Moody's Talks - Inside Economics - Faucher on the Fed and Fiscal Policy

Episode Date: July 20, 2024

The CrowdStrike debacle delayed this week's Inside Economics podcast but did not deter it. PNC Chief Economist Gus Faucher joined the team to talk about his outlook for the economy, the conduct of monetary policy and his thinking around the election and what it means for policy and the economy. Despite living in Pittsburgh now, it was good to hear he remains a Phillies fan. Today's Guest: Augustine Faucher, Chief Economist - The PNC Financial Services Group Hosts: Mark Zandi – Chief Economist, Moody’s Analytics, Cris deRitis – Deputy Chief Economist, Moody’s Analytics, and Marisa DiNatale – Senior Director - Head of Global Forecasting, Moody’s AnalyticsFollow Mark Zandi on 'X' @MarkZandi, Cris deRitis on LinkedIn, and Marisa DiNatale on LinkedIn 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 Sandy, the chief economist of Moody's and Analytics, and I'm joined by my two co-host, Chris DeRides and Marissa D. Natale. Hi, guys. Hi, Mark. Good morning. So it's been a pretty eventful 24 hours or 36 hours. Yeah. It's been a pretty unproductive 24 to 36 hours. Right. I mean, this is Saturday morning. Typically, we record the podcast on Friday. In the delay, was because of the crowd strike patch, which really kind of messed things up for us. So it's still scrambling to get it together. But here we are.

And Marissa, you're still not even on your computer. Right. I mean, everything was fine yesterday, and now today I can't get on. Wow. And you're on your phone, and that's why you send a little. I'm on my phone. So everyone knows a little hollow, but you're not. your normal, you know, boisterous.

Not in spirit, though. Not in spirit. Well, very good. You've weathered the storm better than I would. I would have. I would have been losing my mind if I lost my pace. And Chris, you kind of sailed through this, no problem? I wouldn't say no problem. We had trouble getting on our websites and whatnot, but my computer never had a problem. I never had a problem logging in. So bizarre. So bizarre. Yeah, it's kind of random, a bit random.

Yeah. And other companies are doing just fine. Pardon me? Other companies of their banks here are doing just fine. Even though they have CrowdStrike as their cyber software? Well, that I don't know all the details, but it seems like it's... Because I think we have... I think we have CrowdStrike.

You know, I think... Yes, yeah. We do. Yeah, obviously. Yeah, obviously. Right. I'm not saying that's not known. So...

All right. And we have a guest, Gus, Gus Foschet. Hey, Gus. Hey, Mark, good to be talking with you and Marissa and Chris. Yeah, it's been a long time. It has been a while. And where are you hailing from? Are you from Pittsburgh? I am in Pittsburgh. So I am the chief economist at PNC Bank.

As you know, I left Moody's Analytics back at the end of 2011. So I've been with PNC for a dozen years now. I've been chief economist for about seven years. And in fact, this is a big weekend in Pittsburgh because, the Phillies are playing the pirates this weekend. And so my dad came into town. He and I went to the game last night and then we're going to go to the game again tonight. So unfortunately, the pirates came back and won it in the bottom of the night. So we were disappointed by that. But it was a fun crowd and it's always good when the Phillies coming in town.

Let me get my mind around that. So you've been living in Pittsburgh for 12 years and you're still a Phillies fan. You know, I grew up in the Philadelphia area. You know, my dad still lives in Philadelphia. Yeah, I've been a, you know, a Phillies fan all my life. So, you know, I'm still, I'm still rooting for the Phillies, yeah. Oh, that's good. Because it's called P&C Park. I'm pretty sure. And it is a, I will tell you, it is an absolutely gorgeous stadium.

It overlooks the river. You can see downtown across the river from the stadium. It's a fantastic place. So if you're ever in Pittsburgh, I'll take you out to a game. Oh, absolutely. It just has the wrong team, right? The Pirates are fun. I like watching the Pirates.

They have some good young players, but no, I'm a Phillies fan at heart. Well, I was, you know, I'm a fair weather fan. And I was watching a little bit of the game yesterday. Disappointing ending, I'd have to say, as you pointed out. But there's a lot of red shirts meeting Phillies fans in the crowd. You were probably one of them. You were one of them. I was one of them.

My dad was one of them. I would say it was probably at least where we were sitting. It was more than 50% Phillies fans there. Oh, is that right? Wow. But they did have a sellout and should be another big crowd tonight. Yeah. Well, it's good to have you on board.

I can't believe it's been a dozen years since you were movies analytics. Yeah, no, it's, you know, that was a great experience, and it's been fantastic working at PNC, and we've really enjoyed Pittsburgh. And it's been a great place for us and for Amy and for the kids, and it's worked out very well. That's great. Yeah. Well, I love PNC Bank. Did ever tell you the story about PNC Bank when I, you know, the company, I started with a good friend and my brother Carl back in 1990. We needed our first business loan.

And so my instinct was to go knock on the bank where I had my deposits and that was PNC. And so I knock on the door and I say, of course, there was like, I don't know, five of us at the time. We're working at the company, the predecessor company, it was called regional financial. financial associates. And so I go in there, knock on the door, say, basically, I need a line of credit. I want to go hire people. And they said no. They said no. So I had to go to Malvern Federal Savings Bank, which is, you know, three branches. And the only reason why I got a loan was because the bank president daughter was on my daughter's soccer team. And I was the coach. So I got to, Of course, I had to sign over my home and everything else I owned, which was basically my home.

I don't even have much equity, but PNC turned me down, Gus. I don't know what that's all about. Sorry to hear that, Mark. That was before I started. So I can't be how much as possible. It's prudent risk management. Absolutely. They would have been nuts to give me a loan.

It would have been nuts. But it all worked out. It all worked out in the end. But it's so good to see you and glad to have you aboard. Okay, so how are you feeling, Gus? How are things going out there? So I think things look pretty good. I think that we are headed for a soft landing. I think that, you know, on the inflation front, we've started to get some better news, particularly on the shelter side. So we've been expecting that to happen.

You know, given what's going on with measured rents, we expected to see a slowing in shelter inflation. And so that, you know, we kind of, that kind of stalled in early. early 2024, but the last couple of months have looked a little bit better there. So I think that we're moving towards the 2% objective. And so I think we're looking good from that perspective. And then also we're seeing a little bit slower wage growth, right? So job growth has cooled off somewhat. We've seen, you know, wage growth slow to around 4% year over year, still a little higher than I think what the Fed wants to see, but certainly much better than when we saw wages increasing 6% year over year a couple years ago. So I'm feeling good on that side. And then in terms of economic growth, you know, I think

things still look pretty good there. We're seeing a little bit slower growth. But that's probably a good thing because we want to see growth slow towards potential, which is, you know, probably somewhere around 1.8%, 2% a year. I think consumers are holding up well. You know, I think that with the solid job growth and with real wage gains, wages running ahead of inflation, I think that consumers are able to increase their spending. I think we will need to see a bit slower consumer spending growth. I think we need to see the savings rate come up, so we need to see spending growth that's running below income growth. But I think that we can achieve that, see the savings rate come up a little bit, and that should allow for a bit slower economic growth. I think business investment looks pretty

solid still. I think that, you know, we'll get a little bit of a boost from from lower interest rates, and we can talk about that in a few minutes when we talk about the outlook for the Fed. And then the housing market, which had been a drag on growth in 2022, first half of 2023, it's not like it's adding to growth, but it's not subtracting from growth anymore. So, you know, I think that, and to be honest with you, you know, and I know that you guys were in a different place, but a year and a half ago, when the yield curve inverted. We thought we were going to get a recession. And so we put a recession into our baseline forecast. Obviously, that did not play out. And I think the strength of the consumer was the primary reason that that didn't happen. But I think things look good right now. And we're expecting to

see slower growth this year, first half of next year. But I think that's very welcome. And I think that we should be able to get back to 2% inflation by roughly this time next year. So you use the word soft landing, and that's kind of the way, that's the phrase economists used to describe an economy that is going to settle in at a slower pace of growth, but at a pace that's consistent with full employment and inflation back at the bed's target. Are we, would you characterize the current situation as a soft landing? Have we soft landed, or are we still not quite there yet? I don't think we're there yet. I think we have to get to that 2% inflation before we can successfully say that we've had a soft landing. And it's easy to see.

see how things could go wrong on that front, right? Not that I'm saying this is going to happen, but if we have a conflict in the Middle East, it pushes up energy prices again, and then the Fed needs to tighten further and consumers cut back because they're spending more on gasoline. You know, we've gotten some deflationary help on the good side, you know, and so that certainly has been a positive, but we do have, you know, the issues in the Red Sea, you know, perhaps We see that goods inflation picks back up again. And so that makes it more difficult to get to 2%. So I don't think until we see, you know, do, I don't know if it, I don't know whether we need to see inflation hit 2% year over year.

If we need to see six months of annualized 2% inflation to say soft landing. I think we're headed towards a soft landing. But until we get, you know, consistent 2% inflation, I would not want to say that we're there yet. What about you, Chris? Would you characterize, are we in a soft land? Have we soft landed or, you know, what would, what is the thing that would be enough to say, hey, we have, let's declare Victor where we soft landed. What would it be?

Yeah, I'd say primarily inflation, right? You can get that very, very clear signal there. But I guess I'd go a little bit further and say that I even want some of the financial markets to normally, like the yield curve. I'd say that should be positively sloped to really say, okay, we made it through this entire cycle and things that really have normalized completely. Right. Otherwise, we're still at risk in my mind.

At risk, right. Marissa, what about you? What are you? I'm a little bit more forgiving, I think, on that. I feel like I'm kind of there already in my mind on it. I mean, with, yeah. the labor market has been great for a long time now. So I think the Fed has achieved its full employment mandate a while ago.

I don't think they have to worry about that. Now I think they have to worry about the labor market slowing too much. And I think on the inflation front, yes, we're not at 2%, but that's really at this point, almost a technicality because of shelter inflation. and we, I think, all know that if you take that portion out, right? If you take OER out, we are at or below the 2% target and have been there. And it's equivalent rent, right? Right.

And in terms of things like these markers like the yield curve or consumer confidence, I just think these things are sending false signals at this point. And we don't, I'm not really worried that at this point, any of those things are calling for recession because they've been in the territory that they've been in for a very long time without a recession. So I feel good about the economy. Of course, there's risk. There's always risk. And yes, it's more heightened right now, but I don't know. I'm not, I'm not sitting here waiting to see if there's going to be a recession.

at this point. Like, I feel like we've mastered that. We've made it, yeah. Yeah, but I guess I'm a little more, and you raised a good point about the shelter component in inflation, but, you know, I mean, the Fed by their own lights has set that 2% objective using the core PCE price index.

And so I think from their perspective, I'm not sure that they would call it a soft landing until they actually get there. Yeah, well, who cares what they think? Yeah. Yeah, you ask what I. I'm asking you and Chris and Marissa, that's what I care about. I don't care enough.

Fair enough. I mean, yeah, Gus, I think you're totally right. I mean, that's why they haven't lowered interest rates yet, because they are tethered to this 2% target. And they have said that again and again and again, and it would risk their own credibility to start lowering rates before they're clearly, I don't think they want it. I don't think they necessarily need to be there, but they need to be very close to there

and heading toward there very definitively. So I understand what they're doing, but I think if we're talking about where is the economy and the business cycle, to me, I think we can almost say we've made it to us off. landing. Yeah, I think I think the key is for me, the Fed actually cutting rates. Until they cut rates, it's hard to conclude that you soft landed because they can still make a pretty serious mistake here, keep rates too high for too long, and do some damage. And, you know, we're, so as soon as they start cutting rates for the right reasons, not because the economy is falling apart, but because,

you know, they feel comfortable that inflation is going to target. They've achieved their mandate for full employment and they're good with things. I think at that point, I would declare soft landing. So hopefully that's coming up here pretty soon. One of the other thing before we moved to Fed Policy, monetary policy, Gus, you did mention that you were calling for a recession that didn't materialize, which was, you know, the widespread expectation. I'm just going to brag.

We did not call for a recession. But I'm curious, what was it that you were looking at that made you conclude that recession was more than likely, and that was your baseline forecast. What was it then? So, you know, I mean, it was a tightening and monetary policy and the big increase that we had seen in both short-term and long-term rates, you know, starting in, well, I mean, long-term rates started to go up at the end of 2021, but then throughout 2022 and into 2023. And, you know, we were looking at the yield curve, and the yield curve has been a very reliable indicator. You know, I mean, it's not just my forecast. It's a forecast that we put

together with other people in PNC. And, you know, some people are saying, well, there's no way we do that. It's not me to blame. It's like, it's the committee. It's my name that's on the forecast, Mark. I mean, you know, I get the credit of things. I'm only teasing you. Of course, I'm only teasing you.

You know that. Yeah. But anyway, so, so, you know, and so we had people saying, well, you know, it's, there's going to be a recession. There's going to be a recession. And I wanted to see something more. But when we did start to get that yield curve inversion, you know, kind of in the second half at 2022, you know, I mean, that's been a very reliable indicator,

as we all know. And I don't want to say probably. I did put too much stock in that. And, you know, assume that when we got that inversion in the yield curve, that we would get the recession like we almost always do. But I think that there, you know, it's just, as Marissa pointed out, it's just not as good an indicator now for lots of different reasons coming out of the pandemic, and maybe it'll return to being a good indicator once things really normalized. But, you know, I miss that. And in fact, I write a newspaper column for the local paper, and I did a whole column on how I got it wrong and why I got it wrong. So I'm happy to take the blame for that one. Yeah, the yield curve is a difference between long-term registration short rates, and generally

it's so-called positively slope long rates or higher than short rates. But every so-oft, And so-called inverts, short rates, because of Fed policy rise above long-term rates. That inversion historically has been highly correlated with recession down the road. And I can see why actually from the prism of a bank, like a PNC bank, the yield curve feels very compelling as a kind of a predictor of future economic conditions. because when the yield curve inverts, that makes life very difficult for, you know, financial institutions at bank, right? Because they tend to borrow money short,

at short-term rates and lend long, and they make money on that so-called maturity transformation. So when the curve inverts can't do that, there's no way to make that money or it's harder to make money on that maturity transformation. You pull back on the availability of credit, and that is a catalyst for slower economic growth and ultimately recession. That's me talking. Does that sound right to you? What I just described? Okay. Is that the intuition behind why you think the

yield curve is a good predictor, or at least historically, has been a good predictor of future recession? You know, if we think about what determines long-term yields, it's in, you know, inflation expectations, long-term inflation expectations, and then expectations for longer-term growth. And, you know, the expectation was, was that growth would weaken, turn negative. The expectation that was is that inflation would slow. And, you know, I mean, the slowing in inflation that we've seen over the past couple of years without a recession is really unprecedented. Now, I mean, there are reasons why that's happened, you know, the pandemic dislocations, the supply chain disruptions, all that kind of stuff. But I think the view was is that the only way we can get from, you know, and I think poor PCE

inflation was what, 6% or something like that. The only thing. only way, you know, the way to get from 6% inflation to 2% inflation is through a recession that kind of, you know, that reduces demand. And so I think that, you know, that was a factor behind the long end of the curb being lower, you know, that inflation was going to get to 2%, but only through a recession. So, you know, looking at it from that perspective, that was the view and that's why we decided to put the recession into the forecast. So why was it wrong? Why was the curve wrong? By the way, the curve is still inverted. Yes. And it's been inverted now a long time and maybe as long as it's ever been by some

measures probably. And it's not just a little inverted. It's a lot inverted. It's a lot inverting. Right. Yeah, yeah. You know, I think there were a few things. I think that at least some of the inflation turned out to be transitory, like Powell was initially saying. I think on the good side that, you know, as I mentioned, we're actually seeing core goods deflation. Those prices are down. But, you know, the surge in goods inflation that we saw in 2021, you know, was due to the supply chain disruptions, but then goods demand stabilized, supply chains were rebuilt. And so that dissipated. Marissa talked about the, you know, the shelter component, and, you know, that may not be a reflection of actual inflation. And then I think that, you know, the consumer balance sheets, the excess savings that we've been talking about,

the fact that they had those stimulus payments saved up, I think that meant that even when rates went higher, consumers didn't pull back on their spending as much. And then there's a lot of pen-up demand on the services side for consumers. You know, we've seen good spending roughly flat over the last two or three years, but services spending has continued to increase pretty strongly. And so I think that consumers still had some of that stimulus money saved up, and so they were using that to spend on services. And so consumers held up better than might have been expected,

given the big increases in rates that we've seen. Okay. Hey, Chris, how do you, and by the way, I should just mention on a previous podcast, We had Campbell Harvey, the Duke professor who popularized in his PhD thesis, the relationship between an inverted curve and recession. And it was, I think it was Chris Craterman for wrong. I thought that was a pretty good podcast. Although, and he ended up saying, oh, the yoke curve, as I recall, he said, don't worry,

the yoke curve inversion isn't going to result in recession. This is the first time that this predictor isn't going to work. And then he backed away after the podcast, didn't he kind of reversed himself and got got obviously wrong. I mean, at least so far, he didn't turn out the way he expected. But Chris, why do you think the YO curve hasn't been as reliable or has not been a good predictor of recession this go around? What happened there? Well, I think Gus identifies many of the reasons. I have to tell you, they're not satisfying X-L-L-Rexplan.

They're not satisfying to you. No, no. Okay, I'll give you another one. Yil curve knows all that. Everything you just said, the yield curve knows that, right? The investors know that. That's embedded in the yield curve. So why did, historically, they always get that stuff right.

I mean, the collective wisdom of the yield curve, which means bond investors get it right. So what happened this go around that is different? Why didn't they process the information properly? I'll give you another one. Another reason that's going to be unsatisfactory to you. I think to some extent we got lucky, right? Lucky. Okay, now I like this.

I like this. Okay, go ahead. We were vulnerable in that inverted yield curse. I think we still are. Yeah. We got hit by several shocks that I think also led to the conclusion A, the probability of recession is really high. Right.

We had banking crisis. We got very close to a debt ceiling crisis. And on top of the, of course, the supply chain disruptions from the pandemic, the oil energy crisis or energy disruptions from the Russian. invasion of Ukraine. So either was luck or you want to be more generous, the skill of policy makers adeptly adjusting to some of these shocks. I think that, yeah, I think that's one of the reasons why perhaps the yield curve wasn't as predictive this time. Investors were, didn't believe that we could make it through with all these shocks in a very graceful way that a recession would have

been. So what are you, do you have a probability of that? Do you have an explanation? Hopefully it's better than these other two guys. Well, I mean, there is, some people believe that the Fed was kind of artificially pushing the long end of the curve lower because they were buying so much mortgage-backed securities and longer-dated treasuries. So you had. Yeah, through quantitative argument. Yeah, which is a reasonable argument.

It's got to be at least part of the story. I mean, we haven't, right. We haven't had that in past cycle. That's a relatively new tool. So in previous business cycles, you didn't have that phenomenon. So, I mean, that could be part of it, could be part of why the long end of the curve is lower than it otherwise would be. Right, right. And then we also, I mean, sorry, Marisa.

We also did get some fiscal stimulus, right? We had the Chips Act, we had the infrastructure bill, we had the Inflation Reduction Act that, you know, that was a positive for growth. in in 2020. And I think that's a reason why we saw that pickup and growth in the second half at 2023. So to some extent that, you know, mitigated the impact of the contractionary monetary policy. I kind of like the, the, we got lucky theory. But I would, I would have pointed to some, a couple of other things that were lucky, kind of lucky. I guess so lucky that you could, mean, in the sense that we didn't predict them, like the immigration surge, right? You saw a surge in immigration, like no one thought we're going to get 3.3 million immigrants last year. And that cooled

things off in the labor market and allowed the Fed to, I mean, the funds rate might not have ended at 5.5%. It might have ended at 6.5% without the immigration surge, right? And that probably would have pushed us into recession. Or the other is oil prices, right? I mean, oil prices, they didn't go up when you certainly would have thought, given the sanctions on Russian oil and Saudi production cutbacks in OPEC, that would have happened. But who would have thought that North American frackers could push up production of oil by over a million barrels a day in one year and wash out the loss of production by Russia and Saudi and keep the oil prices down?

That feels, I don't know if that's lucky, but that's... hard to you could not have expected yes impossible imagine but here's the other thing and gus because you know your folk you're you're at a bank my kind of pet theory and by by the way mrs i agree with you on the quantitative easing that's got to be part of the story i don't know how big a part but it's got to be part of the story uh there was no other period historically where the fed was quantitative easing this is the first time they were quantitative easing and uh you know in the curve inverted, is that banks, P&C, did a very good job managing their net interest margins in the context of that inverted curve.

So the curve inverts, net interest margins, the difference between what banks borrow the rate they borrow on and what they lend at, that net interest margins, that's their profit margin, typically narrows and may go to zero, may even go negative. historically. You can't make money. You don't make loans, no credit. And that actually is a real problem if it comes after a period of very rapid credit growth because businesses and households need the credit. They need to refinance. They need to roll over their debt and they can't do it, or they have to do it at a much higher rate, and that becomes very difficult for them to do. But this go around, banks did a good job of kind of matching and hedging. The net interest margins

have held up a lot better than you would have thought. They're coming in now, but they held up for a lot longer, therefore credit continued to flow. And the other important thing is we never saw the kind of crazy lending, surgeon lending, the rapid credit growth prior to the slowdown. And therefore, you didn't have a lot of businesses and households coming back to the banks and saying, hey, I need another loan. You've got to refinance me. You know, you've got to refinance and roll me over. And so those dynamics in the banking system, very different to go around than historically has been the case, therefore the curve as a signal has not been as useful. What do you think? Is that a theory you're not, is that the first time you heard that theory?

No, no, no. Oh, damn, because I was going to say, I was going to take credit for it. I was going to say, no, no, I think that's the first time I've heard it articulated that coherently and kind of. Oh, okay, I'll take that. I've heard the pieces, but I think that's the first time I've heard it put together like that. And let me preface this by saying that I'm not to, supposed to talk about PNC-specific stuff. So what I'm saying now is about the banking system in particular. Right. But I do think that the banking system has held up very well.

You know, I do think that banks have been responsible, much more responsible in extending credit during this cycle than certainly than they were, you know, 15, 20 years ago. You know, some of that is banks learning from what happened during the financial crisis. some of it is the regulatory system that's been put into place. You know, but I, but you know, I mean, you think back to 2021 and the biggest problem was is that banks had too many deposits, right? You know, that banks were flush with cash. But I think that they have been generally been responsible about that.

And we saw banks actually trying to move away from holding deposits, which is, you know, kind of a new situation. And so I think that there is some merit to that theory, and you look at delinquency rates, and they're up a little bit, but they're still very low. You know, you look at balance sheets, they're still pretty good. So I think that there is some merit to that theory. Great. Great.

I'll take that. I'll take that. Well, let's move on to monetary policy, the Fed. What do you think? I think the widespread consensus now, I'm looking at federal funds futures, futures for federal funds to keep the rate the Fed controls. It's putting, I think, oh, correct me if I'm wrong, Chris, I think it's almost like a 100% probability of a 25 basis point, quarter point cut in the funds rate at the September meeting. That would be the first cut. And then pretty steady

cuts after that, roughly a quarter point each quarter going forward. So by the end of 2025, the federal funds rate target, which is now just south of five and a half percent, will be, what, closer to three and a half, three and three quarter, something like that. I'm making that up, but that's roughly right. Gus, is that consistent what you're thinking? Are you in line with the consensus? Yeah, now that sounds about right. We have the first rate coming at the September meeting and then hold off in November and then cut in December and roughly every other meeting in 2025. So I think that that's fairly close to where the consensus is. You know, we've talked about the progress that the Fed is made. I agree with Marissa that they are, you know, when they look at the dual mandate

that they're there on the maximum employment portion, I think that Powell has made it clear that he does not need to see inflation at 2%, you know, to cut the Fed funds rate. The monetary policy will still be contractionary. It will still be weighing on growth. And they don't want to be behind the curve. They don't want to, if their view is, is that if they wait until inflation it gets to 2%, then it's going to be too late and that increases the probability of recession. So I think in, I think a rate cut in September, one in December, and then, you know, roughly every other meeting in 2025, to me that sounds about right. And I think that hopefully should get us to that point where we get inflation back to that 2% objective by, you know, mid-20205.

Good news. We got Marissa. Marissa, you're there. Congratulations. You made it through. Thank you. Thank you. Yeah. And you look no worse for the wear, I must say. Thanks. Thanks. I think you're headed on vacation, aren't you, after all this? I am, yeah. Going up to drink wine in the central coast of California. Oh, that sounds like a lot of fun. I mean, it's, well, it's like 110 degrees up there. So drinking a full-bodied red right now doesn't really sound that great. Well, take your swimsuit, jump in the ocean. It'll be nice. Yeah. Same by the ocean.

Saved by the ocean, yeah. Yeah. Well, it's good to see you. Yes. So back to monetary policy in the Fed. That's what the Fed will do. Is that consistent with what you think the Fed should do? I think so.

I think that the, I think that, you know, I think the risks right now are weighted more towards, weak growth than they are towards higher inflation. But I think that this, if the Fed's cutting every other meeting, monetary policy is getting slightly less contractionary. I think that this gives them the ability to cut more rapidly if they do see that the labor market is devolving. And so I'm comfortable with this.

I think when the last dot plot, the summary of economic projections, that the Fed puts out, you know, as a little surprise that they had inflation staying where, roughly where it was through the end of this year, and then only that really that one rate cut, because I do think that inflation is moving in the right direction. And I think that the Fed should be cutting because monetary policy is still pretty contractionary right now. And that if they, you know, if they wait for, if they wait too long, then we could get that potential recession because monetary policy is, you know, rates are too high for too long.

So, so our forecast is the same. You know, we're with consensus on September, a quarter point each quarter. One of the debate, there's two debates in my mind that I'd like to get your sense of and also from Marissa and Chris. One is, what is the, what do you think the so-called equilibrium rate is. The equilibrium rate, so-called R-star, that rate, that federal funds rate, which is neither a restraint or a source of support for economic growth. It's neutral with respect to growth, which presumably is where the Fed is headed here. They're going to start cutting rate, five and a half percent where the funds rate today is, as you just said, you use the word contractionary. I would say restrictive. So that means that that's higher than the equilibrium rate.

and presumably the Fed's going to start cutting rates and ultimately settle, had the federal funds rate settle in and its equilibrium rate. What is that equilibrium rate today and where are we going to settle? You know, I'm saying this with no degree of certainty, but I do think it's higher now than it was pre-pandemic. So I would say somewhere probably around three and a quarter percent. You know, you mentioned the immigration surge that we had earlier, which means that growth may be a little bit stronger over the long run than we thought previously.

And we bumped up our, you know, a potential growth rate up by about a quarter of a percentage point. And so is that right? Can I ask to what? Is it, are you a two and a quarter now? Or what are you? We're at about 2.1. 2.1. Okay. Okay. So, you know, so I do think that there's, you know, and we'll see if this immigration surge lasts. but I do think that there's higher potential long-run growth. On the other hand, we're unsure what the productivity effects are going to be post-pandemic. And so, you know, that would argue for, you know, a lower, I mean, the Fed funds rate being a little bit lower than that long run. You know, so we'll have to see how things play out.

But I'm saying this with no degree of confidence at all, right? I mean, we can't observe what the neutral rate is directly. we have to infer it. And then the other thing is, is that, you know, certainly the fact that we have had growth that has been this strong, even with the Fed Fund's rate that is five and a quarter, five and a half percent would argue that it might be a little bit higher now than it was pre-pandemic.

But again, just no degree of certainty on that. I think we'll get a better sense during this upcoming loosening cycle to see how the economy responds. Mercer, what do you think? What do you think the equilibrium rate is now? I mean, just again, for a little bit of context, if you go back a year two or three ago, there's a wide view that the equilibrium rate, and this is consistent with what the Fed was showing in its forecast, that the equilibrium rate, federal funds rate target was 2.5%. Now, there's a widespread consensus now is higher. So the question to you is, and I asked that question,

question of Gus, and Gus says three and a quarter kind of feels right, with all the appropriate caveats here, low level of confidence, and it's a moving target. I totally agree with that. What do you think the equilibrium rate is now, and where is it headed? I'm with Gus. I mean, we don't know, but I think it's somewhere between three and a half and four. I think that the economy, as Gus, point, pointed out. I mean, it's been incredibly resilient to the rates that we've observed now for the past two years, right? I mean, we have a job market that is creating well over 200,000 jobs a month, which prior to the pandemic, that would have been a stellar jobs report, and we're

getting that every single month with a slightly higher unemployment rate over the past year, too, which suggests that underlying growth in the job market is much higher than it was prior to the pandemic. So things have certainly seemed to have changed. Now, whether these are permanent changes that we should expect for the next 10 or 15 years or this is something that is going to go away in a couple years, that's what I'm unsure of. But I think as of right now, the equilibrium rate has to be somewhere around three and a half percent. Of course, you have a difference. Or even higher.

Yeah, the number of my mind is closer to three. Right now, closer to three. Yeah, yeah, in terms of an equilibrium, right, it's going to take us a while to get there. Right. Yeah, I guess it's how you weight these various factors. Yeah, there's definitely enough uncertainty from politics. from demographics, from productivity gains to kind of make it very unclear. It's clearly going down from here, but it's going to be higher than it was prior.

Why will it go down from here? Well, I think right now we're quite restrictive. Why is the equilibrium rate going to fall, though? Oh, I'm sorry. I'm sorry. You mean the actual rate. The actual funds rate. Oh, yeah.

It's going to fall down from here. Yeah. Right. The equilibrium is likely higher than. it was prior to the pandemic for the recent mentioned, but then it's a question of, again, how durable are some of those policies and behavioral shifts. Yeah. You know, my view is that the equilibrium rates higher.

And I'm with you, Gus. I don't say this with a lot of confidence, but it's much higher than it was, you know, earlier in the pandemic, it's certainly pre-pandemic. I put it at four. And the reason is that the economy is much less, rate sensitive than it has been in the past. And it's very idiosyncratic. It goes to the fact that households, you know, homeowners have been able to lock in, you know,

very low interest rates. Everyone got a mortgage when rates were lower refinanced down into a mortgage with a rate that was very low. I think the average coupon on an existing mortgage is still about three and a half percent, and they're locked in, 30-year fix, maybe a 15-year fix. So they're very rate insensitive. You know, those run up in rates has not added to household debt burdens or in aggregate, the household debt service burdens.

And I think businesses also did a marvelous job of mostly locking in. Not everyone. There's, you know, distribution here across companies. But I think on average, we've seen businesses do a very good job. In fact, if you look at net interest payments by non-financial corporations, it hasn't even started to rise. It still has fell sharply and it has not even because. to rise if you if you believe the Bureau of Economic Analysis Day, it would be EA data. So if you're

less rate sensitive, then that would require a higher equilibrium rate to get the kind of growth that is necessary to get inflation back, you know, down to target. Now, if that theory is correct, that would argue that over time we are going to see the equilibrium rate come down, right, because these these liabilities that households have in the corporate debt, it's going to adjust, and it's going to adjust at a higher rate, and things will start to normalize. And so I do expect the equilibrium rate to come back in. And we have the equilibrium rate settling in it around 3%. So we're at 4.

We are at 2.5. We now are at 4. We have it settling in at 3, which is still about the 2.5. And that goes to your point, Gus. And that is, I think, the underlying growth rates of the economy are going to be a bit elevated here. Part because of immigration, although that's going to pull back here, I think. I think post-election, I think either whoever wins is going to really clamp down on immigration.

Obviously, Trump is, if he's president, is going to clamp down even more. But regardless, we're going to see that. But I do think we'll see somewhat better productivity gains going forward. But that's a whole different discussion. Yeah, that's a whole different discussion. How do you react to what I just said? Or does that – Well, I mean, my question is productivity growth cuts both ways, right, though, because that means we can have stronger output growth with lower inflation.

and that might argue for a lower downward pressure on the equilibrium rate, I think. So I'm not convinced that stronger productivity growth necessarily translates into a higher equilibrium than fund rate. Yeah. Okay. Okay. Fair enough. The other thing I wanted to ask about is the 2% inflation target.

You know, the Fed is, it feels like it's willing to sacrifice the economy to an altar of 2%. Because, you know, they're targeting the consumer expenditure deflator, the so-called PCE deflator that you called out. And it's 2% on the consumer expenditure flayer. And we're at 2.6%. And the only reason why we're not even below two on a consistent basis is the implicit cost of homeownership, the owner's equivalent rent. You exclude OER, owners equivalent rent, and the implicit cost of home ownership. Like every other country on the planet, most every other country on the planet does, because it's very difficult to measure. appropriately, and particularly now in the current context when the housing market is upside down

with affordable housing shortages and interest rate lock and everything else, you look at that, the consumer expenditure deflator excluding OER, owners equivalent rent, has been below 2% for almost a year, on a year-over-year basis, on a year-over-year basis. So by that measure, we're there. So with all that, what do you think? Is 2% the right number? So what I think the Fed is going to do is they're going to wait until we get to 2% year over year on the PCE, the core PCE, you know, and then they're going to commission a working group

to look at whether that is the new, what the objective should be. And they're going to look at the post-pandemic experience. They're going to look at what's happened overseas. and I think what we're likely to see is, you know, they could say, okay, we're not going to say 2%, we're going to say a range between 2% or 2.5%. Or they could move to some other measure, you know, the harmonized one that they use in the EU or something like that that excludes. That's excluding that's what I'm saying. The excluding owners equivalent rent, right? And, you know, and I think that there are good reasons for that. But I think the first thing that they need to do is they need to get to that

2% objective. So they can't be accused of moving the goalposts because that ruins that that hits their credibility the next time this happens. And people will say, oh, well, you got to 2.5% and then you said that was good enough. And so the next time people are going to think, oh, well, if we, you know, if inflation gets up to 5%, then they'll just, you know, get it back down to 3%. So I think they need to achieve 2% first. Then they'll look at this, say, what have we learned from this experience? Was this the right number? Should we? you know, how can we reevaluate? And then I don't know what the answer is going to be. I don't want to prejudge that process. But I certainly think that we could come out of this with a different,

a different, we could have a range instead of a straight number. We could have a slightly higher number. We could have a different concept of inflation. But I think they want to get to that 2% objective before they start that process. Okay. So that makes all perfect sense to me. I think you're dead on. exactly right but what's the number should it i mean if you had to pick a number would it be two i think i think two would be three i think i think two is fine uh you know could i go to two and a quarter yeah i could go to two and a quarter uh i think it should be that the harmonized with excluding the o er uh you know for the reasons that you mentioned it's difficult to measure it doesn't really i mean it doesn't affect any if you already own your home it doesn't affect your housing

costs. And so I think that, you know, something like two or two and a quarter on a harmonized measure to me sounds good. And I think, you know, that means, and again, they want to be at the point where, you know, and I forget, you know, that where I've read this, but, you know, they want to be at a point where people aren't thinking about inflation. And I think if you're at two percent or two and a quarter percent inflation, excluding OER, then I think, You know, you can go about your day. You're not thinking about inflation. You're not thinking about prices.

And that's good for long run economic stability. Yeah. Okay. Well, I put it at three. Because, you know, why? Because lots of reasons. I'll give you one. If it's three and then you, and say your real growth is two, you say two.

You say two. But let's say two. That means your nominal growth is five. And historically, in recessions, the Fed cuts rates by 500 basis points. So, you know, if it's at two, there's a reasonably good probability that in a typical recession, the Fed's going to hit the zero lower bound on the funds rate and has the quantitative ease. And I don't think that's where they want to be, QE, for lots of reasons.

So it feels like they should set the inflation target higher. so that they can set the federal funds rate, the equilibrium nominal federal funds rate target higher so that they don't hit that zero low bound on a regular basis. That's kind of the thought process. My thought. No, no. I like that argument. I'm not sure.

I'm 100% convinced of it, but it's internally consistent. I'll work on you. Don't worry. There's some merit to it. So I'll think about it. Okay. Hey, let's play the game because I want to, we've already had a nice conversation here, but I don't want to lose you.

I know you're going to go see the Phillies win against the Pirates. But, and I do want to talk about fiscal policy and what's going on with the election and what that might mean. But let's play the game. The stats game is we each put forward a stat. The rest of the group tries to figure that out with cues and deductive reasoning, clues. And the best stat is one that's not so easy. We get it immediately. One that's not so hard.

We never get it. And if it's apropos to the topic at hand, all the better. or the recent data. So, and it's always, it's tradition around here, Gus. We always begin with Marissa. Marissa, what's your stat? My stat is 20,000. 20,000 what, Mercia?

That is the question, Mark. Votes? What's that, Chris? Is it votes? No. 20,000 votes. Oh, that's going to be the margin of victory to the next president. 20,000.

It's not anchovies. No. Okay. It's not widget. No, it's not anchovies. It's not jobs? No. 20,000.

Is it a statistic that came out this week? Yep. Oh, it is. Okay. I'm just thinking of all the statistics that came out. Is it housing related? No. Is it unemployment insurance related?

Yes. Okay. Okay. So, all right. An increase. Oh, it was up 20K in the week. Yes, yes, yes. Yes.

Yes. Okay. Yeah, jobless. So initial filings for unemployment insurance rose 20,000 in the week ending July 13th. So they've popped up quite a bit. They're at $243,000 a week. the four-week moving average is a bit lower. It's like $2.35.

We saw this phenomenon happen last summer, too, in the middle of June and July, where unemployment insurance claims rose. And actually, they were higher, significantly higher last summer than they are at this point right now. So kind of holding my breath that maybe this is just some new seasonal pattern that's emerging. But, well, I picked it for two reasons.

One is that I was kind of uninspired by. via all the other statistics that came out this week. And you know, I love the labor market. It was a tough week. It was a tough week. Yeah. And because I think it highlights some of the risk that we're talking about with the Fed keeping short-term rates high for a significantly long time, that it looks like the job market

is slowing. We've seen the unemployment rate rise by half a percentage point over the last year. Unemployment insurance claims are higher. That might be a false signal, but we've also seen, you know, job openings. hires, quits all come weigh in from where they were. So at this point, I think for the Fed, the risk is that the job market really starts to crater before they can start lowering rates. That's a strong word, crater.

Yeah. I know. But I mean, we did have. You're the one who said we soft landed. What the heck? I mean, I don't know. I mean, how much of her runway. and soft landing in the same podcast.

How much of a runway do we give this? You know, I mean, yes, there will be a recession at some point again. Okay. A hundred percent certainty. So how long do we wait before we connect this, right, to the last business cycle? But, I mean, to your point, with rates elevated and the Fed not cutting yet, I do think it's difficult to completely declare victory on this. And things can still go wrong.

wrong. Because I interrupted you. You were going to say, no, no, I think we did have some impact from Hurricane Burrell on the claims last week. So that could be that's right. I didn't think of that. Yeah. So I think if you look at the state data, some of it came from Texas. So it could be that that's the impact there. So and I like the fact that you pointed out the seasonal pattern. We saw the same thing last summer and then they started to fall again in the second half of the year. So we'll see what happens on that score. So yeah, it's a good point. I didn't thought about Burrell. Okay, Gus, do you want to go next or you want Christopher?

Sure. Okay. So mine is 9.8%. See, Marissa, he gives us the units. You see how that works? Well, what was I supposed to say? 20,000 initial claims for unemployment insurance. Guess what it is?

Good point. Good point. Tusha. Tusha. 9.8%. Is it related to a statistic that has come out recently, Gus? Not particularly, no. Okay.

Oh. Is it a growth rate? No. Is it a percent of some population? Not really a population, no. Okay. Is there inflation related? No.

Jobs related? No. Housing related. No. Is it an interest rate? It's in some respects it's housing related. Let's put it that way. Is it an interest rate?

What's that, Marissa? Is it an interest rate? No. It's housing related. Single family, housing related? Or multi-family? More single-family than multi. But it's not what you would consider a housing market indicator.

Yeah. But housing drives a lot of it. Right. Housing drives a lot of it of the 9.8%. That's not an inflation. shelter cost type no okay no you want to give us another hint can you give us a hint it's something that you had mentioned earlier in our discussion mark see i have such a loud mouth i mentioned lots of things that's the problem yeah nine is it a is it a share of some thing um yes a share of something uh

9.8% of people, households? Is it construction related? No, no. Okay. Here, I'll give you a hint. Okay. It's consumer related. Oh, it is.

Or household related. Household related. Spending, saving. You're close. Close, wealth. But 9.8% I can't. Something to do with mortgages and how. Is it the debt service burden?

You got it. Oh, okay. Got it. I kind of helped you. Ding, ding, ding, ding. I'm going to take credit for that. So I don't know. Everywhere I go, everybody's like, oh, consumer debt is at a record high.

Yeah, yeah, yeah. They're all in a panic about this. And I say it's important to look at it in context. So I think that does a good job of saying, you know, look, you know, it was, it's still lower than it was before the pandemic, much lower than it was heading into the financial crisis. You know, people have refinanced. And so, you know, they're still paying low rates on their mortgages like we discussed. And so, you know, something that bears watching, but I'm not concerned about, you know, huge problems with consumer debt burdens right now. The debt service burden, just for everyone out there, is the percent of aftertax income that has to be devoted to servicing the debt to remain crissing.

current on the debt. And Chris, you want to do a little bit of an advertisement? You guys, you and Scott Hoyt resurrected the financial obligations ratio, which is kind of like the debt search, right? That's right. Because the Fed stopped published, the FOR is a little bit different than debt service in that it includes rent. It includes, well, now. Property taxes. Well, they stopped. The Fed stopped constructing it. So we took it on ourselves and we've improved it. So, Chris, you want to quickly mention that? That's right. You got it. So we added auto leases, property taxes, some of the other recurring expenses, insurance.

Any sign of that's rising? Any different than the debt service burden? Is it starting to show any signs of increasing? At a very similar pace, right? So it is rising relative to the pandemic lows, right? But still very much in line with where it was in 2019. It's not really showing any warning signal. But although, Gus, just to push back a little bit, you know, you're looking at the aggregate,

meaning across all households. Yes. And the folks at the top end in Finland are fine. The guys in the bottom end who take on the credit card debt, this is our prime auto, the consumer finance. I'm pretty sure their debt sort of burden is up, right? Because they don't have a mortgage locked in. And the credit card, I'm sure you look at credit card rates.

Yeah. Record highs, 22%. Right? So, yeah. Okay. Okay. Chris, you want to go? Sure.

$6,000. housing related yes go ahead merce i'll let you please run with this i it's it's new it starts no permits nope no single family starts nope nope it's something over the units under construction a number of uh completions yes what kind it's not it's not total complete it's not total completions because total completion is 1.7 million. Very good. Very good. It's single family. Multi family. Multi family. I'm just saying, guys, I'm like cleaning up at this game. Okay, yes, but you are getting help. What do you mean? I'm getting help. Oh, you mean you're contributing to my thought process. I think so. I'd like to put you on the right road. Yeah, fair enough. I got it.

All right. That's a good one. You want to explain? Why you picked it? I picked it. Well, the other permits starts are, they are weaker than they were last year. I think there too. There's some hysteria that a whole construction industry is falling apart. It's certainly weaker than it was a year ago, but it's kind of on par with where it was prior the pandemic in terms of single family, multifamily starts and permits.

But completions continue to rise, right? There's still a lot of projects in the pipeline. Lots of construction activities still going on. So we're still building houses and we're still putting up a lot of multifamily apartment buildings. And in terms of the inflation outlook we talked about earlier, I think that's important. It's going to continue to keep a lid on some of the rent costs or the owner's equivalent rent that we talked about earlier. So I'm less concerned about that taking off again, you know, kind of disrupting the Fed's plans for a rate cut. So I view this as positive news.

Very good. All right, I got a statistic. It might be a little controversial. And I just preface this by saying, guys, we can edit if you want to. Oh, boy. All right. If we don't edit, this would be a good thing to keep in the podcast. But podcaster listeners, we rarely edit.

We only edit when Chris messes up, which isn't very often. You know, when he starts bragging about his crypto portfolio, we tend to edit that out. And when he brags that he's like the world champion in Bocci ball, we cut that out generally. But here's my stat with that as a preface. $175.51. Share price of PNC. Oh, my God. That's unbelievable.

How do you know that? You kind of gave it away. Come on. Oh, did I get it? Oh, no. That was unbelievable. Really? Gus, did you know that?

I did actually, yeah. Oh, you did? Probably to the scent, right? No, no, wait. Someone told me the Moody's share of stock price. I could round to it, but you guys look every day? No. That's pretty cool.

But I, you know, I just picked that because that, you know, this shows the strength because PNC is a large regional bank. You know, I will put in a plug for PNC. We're now coast to coast. We're in all 30 of the largest metro areas. We completed a merger with the U.S. operations of BBVA a couple of years ago that was a big expansion for us. So I think it's fair to say that we're not at the top of the list, but we consider ourselves now a national bank. Yeah, okay.

What size are you by? I didn't mean I was going to say nice. I love PNC Bank. I love PNC Bank. And I actually could tell you a great story about yesterday. my daughter lost her debit card and great ending and so forth and so on. I just use it as a kind of a benchmark for the broader banking system, and it just shows it feels like the system's back, right?

I mean, because if you go back in the teeth of the banking crisis a little over a year ago, the share price was, I think got as low as $120, $150 a share. So it made a long way about right, yeah. Yeah. So, and that's really key because I do think one of the, because the curve is still inverted, One of the reasons to be still a little bit nervous is with the Fed keeping rates as high as they are for so long, and the yield curve being inverted, that continues to put pressure on the banking system writ large, and that is a potential risk to the soft landing scenario. So, but right now the system feels like it's in a pretty good spot, kind of navigated the crisis admirably well with a little bit of help from the Fed. And here we are.

So a good one. That was great, Chris. You did a great job. That was really, really good. Okay, okay, let's move forward and let's talk about the election a bit. And let me frame it this way. You know, like us, Gus, you have a forecast. Let's call it a baseline forecast, meaning kind of in the middle of the distribution of possible outcome.

So when someone says to you, you know, what's your forecast? This is your forecast for the economy. And in the forecast, you have some insumptions, whether implicit or explicit, with regard to the conduct of policy. We just talked about monetary policy and what the Fed's going to do, but also about fiscal policy. I mean, that's important. Tax policy, particularly looking forward because, you know, we've got the tax cuts to individuals that were passed under former President Trump, the TCGA, the Tax Cut and Jobs Act. They're expiring at the end of next year. And how, you know, what you think about that will determine a lot about what you think about the economic outlook in the near term.

So therefore, you have to have some view about the election outcome. And just, again, before I handed over to you, say that in our baseline forecast, we have been assuming basically the status quo, which means Biden remains president, or I should say to be. more careful about that. The Democratic candidate for president becomes president, because obviously that's a question at the current time, but that the Congress is split, that the Senate, which is now Democrat, goes Republican, goes Republican, and it's split. So that means it's a divided government. You don't get much policy change, pretty much the status quo, with a few exceptions, and that's the baseline. But that feels like a very tenuous election assumption at this point, right?

I mean, it does feel like, you know, Trump's going to be president. A lot of script to be written here and things can change very quickly. But at the moment, it doesn't feel like that's like the most likely scenario. But I said a lot. I'm going to stop right there and turn it back to you and see how you think about this. So ours is a little more generic. I mean, we're assuming that there's divided government in some form. So whether that is a Biden-Harris administration and Republicans in charge of one House of Congress, at least one House of Congress,

or a Trump presidency and Democrats in control of one House of Congress. So I think the, you know, I agree with you completely that I think that in terms of fiscal policy status quo is most likely, and we do not have big changes in particularly in federal fiscal policy. I do think that we may see a little bit of contractionary on the on the state and local side. I think that the property tax. To your point about divided government, which is a reasonable point. You're saying it could be Trump as president and still a divided government. But you have to, but let me ask you this.

What are you assuming about the tax cuts next year? Are they going to be fully extended for individuals or are they going to be extended for people who make over 400K? I think that they will probably be fully extended. So that means Trump's going to be president? Well, I mean, doesn't it? I guess, well, let me put it. I think we're likely to see whatever ends up happening, the total fiscal impact will be roughly the same, whether it is a Democrat or Republican.

So maybe, you know, maybe the mix of cuts is different. Maybe some of it, you have some of the tax rates on higher income households reverting back, at least some of the way, but that's offset with a spending increase. So I think the impact on the projected deficit is going to be roughly, is going to be the status quo, whether it's exactly what the package is. I, you know, I, we're not putting a stake on that. Okay. Okay.

Okay. Okay. But now, you were going to say something. I stopped you about. Oh, yeah. I think that on the state local side, it's likely to be perhaps slightly contractionary in the near term. Just because of the issues that many localities are dealing with in terms of property taxes, because of the, you know, the ongoing problems with the office market.

So, you know, I think that that is going to show up in contractionary. state and local policy, local in particular. So would you agree with me that at the current point in time, the most likely scenario election outcome, and again, this is really important to what future fiscal policy is going to be and what it means for the economy, the most likely scenario is that Trump is going to be president and there's going to be a Republican sweep. I mean, that's certainly embedding markets. That's what they're saying. I mean, I certainly think that, you know, over the past month that that probability has gone up. And I do think that that has big implications for fiscal policy. And it means that fiscal policy is much more likely to be expansionary in 2025,

2026. You know, I'm not ready to put that in the forecast yet. But, you know, we'll see how things progress over the next few months. But I think that that, I think that the likelihood of that happening has gone up dramatically over the past month. that's that we're in the same situation you are right so you know again we assumed uh Biden divided government because we have a very explicit assumption about the tax taxes are going to be extended only for people who make over 400k uh I'm sorry when you say extended you mean the taxes it's going to revert back to the previous level for people who make more than 400k I'm sorry, for people who are under 400K, they maintain the current tax rate.

Okay, under 400, okay, okay. Under 400K, I know what I said. If it's over 400K, your tax rate goes up. Okay. Right. That's the proposal that Biden Harris has, you know, been running on. And that, so that, that's our explicit. But, you know, right now it looks like a Trump suite.

And the question is at what point, what is the catalyst for making a change here in your baseline forecast? Do you actually wait all the way to the election? to see how it plays out or do you make a change before then? I mean, what is the, what is the, I guess I'm asking a philosophical question. What's the forecast philosophy with regard to, this is a major change. I think you would agree in Paul, in assumptions. At what point do you make that change? I think, and I don't want to, you know, preclude changing my mind on this, but our view would be we would, we would wait until after the,

election after the election and we know what the outcome is and we you know see what the you know get at least a uh an indication of what the what the proposals are going to be so we're talking you know may november december let's say no okay november december okay i i feel what do you guys think does that sound right to you chris and marissa i mean in terms of the way we approach it i mean I'll preface it by saying our philosophy has been we don't make any major changes to the underlying assumptions, whatever they may be in the forecast unless we're highly confident in that change. And the kind of the rule of thumb for the level of confidence is a two-third probability.

So if I thought there was a two, we thought collectively there was a two-thirds probability that it's going to be a Republican sweep. at that point we would make the change in our assumptions in our baseline. Now, it does feel like given how uncertain everything is here, at least at the current point in time, there's no way you can come, you can be that confident in any of this. Therefore, we're not changing our underlying assumption. And it feels like we're not going to be there until we're on the other side of the election. But it could be the case.

It could be the case that at some point here in the not-tuce and future, we do feel confident and we'll make that change. Did I, Chris, did I get that, do you get that right? Is that, is that, okay, all right. And, and I agree with you. I don't think that we're going to be any, I don't think the level of certainty is going to reach that threshold before it actually happens. So I think, you know, Gus, the Gus philosophy of we just keep it because it's so close

to 50-50 that, then we just see. what happens after the election and change the forecast after the election. I mean, that, that seems like the way it will play out for us as well. Yeah. Okay. Okay. Go ahead. And part of it, too, is it's like a zero one outcome, right? I mean, it's not like there are gradations that are in between it. So if you get it wrong, then you have to go back and, you know, redo all those changes. Exactly. And so I think under those circumstances, it makes more sense to just wait until you have an answer. Yeah, I think that makes sense. Well, let me, just to play it out. I'm sorry, Chris, were you? Oh, sorry to interrupt. I guess a little pushback. I was about to say that,

I think the margin of victory does matter, that the, you know, if it's a might be a Republican suite, but it's very close. I don't know in terms of what the exact policy will look like. Really? I'm going to next year. I don't know. If he went by, if it's a Republican suite by one vote the whole world did zero one i think you don't think so i think that the negotiations may be much more fraught at that point i mean you still have you still have some variation in terms of fiscal hawks versus uh not yeah true could see some variation in terms of what the actual policies look like i mean the scenario could very well be the democrat wins the popular vote like they've done in the last last couple elections and you still have a republican sweep still

then what what do you do with that i mean still interesting question but let's let's uh because we're running out of time let's go to the republican sweep scenario because that does feel like a real possibility how would you care gus how would you characterize policy under a republican sweep and here i'm thinking tariffs i'm thinking immigration i'm thinking inflation reduction act i'm thinking fiscal policy tax policy spending policy i'm thinking regulation but pick Pick whatever you think is most appropriate, but where are the biggest changes going to be, do you think? And what does it mean for the macro economy?

So I think it is generally more inflationary. I think you get more expansionary fiscal policy. I think that the emphasis is going to be on tax cuts and not, I think former President Trump has shown less interest in containing spending. you're running on a populist platform that, you know, presumably precludes big cuts to Social Security or Medicare or defense, which are really, that's where the money is in the budget. You get, you know, tax cuts talking about reducing the corporate tax rate, for example. And then I think that generally tariffs are inflationary, that, you know, we get those. You know, to what extent that's actually, we get those tariffs, I don't know. But I think that that means that at least in the near term, it's inflationary. And maybe we see the Fed pushing back against that. But I think that a Trump administration is a more inflationary fiscal policy than we would see under a Democratic administration. That's a put words in your mouth. So you're saying more inflation because tariffs of deficit finance, tax cuts. You didn't mention immigration, but.

Well, I think immigration, you know, we've talked about how that's been a source of labor force growth. I think that's. severely restricted and so that that means weaker labor force growth. So I think in terms of the growth impact, I think, you know, I think it's roughly neutral for growth probably because you have the, you know, you have slower labor force growth. You have tariffs, which would weigh on consumer spending growth. You have, you know, stronger fiscal support and then more contractionary monetary policy. So I think on the growth aspect is roughly neutral. Okay, so more inflation, higher interest rates, but that doesn't result in weaker growth. You end up in the same place.

Okay. Okay. Okay. Well, what do you think, Chris, Marissa? Anything you going to say on this? I mean, we've run a lot of scenarios. We'll continue to run scenarios. I mean, we are updating the scenario, the Republican sweep scenario, because we've previously run this,

and we assumed tariffs, but we assumed no retaliation from other countries because we weren't, that felt like it was pretty tough to do. But now we're updating that scenario because we have economists all over the world, and they're coming back with, well, what would the governments of these countries do if we did, if they did face 10% tariffs from the United States? And we're running that through the model as well and we're going to produce those scenarios. But any else you guys want to add on this subject before we call it a podcast? Marissa?

No, I mean, I think the results of that will be interesting because I would expect even more global inflation, right, if there are retaliatory tariffs from other countries that we haven't already factored in and probably slower growth, right? Slower global. I think that's where we depart from you, Gus. Okay. Yeah, I mean, I think definitely inflation and therefore higher rates. And if you want to get inflation back down, you got to have slower growth, less demand.

So I think that's where we would part. But anyway, sorry, Marissa, I interrupted. No, that was it. Okay. Chris, anything on that? Yeah, just to add, I think the dynamic response here is going to be really important, really complicated, right? So you go down on this path, and if there's a violent market reaction, right, to the tariffs,

they're going to backtrack, right? They're going to make some changes here. So, you know, you got to make a, you got to take a stand in terms of the scenario, but I think the uncertainty is pretty wide on this one. Yeah. Yeah, very uncertain. And I guess I'll end by saying Pennsylvania, Gus. Like, we're like the key state, aren't we?

And all that. We are. You know, and in fact, I was, you know, speaking to the Pennsylvania State Mayor's Association yesterday about the Pennsylvania economic outlook. And, you know, I mean, we are, we're a heavily divided state. You know, and we're a slow growth state. I mean, we have an older population. we've seen weaker economic growth.

Some parts of the state still haven't seen a full recovery and employment from before the pandemic. So, you know, it's a, I mean, it's an economically diverse state, too, is right? Because you have a lot of financial services and professional services in Philadelphia and Pittsburgh. You have a lot of heavy manufacturing in the central part of the state. In up in Erie, you know, you've got retirees. in South Central Pennsylvania. So it's a very broad demographic economic mix. And I think it's going to be interesting

to see how the various messages play out in Pennsylvania over the next few months. So I don't like seeing all the ads when I watch TV, but I think, you know, that's going to be, you know, that's going to be par for the course for the next three months. Well, I know you travel the state quite extensively and the state is very,

blueish in Pittsburgh and Philly and then red, deep red everywhere else. I think it was, I think it was, someone said, you know, Pittsburgh and Philly and Mississippi in between or something. Right, right. Yeah. Someone said that. So do you have a red tie and a blue tie, Gus, when you go visit the areas? I try to keep it neutral.

I mean, I speak. You have a purple tie. You wear a purple tie to everything, all your events. Yes. Actually, you know, I do have a PNC tie that has the blue and the orange on it. So, so, so, you know, I kind of, sometimes I go with that. You know, so, no, I, I try to put on my, my neutral hat and, and, and talk about, you know, what the potential implications are like we've been discussing, but try not, I try not to bring my own political biases into this. So. Yes, very good. Very good. As a good economist should. Good. Gus, thank you so much for spending your Saturday morning with us. I know that was a bit painful, and the conversation was great. Really appreciate it. Thank you. All right. Thank you, Mark, Chris, Marissa. It's been fantastic. Catching up with everybody. And thanks for having me on. Chris, Marissa, anything else?

Just, thank you. Mercia, don't turn off your PC. I'm just telling you, don't do it. Don't do it. Don't do it. Okay, with that dear listener, we're going to call this a podcast. We'll talk to you next week. Take care now.