piece of legislation, the last piece of legislation passed in the Biden administration that, you know, addressed prescription drugs,

you know, health insurance premiums. But the big part of that was around climate and trying to incent through tax incentives and other means the move from fossil fuel to clean, to green energy. And, you know, the question is, do you view that as inflationary or disinflationary? How do you, and you can answer to that?

in any way you want, near-term, long-term, because the questioner didn't ask. But, you know, they're pretty, if you read the question that they ask, they're coming from the prism that, you know, you're just adding costs. And because this is costly to move from fossil fuel to clean. And that's going to be inflationary. It's not going to be, it's going to take a long time before you make that transition. And maybe once you make that transition, it will lower inflation. But in the interim, it's going to be inflationary. How do you think about that? It's a, it's a, it's a bit complicated. But yeah, I, I would agree with that general sense that it's, it does add cost in the short term and longer term. Everything will work out. However, you know, as we think about inflation, we think about broad based changes in prices, right? So clearly this, the, the IRA could, it will impact EV prices, right? There's something, it's incenting more EV production, uh, presumably. presumably that that also is driving some of the additional demand that's out there.

So you could see that the prices on EVs and the materials going to EVs, for example, could be impacted. But that's a pretty small sector of the broader economy, right? Is that affecting enough other prices, that it's a general increase in price levels? I don't think so. And I think that many aspects of the IRA are like that. Like heat pumps, right? Again, there can be certain aspects or certain parts of,

the consumer basket that do get impacted. But is it going to have such a broad-based impact? I don't know that it's all that much at the end of the day. And it is spread out over time, right? We're still trying to figure this piece of legislation out. So, for example, I don't see this as being a major driver of the inflation that we're experiencing right now, right? I don't think the act itself has been figured out enough to really have a major impact.

on price, even from an anticipatory standpoint, we're still trying to figure out what these incentives mean, what's an SUV, what's a car, right? So there's a lot of, a lot of answers or a lot of questions yet to be answered there. So I think it'll have some impact in the short term, but over time, I think those would be fully digested. Yeah, that makes a little sense to me. I mean, the one thing that really was struck home for me during this period, since the Russian-enided Ukraine and oil prices jumped.

It's just how critical oil prices are to inflation. You know, it's not only the direct effect on, you know, how much we pay at the pump or how much we pay for electricity, it's the, you know, the indirect effects on, like, food prices, you know, because the cost of diesel getting the food from the farm to the store shop. And even more important than that, the very strong link to inflation expectations and wages. And, you know, I think the reason we're struggling, the most significant reason we're struggling with inflation now, the thing is, you know, the company most persistent is the strong wage growth and getting that back down like something more consistent with the Fed's target. And we're having trouble with that. We've had trouble with that because of the higher oil prices and how that's affected people's thinking about future inflation.

So I don't think we can underestimate how important it is for us to get off fossil fuel. We had just to get, you know, even this, it's critical in the long run for lots of obvious reasons around CO2 emissions, temperature rise and all the cost of climate change. But in the near term, I think we just, you know, we're so reliant on whether OPEC is going to increase production by a half a million barrels a day or whether what the Russians are going to do or, you know, it's just, that just seems like a nutty place to be if you don't have to be there. So I think we need to get away from a fossil fuel as fast as huge. humanly possible. And it really does matter in terms of getting inflation in. I do agree that, that, you know, climate mitigation, climate adaptation adds to cost and will be inflationary. But as you point out, that plays out over a long period of time. I don't think that doesn't have a percentage point to inflation in any given year. It might add the basis points to inflation

in a given year. Anyway, okay, that's the inflation. Let me pass now the Paton back to you, Chris. I think you're going to ask Marissa another set of questions. I can't remember which. Oh, recession questions. We got a bunch of questions. Yeah, we got a lot of questions about our scenarios and that kind of thing. Yeah, that's right. That's right.

I'm going to start off with this question about excess savings. We did spend quite a bit of time talking about excess savings. And Mark talked about some of the demographic effects. This one's really about the timing, though. So when do you think the excess savings run out? And do you think inflation can be tamed before then? I thought that they had already run out for the bottom part of the income tier. Yeah.

So we had showed this chart that showed that excess savings peaked back in the summer and they've been drawn down pretty substantially over the past few quarters, but we're still looking at over a trillion and a half, right, in excess savings across all income tax. tears. Every time we put the estimates together, there's still more savings there than I think that I would logically think there would be given just how pernicious inflation has been, particularly for people at the lower part of the income spectrum, right? They spend more of their income on gas and groceries and that sort of thing. And indeed, there isn't, I don't think there is much left there for lower income households. Folks probably

at the bottom 20% of the income tier. Are we going to get inflation under control by the time it runs out? Well, if you define under control as being back to the Fed's target, perhaps not, because that very likely isn't going to happen until either the very end of this year

or early next year. And here I'm talking about the lowest tier of the income spectrum. not overall. So I think it depends how you define under control. If you define under control is it's on a clear downward trajectory, which I think we all believe that it is, right? There may be some month-to-month fluctuations like we just saw in this week's CPI release. You might have some bumps along the road, but I think we clearly believe that inflation is on a downward trajectory. So I think that the risk is that excess savings runs out for the lower income

tiers perhaps this year, maybe in the middle of the year, and we're still looking at inflation that is above the Fed's target before then, or by the time that happens. The higher income tiers are likely treating the excess savings differently than lower income tiers. So it's unclear if people are just stocking this away and it's cash in the accounts, if they're thinking about it, the way they're thinking about their own wealth. We know it's cash sitting there, but are they planning on reinvesting this in equities? Are they going to invest it in real estate? Are they thinking about it in retirement terms? You know, it's very possible that they're not going to be spending it and probable that they're not going to be spending it in the same way that lower

income households are spending it. So I think more of the risk there for running out before inflation is under control is at the bottom end of the spectrum. Okay. Okay. Another question was around the odds of inflation. So we mentioned there were 50-50 odds of the baseline where we avoid a recession, but it's a slow growth environment. 50% of of recession, several of the audience members asked what that recession might look like, if you can describe that. And specifically, they made references to our various scenarios, the S2 or the S7 scenarios, which are all recessionary, but they're all a bit different. So maybe you can describe a little bit about a little bit what you think is the most likely

path of if there is a recession and what the timing might look like. Yeah, I think that I think the S7 is, it's called our next. recession scenario and we run this for the US and we recently a few months ago started running it for all countries that we forecast. I think that's the most likely and that's more in line with our narrative about why recession may happen, right, which is just that the Fed is struggling to get inflation under control. They're tightening monetary policy. This tightens financial conditions. Consumers pullback on spending and it just it reduces demand to the point that we enter a somewhat relatively mild recession. I think the s so in that sense the s7 is more in line with our with our narrative

right now. The s2 s3 s4 are probabilistic recessions that are based on kind of historical severities and a lot of our clients like to use those for stress testing purposes or stress testing your balance sheet for Cecil or IFRS9 accounting purposes. So those are recessions where the recession happens right away in terms of the timing. What's nice about the S7 is it's in line with our narrative of a recession not beginning until late this year. We have a lot of positive momentum going in the economy right now. So I think it would take something really crazy for us. to go into a recession in the next couple of months. So the most likely scenario is the Fed hikes rates,

once, twice, a couple more times, perhaps. Rates stay high for the remainder of the year. And then by the end of the year, in this high rate environment, that causes the economy to go into a recession. The recession itself, what would it look like? Over the course of probably the next four quarters after the recession begins,

you get a peak unemployment rate, of I believe around 6% toward the end of 2024. The unemployment rate, as we know, right now is at 3.4%. So unemployment at 6%, you're looking at the loss of about 5 million jobs over that time period, and a peak to trough decline in GDP of about 2%. So in historical standards relative to take out the pandemic, We don't want to compare really anything to the pandemic. But if you go back to the financial crisis, if you go back to the recession of 2001, which was also mild in terms of the length that it occurred, that's a relatively mild recession when you compare it to sort of the average recessions we've seen since the 80s. All right. Well, thank you.

And I'll pass the baton back to you. I think this is the last set of questions, is it not? I believe it is. And for life of me, I can't remember what you're going to ask me. Well, we're going to go a little bit. We're going to go in a couple different directions. Okay. We kind of have some random questions.

Oh, yeah. Sure. categorize. You were, I think it's a nice add on to what you were talking about when we were talking about the debt and that if the nominal rate of growth of the economy is below the cost of financing that debt, then we're in real trouble, right? So let's talk about the cost of financing debt. So if we look at the 10-year yield forecast, how does that compare to what markets think? How does your forecast of the 10-year yield? And let's look at like the medium term in addition to

the short run. Like, how do we think about what sort of the equilibrium? 10-year yield should be relative to all these other rates, some that the Fed controls. Yeah. Yeah, great question. I think the equilibrium, so-called equilibrium 10-year treasury yield is 4%. That's equal to the nominal potential growth rate of the economy. So in the long run, the nominal potential growth of the economy, the return-on capital should equal to the cost of capital, the 10-year treasury yield. And I get to 4%. That's 2% roughly, real potential GDP growth plus the 2% inflation target. So 2 plus 2 is 4. That's nominal potential GDP growth. And empirically, that works out. I mean, there are long periods when the actual 10-year

yield is higher or lower than that equilibrium yield. And by the way, the equilibrium yield is not static. It changes over time, given the potential growth rate of the economy. So if you go back 30 years ago when the potential growth of the economy was higher, then the equilibrium 10-year yield was higher, so it's come down. So, oh, I was going to say, if you go look at over a long period of time, so like if you go back to 1970, look at the last 50, 60 years, and take the average of the 10-year treasury yield and the growth rate and nominal GDP, they are exactly equal to each other within a basis point or two. So, you know, empirically, theoretically, it should be the nominal potential

growth rate of the economy. That's the 10-year yield. That's roughly where we are today. I'm just looking, you know, the 10-year-old is sitting at 3.87. So, you know, that's within spitting distance of where we should be, you know, in the long run. It was well below, 10-year yield was well below the equilibrium yield throughout the period between the financial crisis and, you know, most recently. But I think that goes to some, you know, significant headwinds to inflation that caused the Federal Reserve to be constantly trying to get inflation up. So it was following a very loose monetary policy and that easy monetary policy and that kept, you know, long-term yields below its long-run equilibrium intentionally in an effort to get inflation back up to target.

I don't think that's the case going forward. You know, now I think instead of tailwinds, headwinds to inflation. We're going to have tailwinds to inflation. We talked a little bit about climate. There's decoupling, de-globalization. There's labor market issues and wages. So I think the Fed's going to be fighting another battle going forward, and that is trying to keep inflation down,

and that means that might keep pushing rates up a little higher than that equilibrium yield, you know, over extended periods of time. So I think the risks here have changed quite considerably. But it's about 4%. Just as a benchmark, I keep going back to that CBO paper that was done on released on February 15th. I highly recommend it. Their 10-year treasury yield in the long run is, wait for it, wait for it, wait for it, wait for it, 3.8%. So I think, you know, 3.8, 4%.

They get 3.8 because they say real potential growth is 1.8, not 2. So I think it's closer to two, but I'm not going to fight over it. So that kind of one of the questions was what would account for the differences in what you or anyone who's forecasting this thinks the long term tenure yield would be? And is that primarily the assumption that differs? It's what's the long run growth rate of the economy? Well, I'm coming in like an economist. You got other people in the market that don't, they're not thinking like I think.

They got different models, different perspectives, different views. And three quarters of time, I don't understand what the more they're coming from. Usually it's, you know, it's a, you know, what interest rates were in the last six months to 12 months is going to determine their forecast for the next 60 years, you know, that kind of thing. And, you know, they were looking a lot more right than I was back before the pandemic, right? because people were saying, looking at our forecast, because it was always going to 4%, always going to 4%, saying, what are you talking about? Chris would come back with, you know, a lot of folks were questioning our long run, you know, tenure, treasury yield. They wouldn't do it to me directly. It's Chris and say, what the hell is he smoking? You know, why is he so much higher than

everybody else? Yeah. But, you know, I, that's the stake in the ground. And, you know, it's like every asset price. It's like a stock price. It's like, you know, all asset prices. have an equilibrium price and the actual price can deviate from that over long periods of time, but ultimately in the long run, it comes back to that equilibrium price. It's just hard to know exactly when because there's all these other dynamics going on, it's sentiment and it's, you know, in the case of the 10-year treasury yields, not only what's happening here is what's happening all over the planet, right? Because, you know, it's a global market and you got a lot of forces globally that are working. I will say, though, I am predisposed to think, you know, going forward,

10-year-old is going to be on the high side of four, not the low side of four. I mentioned, you know, inflation, but I also think going back to the budget deficits, you know, that would argue because that's a lot of debt that's going to be going into the marketplace, a lot of treasury debt. And the Fed's not going to be buying it, hopefully. You know, they're not going to be queuing. They're QTing. They're allowing their balance sheet to wind down.

So if that's the case, it feels like, you know, if anything that's going to be on the high side of four, not on the south, the north side of four, but our forecast is four. it's our forecast. By the way, that implies a five and a half to six percent 30-year fixed rate mortgage, right? Because the typical spread off the 10-year treasury is about 150, 175 basis points. So if you told me that the 30-year fixed over the next 10 years is going to average five and three-quarters percent, I say that sounds about right to me. And by the way, right now, it's six to six and a half, you know, maybe up a little bit in the last couple of days because of what's going on the bond market, but that's, you know, roughly where it's been. So we're not that

far away from where it will be. It's on the high, a little bit on the high side, but not a lot on the high side. The market's going to have to adjust to these higher interest rates. The mortgage market, the housing market is going to have to adjust to these, you know, higher rates going forward. Okay. Of course, I'm going to throw that back to you. What do you think of the way I just explain that? Does that make sense to you? It does. Certainly the theoretically equilibrium, but as you said, a lot of things are influential in the medium to even long term. Right? So it's hard to say. And I think the international aspect is something you need to consider here that 10-year treasury today is not just a U.S. asset. It's global. So it can be, my bias would be that it could actually be a little bit lower because of that additional demand from overseas. But that could change very rapid. I don't think you want to make a forecast based on that trend persisting forever. Right.

Okay. Any others? You want to fire away? Maybe do it up. Is there one more? Well, we have that closing question that I want to say. Yeah. So I don't know how much time we have.

Should I do that? Go ahead, fire away. We'll do it real quick. Lightning round. All right. The closing question is what do you think the best historical analogy is to what we are experiencing now from an economic perspective. Oh, right, right. You want to want to take that? I like this question. Well, I would, I would go ahead. Why don't you go first? No, you go first.

I think it's like a natural disaster, right? I think that if you look at the pandemic. Go ahead, go ahead. Bad joke. Yeah. If you look at the severity of the pandemic and what happened and the supply chain disruptions and not necessarily everything that followed, but just the catastrophic, very sharp, quick destruction in the economy, it's kind of like a natural disaster. When we would model natural disasters, and I did this a lot when I was, you know, very focused on regional work, you know, you would see events like a hurricane or a fire or a tornado or an earthquake and you would just get this massive, massive shock, supply side shock, right, to a greater extent than demand, to the economy.

And you would see this sharp fall and then this extremely strong rebound as things get rebuilt and things come back online. So that's what I go to is some sort of exogenous catastrophic event like that. Now, other things have happened since the pandemic. pandemic that have kind of piled on to the situation. But that's sort of the way I think about it when I talk about it. Yeah, I love that. I love that. I think that's a good frame for thinking about this. Yeah. And it's very kind of mind-numbing because it's hitting the supply side. People think of the economies from the prism of demand because that's typically what's been,

what drives the business cycle. The ups and downs is demand is strong. Demand is. week, you know, the Fed's raising rates and demand is weak. You don't really focus on the supply side, except for long run forecast. You know, what's the economy going to do in the long run? But when you have a supply shock, which, again, that pandemic and the Russian invasion are massive, massive global supply shocks right on one on top of the other, you know, that makes you have to think about demand and supply and the relationship between the two. And then you're thinking about prices, which is the, you know, the result of the, the, the result of the demand. these demand and supply forces working with and against each other very difficult to do.

And that's why there's been so much confusion and so much debate and so much, you know, difficulty gauging all this, I think, for, you know, for people. And for us, you know, it's been, you know, difficult, you know, time to do forecasting. Although I think I feel pretty good about our forecasting, you know, throughout the pandemic period. I think we did. Of course, I probably wouldn't say otherwise, but it's, I think it's, But I think that's a beautiful answer. I think that is the answer. You know, Kristen, you want to add to that? It's a great. The only, the way I would have answered it is I think there is actually no historical analog.

It is so different in what we're experiencing today that I don't even want to give an historical analog because I don't want someone to go back and say, oh, well, it's kind of like the 70s. and take a look at what happened there and fail to consider everything else that is so different demographically and the supply chain effects that you talked about, Mark. So, you know, I hate the phrase, but I actually do think in terms of the current situation, this time is different. There are many different forces. I was waiting for him to say that. In terms of what the recession is going to look like, yes.

It is different. Is that apply to the yield curve? He still believes the yield curve is a harbinger of recession. session. Oh, yeah. Don't discount the yield curve quite yet. Yeah, true. Yeah, yeah. Okay, very good. This was very much. How would you answer that, Mark? I like the way you, I like the way you answered it. I think it is analogous to, you know, a massive global natural, two natural disasters piled on top of each other. That's what it feels like to me. And, you know, kind of the metaphor I have in my mind is the economy is this, this little paper ship in the

middle of the ocean, or maybe better at a pond, right? You take a rock, you throw it. This is what I would do when I was 10 years old, hit near the ship, and that's the pandemic. And the ship's going like this, you know, like crazy like this. And then you go, oh, let's throw another rock. And that's the Russian invasion. It is. And the thing is going like this. And you're afraid it's going to tip over. And the only reason it didn't tip over is because of pretty deaf policymaking by the Federal Reserve and the federal government. They stepped in and they righted the ship, you know, kind of kept it going. But the ship is still doing this. Still trying to, you know, navigate around. And by the way, it's the, it's the waves created by the one and then the waves created by the other. And then the two of them, the waves coming together

that really complicate things. So that's the kind of the metaphor I have in mind. But I think, you know, that's the natural disaster. That's the kind of, you know, what it does. So I think that's exactly right. I think it's a great answer. Okay, we're going to call this quits. In fact, this feels like, you know, we did this as an answer to a webinar, but I, geez, whiz, this feels like a podcast to me somehow. I don't know.

What do you think? Maybe we can do. It could be. The bonus podcast. Inside, inside economics. Watch it. Listen to it. You know, we do that every Friday.

Okay. With that, we're going to call it a, I don't know. what we're going to call this, whatever this is. A webinar Q&A session. A webinar Q&A, we are out. And there it is. That was our Q&A session in response to all the hundreds of questions we got in our webinar a couple weeks ago.

I hope you found it of some interest, some value. Let us know if you did. And with that, we're going to call it a podcast. Take care, everyone.