Moody's Talks - Inside Economics - Festive Names and Forecast Games

Episode Date: December 22, 2023

In the last podcast before the holidays, Inside Economics chats with Carl Tannenbaum, Chief Economist of Northern Trust about the economy, financial system, Fed and forecasting. The group took as a good omen that they had a Tannenbaum and a DiNatale on the podcast just before Christmas (you may need to Google the names). Not that they attribute their forecasting process to the use of such signs. For more on Carl Tannenbaum click hereFollow 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 Sandy, the chief economist of Moody's Analytics, and I am joined by my two trusty co-hosts, Chris DeReedies and Marissa Dina Talley. Hi, guys. Hi, Mark. Hey, are you ready for Christmas? I mean, this is, what is this? This is December 21st.

Yeah. Christmas podcast, right? Yeah. Are you guys ready? I'm ready. Oh, you are. Done shopping. Everything's wrapped.

I'm ready. I have to tell you, I don't think the world's ready. I mean, I was just out going to my local Wawa. And it was 1 o'clock Eastern time. I could not even get a parking spot to just get my Wawa coffee. I mean, it was really unbelievable. You think that's Christmas related? Wawa, yeah.

Well, I mean, the whole town was hot. You just mean there's a lot of traffic. There's cars everywhere. Yeah. People everywhere. It was like craziness. I don't know. It felt very Christmassy to me.

But I'm glad you guys. are already. I, you know, I do, I would be remiss if I didn't bring up, uh, an email, uh, conversation we had with my brother, uh, turns out that, it turns out, Chris, Chris was on NPR. You were interviewed by NPR. What was in, indeed? Indeed. You were indeed. No, no, no, it was NPR. Yes. Oh, it was NPR. And they quoted you as Chris Doritos. Yes. Yes. And this brings back really bad memories. Yeah. Childhood trauma. Yeah. Really? If any of my elementary school classmates are listening to this podcast now, they'll know exactly what I'm talking about. Apparently, they called you Cool Ranch. Yeah. One classmate extended the whole Adderido's, you know,

theme. That's pretty creative. Very creative. So what's so funny is Carl, my brother, you know, because we, you know, we get all the clippings and he looks through the clippings. I didn't know he did that, but he's looking through the clippings and he saw this. He saw Chris Doritos. So he chats GPT, he puts it in there into chat GPT and chat GPT comes out with all these insults. It was pretty funny. It was really funny. Oh, boy.

But, oh, I'm so sorry. But are you over right now, Chris? I think so. I think this has been this conversation is very therapeutic, you know, somehow. I've owned it somehow, you know. He's been able to work through it. Yeah. Okay.

You'd be able to work through the whole. Exactly. Well, you know, the thing is I never, did you, Mercia, did you ever think of Doritos when you thought? No, never. Never. I never would have thought of that. No,

I would have thought of Lays potato chips. I wouldn't have thought of Doritos, right? I mean, kind of plain, plain, straight up. Oh. Ouch. Wow. All you've been thinking about this. You've been preparing.

Brought the bullying to a new level. That was not off the cuff. Not that, you know, because Doritos is kind of cool, you know. Actually, I don't know if you know this, but there's a whole science behind Doritos and why they're, so everyone loves Doritos. The whole thing, the color, the dust comes off on your fingers, the snap, you know, everything about it. They've really thought about it. You know, they being whoever it is, Frito Lear or whatever, you know, who does this. But anyway, I digress.

I digress. Now, Marissa has the better last name for this time of year, right? That's right. Just to divert attention here. And Dina Thalia, that's what is that? Of Christmas. Oh, I did not know that. Yeah.

I thought you were going to go there instead of my trauma. But that's okay. Yeah, I mean, it's weird. I've known Marissa for God knows how long and that I did not know. But what else don't I know, Marissa? You know, DeVold. Probably a lot, Mark. Right. Right. I think we better bring in our guests. What do you think? Yeah, it's probably bored by now.

Probably. Probably shit at this point. And we have a guest, Carl, Tannenbaum. Carl, good to see you. Good to hear you. You know, I don't know what I've gotten myself into here, folks. I mean, I get this message to my old friend. Carl, we've got this inside economics podcast. And the first five minutes are making fun of high school nicknames. And I'm beginning to think of, you know, what my high school nicknames were and thinking I should hang up right now. But, you know, it is the holiday season. I appreciate that. In addition to Di Natale being of the season, as many of you will know, Tannenbaum. Yep.

That's Christmas tree in German. Oh, yes, of course. Very popular person at this time of the year. That's, of course. This is great. This is great. It's something special. about this podcast.

Good. Amazing. We got Carl Tannenbaum and Marissa Dina Talley on the same podcast four days before Christmas. Like what a quinky dink that is. It's a Christmas miracle. It's a Christmas miracle. It's got to be a miracle. That's kind of cool.

That's kind of cool. A good omen. Good omen. Hey, so Carl, we've known each other. I don't know how many years, but a long time. But I really don't. And I know you're now chief of constable. of Northern Trust, a fabulous institution headquartered in Chicago.

But I don't really know much about your history. Would you mind just giving us a sense of you and where you came from and how you got to be chief economist? Sure. Well, first, Mark, I appreciate your aging me by noting how long we've been friends, but since you're only 45 years old, then we've been 20 years or so. But look, it's an incredible arc because I think both of us began practicing. in the early 1980s when, you know, so there were a lot of phenomenon that we'd certainly not like to. Wait, wait, wait. Did you say the early 1980s?

Yes, sir. Oh, okay. You're a little, a teeny bit ahead of me. But that's pretty cool. No, you're supposed to grease the guests here. Let's just say, I've got a little bit of history. Okay. And remember it's interesting during the end. You remember the inflation. You remember the high.

You remember the info. Yes, I lived it. It lived experience. And, you know, I had deja vu during the Silicon Valley Bank crisis during the spring because my first job in banking was building models that measured interest rate risk because we were having all kinds of fluctuations. And 4,000 institutions, financial institutions, the United States failed during the decade of the 1980s as an ultimate result of poor interest rate risk,

understanding. So I began doing that, and in the committees where our work was being presented, we found ourselves talking a lot about the economy and markets. And one of those meetings, my boss, the vice chairman, he said, you know, Carl, our clients might be interested in the content of these conversations. And I noticed that you had an English class in college. Would you mind putting these to paper? Before you know it, I was a chief economist and writing and giving presentations and that's been going on for a long time. I was with a bank called LaSalle, A.B. and Amro, LaSalle being the Chicago-based North American part of A.B. and Amro, which is still a very large global organization. I was there for almost 25 years.

Doing economics and I've always paired that with risk management. I think there's a natural linkage between the what-ifs that we always do in economics and trying to understand the impact of tailish kind of events on bank risk. The organization went through a painful merger and dissolution in 2007. And then I got a call from Charlie Evans, who was at time the president of the Federal Reserve Bank of Chicago. I'd known him for many years. And he pitched me on the idea of going to work at the Fed. And he said, have you ever considered working for the central bank and I said, you know, having dealt with supervisors for a long time, I didn't think that was a community that would welcome me. But he, I give him credit, Mark. I think he had a very early

sense that something just wasn't right because the storm clouds had been gathering really for a lot of 2007. And he felt that his community of academic economists did not have enough of a link to what was really going on in markets. And he felt I could be part of a program where we could really see the dominoes where they were lined up and how they might fall. So I went to work in the spring of 2008 for the Fed. Some of you may still think that I caused the financial crisis, but by the day that Lehman fell, I was in New York trying to mop things up. I remember those conversations vividly. After we stabilized things, I was part of a team that created the first bank stress tests, which are still being done to this day, and enjoyed those four years.

immensely. They felt like eight. But many of you, and I don't know if Chris or Marissa, you've had experience at a central bank, but it is a great place to spend part of your career. And I highly recommend it to either young or mid-career professionals. But in 2012, I got a telephone call from the chairman of Northern Trust. The job I hold is one that, you know, those of us who are economists in Chicago have been following for a long time, both because of its previous owners and also because of the organization. I've been here for the last 11 years. So it's a long career of trying to figure things out, connect dots, separate signal from noise. And, you know, Mark, I think you would agree. It's a field where, I mean, I'm still energized every day trying to decipher all of what's going on.

So that's a great career. I forgot that you were at the Fed during that period. That must have been, as you say, it must have been an amazing experience to be there at that time. I tell my partners here at Northern, if they get a couple of martinis in me, I'll, you know, spill all the salacious details about who is doing what to whom and when. What they don't realize, though, is after half a martini, I'm passed out, so they'll never find anything else. That's great. Well, it's good to have you on. In your recount of your history, there's so much interesting stuff to kind of dive into. But one quick thing, you know, given what happened during the SNL crisis and what we learn from that,

that and all the different things that were put in place to guard against that, how shocking was SVB? I mean, that just, how shocking was that? I think that there is a lot of accountability to be widely spread because this is a risk that has been well documented for a long time. It's the subject of any number of SR letters, which are the pronouncements that the Federal Reserve puts out there setting standards for the way that banks should manage themselves. It's certainly interesting. Mark went up farther and a little bit faster than the market had anticipated, let's say, at the beginning of 2022, but the tightening cycle did not come as a complete surprise,

and so it was not wholly unanticipated. What we also know is that there were trails of problems at SVB in this area that were noted as early as the middle of 2022, and for reasons that I think still need to be surfaced, the Federal Reserve did escalate its concerns, but never ultimately got to the point where they used their ultimate tool, which would be to force the organization to hedge. The other thing about that company that dates back to the S&L crisis is I remember the saying at the Fed mark that if something grows quickly is probably a weed. That sounds like my line, doesn't it?

I say that all the time. I say if it's growing like a weed, it's probably a weed. An organization, which if it grows fast, you've got to wonder whether they're still crossing the T's and dotting the eyes on all of their policies. This company, I think, almost doubled in size over a six-quarter period. They were heavily reliant on professional deposits. And as we now know, the irony is that many of the firms that they banked were pioneers in mobile communications, mobile payments, social media, ingredients that really condensed the time frame until death for the organization. So they could have and should have done better.

Federal Reserve, in my view, and their own words, could have and should have done better. I get asked often everybody whether there are still problems in the banking system in this area that are yet to surface. To be very honest with you, Mark, I do not think so. As you might guess, supervisors want to problem surfaces, send their examiners far and wide to make sure that other institutions are not similarly off sides. And so I'd be extraordinarily surprised if we had another failure situation with the same root cause. So you think the banking crisis that hit in March, that's in the fulsome, obviously, muscular response by the Fed and everyone else, has put that to bed. That, that, in all likely, I mean, it's hard to gauge, hard to handicap everything, but the most likely scenario is the banking system is going to be able to navigate through the remainder of this environment without another break somewhere. That would be my view.

And for anybody just listening and is nervous about their bank, you can always bring your money to Northern Trust. That's right. And he's pointing to the, yeah, pointing to the. If you send it your money, you'll never have to worry about it again. You might want to explain. You've got a little, what do they call that behind you? The Northern Trust, what is that? A logo?

Oh, it's a beacon. It's a banner. It's a banner. A be a logo to end all logos. Our logo has always been an anchor because our organization has often been seen as very stable. In fact, during the Great Depression Northern Trust received immense numbers of deposits as people pull their money out from other organizations. So that's our story and we're sticking to it.

It sounds like a good story. Well, I want to come back because we're on the bank topics of of the banking system and maybe financial system more broadly. Maybe we'll finish that conversation. Then I want to obviously pivot and go back, talk about the economy, your views on that, because I think you're going to be able to say, I told you so, but I want to hear you say that about the economy. And, well, we'll come back to that.

And then we'll play the statistics game at some point as well. And then there's a lot of other ground we can cover, you know, after that as we move along here. But in terms of the banking crisis, are you, I'm surprised by the lack of any kind of fallout from the crisis. I mean, sure, banks tighten their underwriting standards in response. If you look at the senior loan officer survey results from the Federal Reserve, the Fed canvases, senior loan officers and asked them about their underwriting standards. And pretty clearly, they've tightened up across the board. There's been some slowing in loan growth, credit growth, but broadly speaking, feels like really not much of an impact. Does that resonate with you,

the way I just described it? And so has that surprised you? It has surprised me, but it illustrates a very important fundamental that I think is worth spending a moment on. Monetary policy traditionally works through financial channels. When the banking system was the financial channel, the standards set by banks in response to both interest rates, reserve requirements, and then supervisory standards, was really the way that the Fed got credit to contract and or expand. Today, Mark, households and firms in the United States get about 75% of the capital they need directly from the financial markets through bond and stock issuance, private equity. And because of that, market credit conditions are much more important for determining whether

monetary policy is successful in curtailing the flow of capital. What's been very interesting, on the bank side, I mean, you've hit it, the standards are really quite conservative. But on the market side, especially as we visit here today, the recent down drafts, in interest rates makes borrowing cheaper and eases conditions. As we visit today, the spreads on high yield and investment-grade debt in the marketplace are really skinny. Stock market volatility, for reasons I hope you can explain to me better than I can explain

to myself, are very, very low, and equity markets are closing in on their all-time highs. So measures of financial conditions, which typically are more heavily weighted towards those market indicators are actually on the very easy side of neutral. And even the Fed's own brand, which they introduced earlier this year, which is heavy on long-term interest rates and bank lending conditions, has come back much closer to neutrality because of the rally in the 10-year U.S. Treasury. So it'll be very interesting as we go into 2024, Mark, to see how the Fed factors in its rate setting, along with the market conditions, which are modulating the flow of capital. And it may be one reason that they wait to lower interest rates, because relative to three

months ago, financial conditions are a lot easier. Right. So, okay, so just to put it into my own words, what you're saying is one of the key reasons why the economic broader fallout from the banking crisis has been relatively modest, at least so far, is because the banking system is only a piece of the puzzle in the financial system. If you look at the non-bank part of the system, and you said the financial markets, that would be part of the non-bank part of the system. There, if anything, conditions of ease, they've not tightened like they have in the banking

system. And so credit continues to flow to households and non-financial corporations and therefore the economic fallout modest, at least so far. But that does, did I get that right, roughly right? That's very well said. Can I add one other ingredient? Something that many of your listeners may not recognize is that a lot of the credit activity that has historically been performed within banks is now being done by private capital pools. Estimates vary, but at the, the high end, these things are making about $2 trillion of corporate and consumer loans. And I don't have these numbers exactly right, but by comparison, the number, the amount of loans that we have on bank balance sheets is about $16 trillion.

So it's not an insignificant fraction. And because of heavy regulation, the movement of lending activities from the regulated sector to the lightly regulated sector has been accelerating. So if I do have a lingering concern, Mark, in the wake of the banking crisis, is that there could be latent interest rate risks in some private equity pools that we don't know very much about because of the really light reporting standards that they have and an inability to aggregate them across providers. Yeah. So going back to your adage, if it's growing like a weed, good chance it's a weed. If you look at the growth of the private credit markets, the leverage loan market, you mentioned private equity. The junk corporate market hasn't been growing quite as quickly, but still growth.

If you kind of add it all up, there's a lot of leverage building, particularly in a non-financial corporate side. A lot of that lending is into U.S. businesses, non-financial businesses. You're saying that's if you were going to kind of scan the financial system and say, where the stress point might be, where the next thing that might break be. It's not in the banks. It's probably in that part of the non-bank system where there's been rapid growth. That's the area that keeps me awake at night. Yeah, yeah.

Let me bring Chris in and, Marissa. Chris, in that regard, are there any – and I'm always fishing here to trying to find, you know, where in the non-bank system we should be really shining a light. You know, what exactly are we worried about here? Is there any, do you have the same concern, Carl and I have it just expressed? And if so, are there something in the non-bank part of the system that you would shine a light on? Certainly. Same concerns, really because of the lack of transparency.

I think that's perhaps the biggest issue. We don't have a lot of data or information on these entities. The one that I always come back to, because I'm the housing guy, is the, the, the, um, The non-bank mortgage originators, right? Just, again, their dominance in that industry, in the housing industry, just introduces some vulnerability or some risk. So that's clearly one to watch. And they're a big part of the mortgage market now, right?

I mean, they count 90% of all GSE, Fannie Freddie FHA loans, something, somehow. Something large, but it's pretty high. 80-90 something in there. Yeah, 80-90, right. Yeah. So yeah, significant. If they were to go down or experience some type of stress, they have to pull back on their operations, that certainly would have a chilling effect on the housing market. So that's one to watch. Now, there's some good reasons, I think, to believe that they, the risk may not be that elevated. Will the banks actually pull warehouse lines or deny credit to these entities? That's, you know, remains to be seen, but certainly one that does keep me up at night. The stress point. Yeah, and the worry is that these non-bank mortgage companies that make originate loans,

mortgage loans, they fund themselves. They get their money to lend through so-called warehouse lines with the big banks. I don't know, Carl, is Northern Trust in the warehouse lending business? Probably not, but we are not in the mortgage warehouse lending business. However, other types of private equity vehicles do have either backup or central lines to the banking system. And so the industry will tell you that we're very highly capitalized and there are grown-up women and men who invest in our funds and that we should not be considered a systemic risk, but it could easily go to the traditional financial sector if the yogurt hit the fan. Mm-hmm. Hey, Marissa, this is probably unfair, but I'm just fishing.

Any stress points in the non-bank part of the system you would call out? I've got one that I'll throw out in a minute and see. But do you have any that come to mind? I mean, there's been a lot of lending to businesses by non-bank entities, a lot of leveraged lending. And given the higher interest rate environment, it just seems plausible that there's something else still to shake out here that that we can't quite track. I mean, I do wonder how the feds shift in its forecast that we discussed on the last podcast. You know, if rates do come down a little quicker next year than we were thinking, maybe that ameliorates some of the risk.

Although even at the end of next year, rates will still be higher than they were prior to the Fed hiking, but we could see rates come down significantly faster than we were first expecting. So I'm a little less worried about it, I would say, than I was maybe six months ago. Right. Just put a finer point on it, just the numbers, because I've been looking into this a little bit, there's $1.6 trillion in private credit. So that's lending by funds. Carl called them funds, business development corps, could be sovereign funds, could be other types of mutual funds, that they're private lenders. A lot of insurance companies, pension funds,

sovereign wealth funds all participate, and they lend to non-financial corporate. So 1.6 trillion there. There's 1.6 trillion in leverage loans, about a trillion go into CLOs, collateralized loan obligations. The rest kind of go out there in the system, very opaque. And then there's 1.2 trillion in junk corporate debt.

So if you add that all up, that's a lot of debt, you know, about one third of all non-financial corporate debt is now in this kind of, to companies that are below investment grade, lower quality, less transparent, you know, institutions that are probably going to have some difficulty managing it. So I agree that that's an issue. I did want to bring up one other stress point, get your, if you've thought about this, Carl, liquidity in the treasury market, there's a lot of concern that the big banks and their broker-dealer subsidiaries

have not been able to expand their balance sheets as fast as the growth in the amount of Treasury debt outstanding. We've got a lot of big budget deficits and the Treasury is issuing a lot of debt and that the broker-dealers that kind of make markets, the Treasury market work and match buyers and sellers, that they've not been able to expand out what they do as significantly, in part because of capital requirements,

the capital requirement, higher capital, and more stringent capital requirements have just changed the economics so that this doesn't work for the big banks. And this is now starting to result in, you know, periods of illiquidity in the market, that the matching between buyers and sellers isn't playing out well and that's causing lots of volatility. I think you mentioned this in interest rates. And, you know, there are some points in time where there's no liquidity. The market kind of freezes.

Is that something on your radar screen as well? Carl? So a bit to unpack there. I'm sorry, I'm just making a couple of notes so that I make sure to cover off on all of your points. There are dashboards that many of us look at for indications that the Treasury market is less than fully liquid differences between on the run and off the run yields. There are daily transaction volumes relative to the size of the market.

the amount of volume it takes to move. And these are kept. And the evidence mark, I think, is mixed in terms of has QT, for example, had a detrimental impact on liquidity in the treasury market? The angle that you hear from the banking industry, and here I'm having a regulatory moment because the part of the reform in Dodd-Frank was the vocal rule and capital requirements and stress testing that made it much less attractive for large banks to be primary dealers. In fact, I think the Treasury has,

at times in the last decade, had trouble keeping up the number of primary dealers because it's a little bit of a loss leader. The pushback on those regulations began almost as soon as the ink was dry, and the industry often, or let's just say the handful of primary dealers, is often saying, oh, my God, Armageddon is here and the market isn't function anymore. Give us back our market making. Give us back our position limits and our Christmas parties. And as you can tell, I'm getting a little bit pejorative here. The Treasury market is the deepest and most widely held market in the world.

There are lots of pools that are ready to trade. And I do not think the absence of primary dealers or market makers at banks is a significant ingredient in any loss of liquidity in the Treasury market, to be very honest with you. So there is increased volatility in periods of liquidity to what do you ascribe that to? I think it's more just uncertainty over the direction of interest rates. I think about the experience that we've had. just over the last six weeks or so. I remember we were touching 5% on the 10 year, and I don't have it up on the screen just now,

but I mean, we got below 4%. The move index has been elevated for a while, and I think- That's a measure of bond market volatility. Yeah. Exactly. So on the way up, it was how far is the Fed going to go and how fast, and now that we're kind of plateaued, it seems.

The speculation is on the other side. And so it's more a fundamental than a technical driver for the volatility that we're seeing. Interesting. Okay, good. Well, I'm not sure I'm completely appeased by that, but I feel better. I feel better. Good. Well, let's move on. Let's talk about the economy. And let me preface this by saying, I think you were one of the few folks that thought we'd navigate 20, 23 without a recession. And I have that right, don't I, Carl? So now my forecasting record is two and 33. See, now that's so you're so humble because if someone said that to me, because I was right there with you, I didn't expect a recession 20, 23.

But I run with it. Like so damn right, I was right. And I told you so. I told you so. But you're so humble that you wouldn't do that. Well, I'll tell you a funny story, Mark. And, you know, hats off to Moody's and Mark, who are among the better modelers that I know. But a couple of years ago now, I think it was.

I got a telephone call from Maureen Haver, who many of our listeners will know. Maureen was the pioneer in one of the most popular economic data and graphics software. It's used ubiquitously in our industry. and she told me that I had won the Blue Chip Forecasting Award. And I was convinced that somebody was playing an elaborate trick on me because having been such a failed forecaster for so long. And so I hung up. And sure enough, she called me back.

And she explained that the pandemic had so thrown off the legitimate forecasters that I was the only one left standing. That's funny. I said, you know, I'll take it. Yeah, absolutely. On your resume, I mean, somewhere in the junk back there is the award. So, and Mark, I think this is an observation I would make around the way that we do economics. I think you do too.

If a high accuracy rate for forecasting was the benchmark, I think a lot of us would have moved on to other things. I think those who make economic forecasts and use them should really busy yourself less with the central tendency, but more with how the tails might look. If you're doing portfolio management or business planning, those what ifs, I think, are the way that those of us who anticipate what might happen can still earn a decent living. Yeah. But you are humble and you are a very good forecaster and an excellent economist. And not many people saw how well the economy would do in 2023. I mean, when I say widespread, I mean, widespread expectation.

There generally is never that kind of a consensus on anything in the economics community, but there was a widespread consensus that, you know, 23 was going to be a bad year. And if it wasn't 23, it would be now going into 2024. And that did not happen. So to what, and it's understandable, right? I mean, we make forecast based on history. And historically, if you have a period of high inflation and the Federal Reserve jacking up interest rates, that kind of invariably land you into a recession. So history would have said a year ago, we're going into recession.

That's what most economists said. So what is it you saw or understood that made you think that we would not go into recession? The labor market. The job market. It was really the labor market. You know this as well, if not better than I do, Mark. While there are lots of sources of strength for consumer spending, wage income is the most powerful and durable. And, you know, having watched the labor market for a long time, I mean, Mark, did you ever think that you would live through a period where unemployment was 3.4%?

Yeah. And I laugh a little bit. Yeah. Yeah. I laugh a little bit at, you know, those who say, oh, my God. know, we're in real trouble. Unemployment is up to 3.6 or 3.7. And, you know, again, a history lesson. I mean, when I started doing this, unemployment was, you know, well up into the double digits and durably so. And there wasn't a clear avenue how we're going to get back there. Look, the pandemic

distorted a lot of our models, a lot of our simple identities, but it had a profound impact on the labor market. And it had a huge impact on the supply side. We had to close the borders for public health. And so I think the data are that there are one and a half million people not working legally here in the United States who would have emigrated during 2020 and 2021. We had a wave of early retirements. We looked at this. It wasn't just people close to 65, but we had a lot of 55s to 65s that decided to retire early because of the public health risk that they perceived. unfortunately, I think we lost 250,000 or so working age women and men to the disease.

The estimates are that somewhere between 5% and 10% of those who have survived have some lingering cognitive or respiratory symptoms that are filed under the heading of long COVID so that they aren't able to work full time or at all. And so when you thought about the supply of labor and still robust demand, we did not see much of an increase in unemployment. And further, the leverage that workers have to ask for wage increases that would match the price of bread. And what's been interesting, Mark, is we've had a lot of strikes this year, not just in the United States, but around the world. And they've been pretty successful. And so when you have an imbalance between supply and demand in any market, it's typical. that the price is going to go up. And so even as pandemic savings were dissipating,

which we all thought that they would, the ongoing income earned by households gave us the confidence that we could see our way through this year. But I want to pull the onion back one more layer. Why do the labor market hold up so well? I mean, why didn't businesses, you know, pull back and start laying off workers? What fundamentally is the reason?

Well, I'd be interested in thoughts from others on the panel, but the thing I heard most often from our clients is that even though many of them expected a recession, they did not expect it to be long and deep. And they had struggled to sustain their staffing levels and did not want to have the risk of hiring back into a tight labor market having excused a handful of their staff in order to make it through a brief slow period. Yeah, I think that's totally right. I mean, so you tell the CEOs, hey, we're going to have a recession. CEO says, oh, that's not good, but how long and how deep? And the economist says, well, not that long, maybe six months and not that deep. Maybe unemployment goes up a point or a point in a half. CEO says, oh, I don't think I'm going to lay anybody off because for the last 10 years before the pandemic, during the pandemic, after the pandemic, I've been fighting to find workers and retain work.

And I'm just not going to, and by the way, you work for a large multinational organization. You know, you shut down the HR function. You restarting that thing is like really hard and painful. So I think that's, I really think that's it. I mean, Casillas going, I'm not, I'm not laying anybody off if it's a six-month recession. Why would I do that? You know, so I think ultimately. Yeah, there's something I'd add to, which is that, as you know, Mark, the propensity to spend is

greatest in the lower income quintiles. And that is where we've had the biggest shortages of labor. We see it in the prices of basic services. I just wrote an article on caregiving, which is a sector which is in terrible shape in the United States. It has been for years, but it's much worse as a result of the pandemic because we did not want our loved ones in close proximity to strangers who might infect them with COVID. So we dismissed them. And they moved on to other things because it's poorly paid and the working conditions are often substandard. We close the borders to immigration. The data show us that caregiving, especially for elders, a community that's growing very rapidly in the United States, is given in a very large measure

by relative newcomers to our country. And so the prices for those services reflected the shortages of labor. Still today, restaurant tabs are sometimes difficult to believe, and part of that is just the difficulty securing weight staff cooks and everybody else that takes care of us in those establishments. So, you know, even today and, you know, we're visiting everybody on the day that we got the latest round of PCE inflation, core services still escalating at 3.9% year over your a little slower over the last three months, but that has been the sector that the Fed has been watching for one of the last signs where they need to feel a little bit more comfortable with the overall inflation picture. Well, that's a good segue into where we're headed. And the Federal

Reserve met last week and came out with a new forecast for where they think interest rates are going, and they have now three rate cuts in the forecast. This is kind of the baseline in the middle of the distribution of folks that take the survey on the FOMC, three rate cuts, each a quarter point rate cut next year. Does that sound about right to you? Or do you, it feels like you're kind of saying, given everything you've been saying, maybe that's a little bit more aggressive than you think they'll actually do next year? In our forecast, you will find three cuts, 25 basis point cuts, but they don't start until after the middle of the year. Okay.

So I will confess that I could work another 40-some years, and I still would not understand financial markets. Like you, Chris, Marissa, Mark, I watched the press conference after the FOMC, and I did not get the impression that Mr. Powell was dancing a jig and winking at the market indicating that there was going to be a lot of ease coming. The dots don't support it. His comment about, you know, still being focused a little bit on the upside risk of inflation. And, you know, in the back of the SEP mark are a few graphs that I find interesting where the committee asks.

The SEP is the summary of economic projections. Sorry, the Fed puts out. No worries. At the back, in addition to their forecast, they have balances of risk and the risks to inflation are better balanced than they were in September, but still on the upside. One other thing I would note, and many of our listeners will know this, Federal Reserve is an organization that is very aware of its history and tortured by its mistakes. and anybody you speak to there who's been there for any of length of time will tell you the two biggest mistakes the Fed is made is not putting enough money into the economy during the Great Depression and not taking enough money out of the economy in the 1970s. And this crowd is frightened, is just frightened that they'll be remembered as the ones who let the genie back out of the bottle. The reason I bring this up is I think that they're going to want to be trebly sure that inflation is firmly and resolutely under control.

It's been harder for them, Mark, for the reason that we kind of talked about earlier, the Fed's models are no better than yours or mine. They're based on mean reversion. They're based on the history over which they've been fit. And we've just come through three years that is very, very atypical with amounts of government stimulus that are absolutely immense. I think 25% of GDP in the case of the United States. So they've been having to operate without that same level of clarity over what inflation might be in six months, which if you're a monetary official, you have to have, given the normal lags of monetary policy. So they've been kind of, you know, forced to look a little bit too, you know, too far, too closely in front of their faces.

and I think they're still struggling to get to that full level of confidence that, you know, the last three months, I wrote them down for us, everybody. So the core PCE deflative, that's personal conception. I hope you're not taking anyone's statistic, I'm just saying, but go ahead, go ahead. Anyway, it is the number that the Fed apparently fears, too. This is excluding food and energy because of the volatility of those prices. Over the last three months, when you analyze it, is about 2.3 percent, which is a very, very, very acceptable range. Now, you know, their puts and takes there, Mark, if we get another few months where it stays at that level, I think that would be sufficient for them to have a little

bit more confidence. But growth has surprised us all year. Growth is surprising us in the fourth quarter. And I do think that there is that risk that demand remains stronger than we expect and keeps the pressure on the price level so that the Fed will want to just stay at this plateau. for a little while. Hey, Marissa, were you, Carl was surprised by the market reaction to the Fed decision last week. Were you surprised by the market reaction? I'm always surprised by the market reaction. You are.

As with Carl, I rarely understand what they're thinking. Yeah, I did watch the press conference and read the statement, and it wasn't nearly as exuberant as the reaction in the market. So yeah, yeah, I agree. Chris, were you surprised? Yes, same with me. But I've been surprised all year, I guess. As Marissa mentioned, it seems as though the market overreacts or has been overreacting on every statement, right? It's been pretty typical. I'd say the market always overreacts, but I thought it reacted in the right direction. I mean, that was a pivot. There's no doubt about it. And you've got, go back to the previous meeting, they had one more rate increase in the forecast, right? And so now

there's no rate increases and then three rate cuts next year. I mean, that's pretty definitive. And then it just reinforces what markets are already thinking because of the great inflation data that we've been in it. Two point three percent. That's amazing, right? I mean, that's like, you're there. You're within spitting distance of the target, you know, over the last three months. Now, maybe it's data and, you know, we're not there yet, but we're moving in the right direction here pretty quickly. So I don't know. I was very, let's put it this way, I would be buying stocks, you know, based on that.

But we certainly wouldn't be selling stocks, you know, based on that. So maybe a bit of a reaction. Anyway, let's play the game. And then we're going to come back and I've got a couple of other questions I'd like to pose. But let's play the game. The stat game is we each put forward a statistic, the best one. is that's not so easy that, oh, and the rest of us try to figure that out through cues and deductive reasoning and what else?

What are the cues? Questions? Deductive reasoning. Clues. Reloeless interrogation. I've been doing that for so many times. I got it wrong. But, okay, the best stat is one that's not so easy that we get it immediately, one that's not

so hard we never get it. And if it's apropos to the topic at hand or trying to make a point, all the better. So, Marissa, you're up, as tradition would have it. Okay. My statistic is 2.4% annualized. And it's not core PCE inflation. No, it's not. Is it from the GDP report today?

No, but it's related. It's related to GDP. spending? What, Chris? Spending? No. No. When we said related, is it in the GDP?

Is it something that feeds into the GDP accounts? You always do this head fake thing where it's related, but that's not really related. Yeah. You're sneaky that way. You're sneaky that way. I got to be careful. It's trying to keep us on our toes, right? I'm trying not to give it away.

Yeah, yeah. Is it a statistic that came out this week? Yeah. Okay. Is it a government statistic? No. No. Okay.

Is it from, okay, now we're just going to play. Oh, wow. Check the box. Mortgage Bankers Association. No. Home builders. No. Realtors.

It has anything to do with retail sales. That would be sense of, right? It has something to do with retail sales. Oh, is it like Christmas sales? from the National Retail Federation or something? But am I in the ballpark? No. Retail sales is an input into this.

Into overall consumer spending. Is this our GDP tracker? Uh-huh. Yes. This is our estimate. 2.4% is our estimate of fourth quarter GDP that we just updated the other day. And we based it on all the incoming source data that we have. So the biggest thing that we got recently last week was retail sales.

So most of this is driven by consumer spending data at this point. So GDP revisions for Q3, the third and final revision just came out. And we saw that GDP in the third quarter grew by 4.9%. So our GDP tracker for Q4 is showing 2.4%, which is actually up quite a bit from where we were, up a few tenths of a percentage point from where we were. It's looking like it'll come in a little bit stronger than what we were anticipating just a few weeks ago. So 2.4% dramatically lower than 4.9% but still pretty respectable growth, right, right around the potential growth of the economy. Yeah. Yes, especially after 4.9% Q3. I mean, 2.4 is pretty darn good. Yeah, that was a really

good one. That was, and you're right, it was related. You see my yeah, it was related. Yeah, exactly. That was a really good one. So we, Carl, we take all the, this is a current quarter model. So we take incoming monthly data and then translate that through to what it should imply for GDP growth in the quarter. Okay, Chris, you're up. What's your statistic? All right. I'll give you the difficult version first. I'll have to obfuscate here. And then I'll I'll give you the hint. 41.3. 41.3.

Stat that came out this week. Yes. A government stat? No. Is it an index? Is it NHB Home Builder's sentiment? It is the difference between two indices. Oh.

Oh, is this in the conference board survey of confidence? Is it a job differential? No. It's conference board leading indicator. No, it's conference board. Oh, it's a conference board confidence. Oh, minus the University of Michigan. Oh, I think Carl got it.

Carl got it. Yeah, Carl got it. So the divergence between these two confidence measures, right? So I guess the main story when it comes to confidence is that it shot up this week or with the last reading, both for the conference board measure and the University of Michigan, which came out last Friday. So confidence is improving. Right? Lower gas prices, perhaps lower interest rates, right? Might be some of that. But the differential between the two is still pretty wide. 40 point differential is at the high side. If you look historically, at the at that differential between the two series, after it peaks, typically

have a recession six to 18 months after that. We peaked last last, September. So, you know, we're still in the, in the neighborhood here for potential recital. See, Carl, see what he, he's, he still has not given up the ghost. He still thinks there's a possibly a resuscity. He is not declared. He's probably an inverted yield curve guy, too. So, Chris, if I could ask you a question, because we wrote an article about this, because it mystifies us. The economy has outperformed this year. Labor markets have been stronger. The markets have done very, very well. Why are people so glum? Inflation.

They hate the higher prices relative to three years ago. So even though the inflation rate may be coming down, nice, but are decelerating. Still. And the way I explain that to our clients is that econs and human beings look at inflation differently. And I am still angry that the prices of groceries are so high. I mean, I'm trying to get a few things here still to do my holiday baking. And, oh, my God, I think I'm only going to bake two cookies. That's all I can afford.

Right. We were talking about this last podcast, and everyone, I was talking with a Wharton student. I was teaching a class and we were talking about how he thought about the economy. He didn't feel so good. And the reason he had to pay a lot more for ramen noodles. And then my niece is paying a lot more for kombucha tea. So what, so yours is, you're upset about the cookies, all the things that go into the cookies. That's what's bugging. Yeah, now let me tell you, the consumers can substitute. So when I hear a college student complaining about the cost of kombucha, get yourself a box of Lipton, right, and be happy, right? Now I'm going to sound like the crazy old man that I am. You are going to get some money. You are definitely not going to be elected to any office. This coffee, fru-frew stuff with her that is probably getting else out of my refrigerator

because she has to have it just so. And, you know, Mark, when you and I first went to work, you know, you got black coffee and you were happy for it. I'm sorry. I'm sorry. I'm with you all the way. I'm with you all the way. But, you know, this is the world we live in.

And it was funny. I don't even know what kombucha tea is. And she's complaining about the kombucha tea. If you ever seen kombucha made, you would never drink it. Oh, is that right? It's allowed to age, shall we say. Did I get that right, Marissa? It's fermented.

It's fermented. Yeah. Yeah. Yeah. If you tasted it, you would probably never drink it. Although I was reading, I was reading, it's good for gut health. Yes. Just saying, it's good for gut health.

So obviously you don't have a good gut, Carl. I'm just saying you're, or he has a great guy. It doesn't need the question. That's funny. Oh, well, you know what? I was going to say one thing about the difference between the University of Michigan and conference board that I think I learned. In the conference board, both of them,

ask about the demography, you know, who are you? Because they want to get a sense of your age and gender, so forth and so on. But in the University of Michigan survey, they ask what party, political party are you affiliated with, Republican, Democrat, or independent? And by so doing, as soon as they ask that question, everybody puts their political hat on and looks at the economy through the prism of that political hat. And that's why, if you look at the Republican responses, they are in the University of Michigan, they are on the floor, right? I mean, I think they're probably as bad as they've ever been

in the teeth of the pandemic and the teeth of the financial crisis, they've never been as bad. They're worse than they were in the 80s. Worse than they were in the 80s. So, you know, the Democrats aren't all that happy, but they're not like, you know, they're like the conference board.

It's, you know, it's not great. It's okay. It's fine, but it's not like the world's coming to an end. And you can actually see over time when the, Who's ever in office switches, so does confidence. So it went from, it went from, who was before Obama, went to Obama to Trump.

And of course, the Democrats went down, the Republicans went up. Then it went from Trump to Biden and we're just completely flipped. So it feels like there's a significant political overlay on top of every, these sentiment surveys, you know, that, that we're taking. Anyway, I rant. Chris, that was a great one. That was a really good one. Very good. Carl, you're up. So my number is 0.5, and I'll give you the background so that we don't don't go searching too far. It is not a current economic number, but one that I drew from the past. 0.5. The past quarter, past year. Carl generally goes back three or four century.

trees. Not that far, but two than one quarter. More than one quarter. More than one quarter. Is it a growth rate? It is. Is it

labor force growth? It is not. Population. It does not have to do with demography. It does not. Okay. So that's the U.S. population grew 0.5% in, in 2023.

Yeah. or July 22 to July 23. It doesn't do with demography. It is a growth rate. It does have to do with inflation. Does it does not. GDP? It does, it does express a view of GDP.

Oh, GDI. Oh, oh, yeah. GDI, gross domestic income. No. No. All right. Okay. Oh, so it's GDP, some transformation of GDP.

GDP. GDP per person, GDP. It is the product of a survey. Oh, product of the survey? A government survey or a private sector survey? Private sector survey. Is it like consensus forecasts of GDP? Is it the margin of error or?

No, it's a consensus GDP forecast. Okay. from the blue chip as of oh it started the year or is it started the year oh census among the 60 or so

blue chip economic forecasters yeah was we'd have real GDP growth in 2023 of one half of 1% I see and Mark as you noted I went back and looked there were more than a dozen that had overall recession this year

Marissa, you've probably got the more current tracking, but the last blue chip number out of their survey was 2.2. But now with the better numbers that we've had for the fourth quarter, my guess is that that'll get marked up during the next survey. So there's every chance that growth will be five times faster than even the best forecasters thought that it would be. And there are two lessons that I draw from that. Number one is, once again, the frailty of forecasting. But number two, the robustness, the resilience, which is a pretty good summary word for economics in 2023, that we probably shouldn't discount as we think about the outlook for next year. Yeah, that's a good one. That's a really good one.

Do you know what the – so what is the consensus for the coming year? Do you know that offhand? I don't. Okay, no worries. I don't. I think ours is probably higher. Yeah. Yeah, ours is somewhere in the range of one three, one five.

I mean, it's going to be slower. Yeah. Yeah, I think we're at one seven for the calendar year, calendar year, 17. Yeah, 15 Q4 to Q4, I believe. 15 Q to 4. Oh, you know the data there. I've got a question about it yesterday. Very good.

Okay, I've got one. Ready? 103. 103. Number of days until you retire. I am never retiring. They're going to have to take me out on a stretcher. which they will probably do.

So maybe 103 days from now. I should have said, is this an economic variable? It is indeed. Came out this week. Is it an index value? It is. Conference board, yes. Is that the current conditions?

No. It's not in the confidence survey. It is a conference board number. Boy, that's a lot of hints. Oh, is it part of the? The leading economic indicators? Yeah, it's the LEI, the LEI, the leading economic injury. Fell again.

Fell again. Carl, not only are economists, most economists, dead wrong, but all the leading indicators are dead wrong. All the data is wrong. Huh? All the data is wrong. No, no, these leading indicators, the yield curve is wrong. And now the LEI, the leading economic indicator put together by the conference board,

which used to be put together by the government back in the day. as it kind of give you a sense of whether the economy was going to navigate through or without recession or going to recession, that leading indicator has been falling for two years, two years. It peaked two years ago, and it's been falling ever since. And I don't think in the long history of the LEI, it's ever fallen by that much without us already being in recession. So that's got it wrong.

And my sense is it's part of the problem is that this time. time, you know, this is the dreaded four words. This time is different in many respects. I mean, historically, what led you into recession was the interest rate sensitive sectors of the economy, manufacturing and construction. And this go around manufacturing construction have kind of held up pretty well. I mean, they're, they've not really, construction is basically flat. Single families down, but multifamily's up. You know, there's a lot of data centers. It's because of all the government support, Chips Act and infrastructure law, we're getting a lot of construction activity, a lot of manufacturing activity. So those two rates sensitive sectors of the

economy that kind of drive the economy down under because that's, you know, high inflation, high interest rates, and those are the sectors that go go into recession first and take the rest of the economy with it. They just didn't do that go around for reasons that are idiosyncratic, largely idiosyncratic to the current period. If you go look at the LEI index, just go take a look at the components of the LEI, big chunk of it is manufacturing and construction activity. So just that's the problem. So what do you think? I saw, oh, now Carl shaking his head up and down.

I thought he was saying no. That was wrong. No, I think, what is it they say? Unfortunately, we measure things that are easy to measure and we don't measure well the things that are hard. And now that we're two-thirds services, all three of you could probably run rings around me describing the difficulties that we have defining output price and productivity in service sectors. I would say if I were the head of the BLS or the BEA, I would be spending a lot of time using

alternative methods, alternative data sets and machine learning to try and get better at divining what inflation is in the output is in the service sector and developing indices around that, mark that are leading. Totally, totally. Okay, we're getting a little long in the tooth here. Maybe we can end this way. I'm going to go around the horn, get everyone's update on, and hopefully you will be able to play here, Carl. What's the probability of the economy entering into recession at some point in 2024? It's kind of a parlor game, but it really nicely quickly encapsulates your thinking about the year. And then also, what is the most significant downside threat? Because as you said, we should be looking at the distribution

here, not just the point forecast. What's the most significant downside threat? And if you've got an upside risk as well, I'll take that also. So sound okay? Does that sound like a reasonable thing to end on? Okay. Let me begin with you, Marissa. What's your probability of recession starting in the next 12 months? 20%. 20? 20. Okay. Okay. And just for context. the unconditional probability simply measured is about 15. So that's just a little teeny bitty, teeny itty, teeny itty,

itty, you know what I'm saying. Yeah, either one. Okay. They both mean small. They most mean small, right.

Okay. Yeah, so 20%, which is where I've been the past few weeks, I think. Right. The most prominent threat that I think is facing the economy. Yeah. Well, the Fed screwing up somehow, I think is the most likely reason that we would enter a recession.

So either they cut too soon and too quickly or they keep interest rates high for too long. But I think that's also in the context of an oil price shock, I think would be the most likely thing that sends consumer spending lower. has the potential to cut economic growth more than we're anticipating. And given all the geopolitical stuff going on, right, it's not that difficult to envision some kind of oil price shop happening next year. Great. Good. Okay.

Chris, what's your probability? In Carl's honor, I'm going to go with 37.7%. Why, in Carl's honor with 37.7%? I'm missing something. You know, Carl? 0.377. 0.377. Has it something to do with Carl's name?

Nope. My batting average is a major league. Oh, you're very close. That was the record of the White Sox this year. Oh. Oh, very good. And we've come back to the bullying portion of the podcast. Yeah, I put that that statistic.

out of my mind, Chris. Thank you for resurfacing it. That is good. That is good. So 37.7, so that's, that is more elevated. What's the biggest downside threat? I'd agree with Marissa in terms of energy prices. Also concerned about some of the risks we talked about in our previous podcast in terms

of geopolitical and just even the political or lots of elections going on this year. Okay. Carl? So we have our recession. probability for next year at about 30%. I remind my clients that while, you know, we'd like to talk about it in this way, cycles never die of old age. Something kills them. And the last few times it's been something financial. And in retrospect, we go back and we say, oh, yes, you know, this fundamental problem was as clear as day, but you don't see it in real time. And with markets

extended the way that they are, the potential for a correction that could then get back to the real economy, that would be the scenario that I'd be most concerned about. You ask for an upside scenario, and you know there are folks out there with a no-landing scenario that would have growth next year continuing along at, you know, two and a half or three percent sustaining the pressure on inflation and forcing the Fed at some point during the year to say, wait a minute, maybe we do need to do just a little bit more. That would not be pleasing for the markets, even though continued growth is usually better for revenues. I think the way they're set up with interest rates,

that would be a very unhappy outcome. Boy, it's kind of a backhanded upside scenario, temporarily upside. Yeah, got it. I'd say I'm sticking to 25%, still a bit elevated. I'd say the biggest downside threat is some type of financial event. It just feels like to me all the ingredients for something kind of going off the rails are in place. I'm not quite as confident about the banking system, but definitely the non-bank system remains under a lot of pressure.

The operating environment is difficult. Net interest margins are under pressure given the yield curve. The loan growth is under pressure. Credit qualities eroding. Regulatory costs are rising. It just feels impossible to predict timing even more impossible, but it just feels like something that could go off the rails and cause a real problem. On the upside, I actually think there's real upside.

because the supply side of the economy could outperform. I think 23 was even better than anticipated because we got a lot more productivity growth than labor force growth than anticipated. And that a lot of the economy grow a lot faster and even, and despite that, get inflation coming back in. So, you know, it was really amazing how significant the revival in the supply side of the economy was after getting nailed by the pandemic in the Russian war. And I think that that's possible it could continue. I mean, the productivity gains, hard to know what's driving that. I'm sure some of that's cyclical, temporary.

But, you know, when you had all those people quitting jobs and now they're in jobs that they're more suited to their skill sets and they're happier. You see the surveys. People say they're very happy with their job, more happier than they've ever been in the surveys that, you know, if you look at back in time. So maybe, maybe the productivity hangs, you know, I don't know if it stays at 2.3. which is what it's been over the last year, but, you know, something closer to two, that's pretty good. And labor force growth feels like that might have some legs, less on the participation

side, but immigration is strong. And, you know, the number of foreign-born workers is rising very rapidly. And that, you know, there's a lot of challenges to the immigration for sure. But one of the benefits is that it's adding to the labor force and helping to propel growth. So that's all to the good. So I think there's a real, you know, reasonable. upside scenario here where we could get, you know, just even better than we're anticipating. Any other last comments? Carl was just really wonderful to have you on. Really appreciate it.

Thank you so much. And hopefully we can get you back on the not-to-due to some future, but I really want to thank you. Oh, it's a real treat. And if people listen to this in time, please spend. The economy needs your energy here before the holidays. But the thing I often say, though, everybody, is that this is a season of the spirit as well as the wallet. And so I hope that the approach of the holiday gives you the opportunity to recharge and remember what's really valuable in our lives, which are our family and friends. And so, Mark, Marissa, Chris, I hope you have a great holiday with your families.

Amen. I totally agree. That was very nice. Very nice. Well said. And I really appreciate it. And Marissa and Chris, I'm not going to, we're not going to be chatting until the other side of the holiday. I guess. So have a happy holiday.

And to everyone out there, I wish you a wonderful holidays. I hope it's joyous. And as Carl said, you have a chance to be with family and friends. So with that, we're going to call us a podcast. Take care, everyone.