Moody's Talks - Inside Economics - New Year, New Outlook

Episode Date: December 30, 2022

To kick off the new year, Mark, Cris, and Marisa share their U.S. economic outlooks for 2023. Which sectors are at risk? Will the Fed tip us in? We discuss the full gamut and introduce a new segment where we take listeners' questions.Full Episode TranscriptMark's Slowcession paper.Follow 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'm joined by my two co-hosts, Marissa Dina Talley and Chris Doretties. Hi, guys. Hey, Mark. Hi, Mark. We had a nice dinner last night. This is, we're taping this a little early.

We're going to release this podcast, I think right before New Year's or was it right afternoon? Right before New Year's. Yeah, okay. So this is before Thanksgiving. This is for Christmas. So a little early, we're going to talk about the 2023 economic outlook. So a little bit of an evergreen, so not as time sensitive.

But we had a nice dinner last night for one of our retiring colleagues, Sophia Korpetsky. Well, Ms. Sophia. She's said she's been with us with me for 28 years, something. I think it was 28 years. That's what she said, yeah. Yeah, pretty amazing career. And, you know, she was kind of in the background. She's not like a publicity hound like Marissa is, you know.

She's always looking for publicity. So. That's me. Yeah. Yeah. Sophia is a very quiet person, but it was really critical to keeping all the trains on the tracks. Keeping our work going forward and across the finish line. Fair, but I'd say a pretty, you know, reasonably tough taskmaster.

You know, you need a little bit of. Brett and the ability to swing some elbows every once in a while to get stuff done, especially with a bunch of economists. And she did that with great aplomb. So we'll miss her. It was a very nice dinner. And thank you, Sophia, for all you've done for the organization for 28 plus years. And she's been a great labor market economist too. Oh, yeah. That's right. Didn't she say, first, last night, she covered on Economic View, where we cover all the releases, the employment report were, I don't know, what, 23 years or something like that. Yeah, she told me she's written it for 25 years.

Oh, 25, 25 years. Yeah, something like that. Yeah, pretty amazing. And who's going to cover that report now, do you know? Dante. Dante, De Antonio, of course, yeah. He's always on the podcast on Jobs Friday, so he knows his stuff. So that's good to have Dante.

Yeah, she made us better, definitely. She was, you know, high standards from quality standpoint. She wouldn't let your writing just go through. So she will definitely be missed. Yeah, very, very nice person and key to our success for sure. Thank you, Sophia. Okay, we're going to talk about the 2023 Outlook. We're also going to add a new feature to the podcast, where we're going to answer

listener questions. We've been collecting a few. We get them every week. We've kind of tried to weave answers to the questions in the podcast itself, but I think we're going to see how this works, how this goes. We're going to carve those questions out into a part of the podcast and just go through them, you know, and answer people's questions. Because if you have a question, it's very likely others have the same one or a similar one. So this means the onus is now back on you, your listener. If you have questions, so fire away. What's the best way to reach us? It would be help economy at moody's.com. So that's kind of our help site. So help economy, one word, at Moodys, M-O-O-D-Y-S dot com. Help economy at Moody's.com. Just, you know, fire away. Send in anything

that's bugging you. And we'll, well, when it comes to the economy, I'm sure things are all kinds of things may be bugging you. when it comes to the economy, financial markets, you know, any kind of, any of that kind of stuff, you know, far away. And we'll respond to them in this part of the podcast. I don't think we'll do it every week when we have guests on that might be tough to do listener questions, just given the flow of things. But when we don't have guests on, that would be something we would add to the conversation. So we'll get to that in a little bit. That sounds like a good idea, right? Absolutely. And if you can't remember the email address, you can always just go to

Economy.com, and there's a link to the podcast there. There's also some of our content. Some of our listeners have asked for follow-ups or articles. You can just go there, and oftentimes you'll find articles that are related to what we're talking about. Yeah, you know, the other thing, I haven't begged for reviews in a while. How come people, give us a review, you know, that's helpful. Good or bad, you know, that's, the feedback is important. So please feel free to do that as well. You can do that on Spotify and Apple. podcast, whatever, you know, you can, you can provide a review and that would be good to have as well. Okay.

Let's get down to business, the 2023 Economic Outlook. And I thought we just go, you know, get to the meat of the matter. And I'll ask, what is the, because all the debate is here is, and it has been on this podcast for some time in the, in the media and economic circles. are we going into recession in 2023? And just a level set, a recession would be as defined by the National Bureau of Economic Research, the business cycle dating committee, a group of academic economists that meet regularly and identify the start and end dates of recessions. And they look at a wide range of data, plethora of data, everything from GDP, jobs,

industrial production, incomes, retail, sales, you know, the whole shoot match. And then based on their judgment as to whether the economy's experience a broad base across lots of different industries, declining economic activity that's persistent, not just for a few months, but for, you know, a few quarters, that's a recession. And they would define it. Now, unfortunately, unlikely they, even if we had a recession in 2023, they would, they would determine that in 2023, it takes a while to get all the data, revisions to come in, and the dust to settle, and then they ultimately will tell us. So this may not be, you know, ultimately settled into 2024, but when they opine, but, you know, barring that kind of, you know, practical issue, that's the

recession. So with that as backdrop, Chris, what is the probability that we, the U.S. economy is going to experience a recession beginning at some point in in calendar year 2023. It's going to stick with my longstanding prediction of 70%, 70% chance that the NBR will declare a recession. Do you know you are now firmly in the consensus? That is the consensus, I think. I saw a Bloomberg poll. I think it was this morning.

I think it was this morning. So it's moved up. But it's 70%. It moved up. but it's 70% of economists that were surveyed by Bloomberg. And I only read the headline, so I don't know any details, now say recession in 2023. So they've been coming to me. I haven't been going to them.

That's exactly right. Yeah. Well, how does it feel to be in the consensus now? Now I'm a little nervous. I know. I was going to say. And it has gone up. I like to be the outsider.

Yeah, it has gone up. It was, I think the last time they did the survey, and again, I don't know when that was. I didn't read it carefully was 66, 66%. So they went from 66 to 70. So which means there are, you know, that's presumably the middle of the distribution of responses. So there's got to be a fair number of economists that are 75, 80, 85, 90 percent. So a high degree of certainty. Well, there's one outfit we know of that has declared 100%.

Yeah. Bloomberg itself, I think, right? Yeah. Yeah, I think they think for sure we're going in, which is a bit bold. A little hoobberus, but, okay, you know, making a statement here, yeah. Yeah, loud and clear. Yeah, okay. And Marissa, what is your probability of recession in 2023? 55%.

55%. Okay. I'm going in the opposite direction of Chris. I've been coming down. I got to mix it up, you know, it's good. That's good. Yeah, I mean, if you go back when a month ago, maybe two, I'm not sure. A couple months ago, I was at around 60, 60.

65. 65, right? Yeah. So you've grown a little bit more optimistic. I have, yeah. Okay, we'll come back and explore that in a little bit more detail. And then I'm still at 50%, 50, 50, which I know everyone's saying, oh, that's just a cop out. And, you know, to some degree it is.

But I do have to pick aside because I have to put pen to paper, have to produce a forecast, an explicit forecast that our clients use that's sitting in our data. databases that clients use, you know, regularly. And in our baseline forecast, there's no recession. The economy is weak in 2023, slow growth, job growth comes to a stand still. Unemployment starts to notch higher, but no recession in in 2020. Chris, can I ask? This is a recession, though, right? You have a 50 basis point increase in unemployment rate over a year, which has been consistent with recessions in the past, you just get up to that line under the baseline. Oh, yeah.

Yeah. I mean, 50-50, right? Yeah, exactly. Yeah. I mean, I wouldn't argue with anyone on either side of it too strongly. I mean, I can see it going in either direction here. And of course, I think the Fed, with the recent meeting, FMC meeting, where they raised interest rates at another half percentage point, they put out their summary of economic projections,

so-called CEP. And I think in that forecast, they have the unemployment rate rising by more than a half a point over a year. That's right. That's right. So the implied recession, I guess, is there. And people think that because every time the unemployment rate has risen by more than half a percentage point over a period of a year, that marks almost to the month, I think, the beginning of recessions. Yeah. Right.

So if the Fed has a forecast that has the unemployment rate rising by, I don't know what it was, seven, eight, tens of a percent by the end of 23, that would be if history is a guide, which suggests reset. They are now collectively, their collective wisdom is recession, although right on the edge. Right on the edge. Right on the edge. Yeah. I don't think we've ever had a recession that stopped exactly, right, got up to 50 basis points

and then didn't go higher, right? Yeah. just where it's where demarks. That's demarcation. You keep on going, but that's the recession. I mean, we're unemployment. Yeah. Yeah, exactly.

Yeah. Let me ask you this, Chris, just because this is a discussion we've been having it internally. Yeah. How would you describe the baseline? I mean, in a typical time, you know, you have this distribution of possible economic outcomes, right? You know, the baseline, the easy way to say it is it's in the middle of the distribution of possible outcomes. There's equal probability things are going to be worse than the baseline, and that would include recession scenarios and some pretty dark scenarios. And there's an equal probability things could be better than the baseline.

That becomes a little more complicated to say when the economy is at full employment, right? because at that point, you can't push unemployment any lower without generating inflation and ultimately higher rates and a recession. So it gets a little more complicated. But generally, that's the way we think about it. In the current context where the distribution, it's not normal, it's not a normal bell-shaped kind of distribute. Obviously, the risks are skewed.

When I say 50-50, the skewed risks are definitely skewed to the downside here. So how would you characterize? the baseline in the current context? I'd say our baseline has a growth recession. I know it's I know people don't really like that. It's a little squishy term, but I can't come up with anything better. It's right on the edge between a growth recession and a very mild recession, right? So that's how I would characterize it broadly.

I also would point out, though, that we're talking about the aggregate, right? We're talking about a broad-based type of description here, but there clearly are parts of this forecast that are very dark when it comes to, say, the housing market, right? There are parts of the economy that are deeply in recession, even with this overall skirting of the recession definitions. So I think it really, the overall definition is interesting, but the components, I think, are even more interesting to different people with different interests, different perspectives, different places where they participate in the economy. So I wouldn't just look at the overall definition and stop there. I'd want to go a little bit deeper.

Yeah, that's a good point. I mean, in our baseline forecast, no recession forecast, growth comes to a So GDP growth, I think, you know, Q4 to Q4, Q4 of 2022 to Q4 of 23 is less than 1%. You know, so well below the economy's 2% potential. Job growth slows to a trickle. We have some months that are pretty close to zero, maybe slightly positive. And in that kind of environment, that does mean parts of the economy are in recession, right? By definition, if the aggregate economy is traveling close to zero in terms of growth, something's got to be falling.

And that's, you know, housing obviously would be a case in point. Anything housing related mortgage finance, that would be struggling. Big parts of manufacturing are, I think, if not in recession, pretty close. I guess the exception might be the vehicle industry just because there's so much pent-up demand there. We may not, you know, as supply chains ease and vehicle industry can get more cars to sell, they'll sell them. But, but manufacturing is in recession. The transportation sector, do you see Federal Express? They, you know, downgraded their expectations for profitability and they're going to engage more cost cutting.

Their CEO thinks we're going into a worldwide recession. And no doubt for him, FedEx is in recession, right? because, you know, they, this time last year, we're shipping lots of stuff because people were still buying goods and now they're not and they're struggling. So transportation, distribution. Any other sectors, you know, even in the baseline, no recession scenario where we'd see what sectors would be down? I think those were the most notable.

I'd say construction broad. If you think about commercial real estate, I don't know if you include that. Sure. No, yeah. Because we also have the structural issues that are catching up with us as well in terms of office usage. So I think in 2023 we'll start to see some reckoning in terms of office prices really revealing the underlying value or lack of value as firms are refinancing and also trying to understand or plan for future investments. So I'd say construction, probably the financial industry is going to. to suffer here as well. If there is a pullback in credit and if we are starting to see some

additional losses here, there's certainly weakness, maybe not a full-blown recession for finance, but limited growth at minimum. Right. Any other's Marissa? Any other sectors? That's a lot. That is a lot. That's a lot of interest rate sensitive segments of the economy. I mean, the stuff that continues to do really well is education, healthcare, and I don't think we're expecting much of a slowdown there. So, yeah, no, I think you covered it all. Yeah. But you're right. I mean, if we're getting barely any job growth on a month to month or quarter to quarter basis, that means there are industries that are outright losing jobs, right? And I think I think you're right that it's going to be the interest rate sensitive parts of

the economy. I mean, we're already starting to see that tech. We're seeing, now. Oh, text the other one, right? Yeah. Yeah. Companies that need to finance, right, large investments that's becoming more difficult in a high interest rate environment. So expect that to continue if the Fed keeps raising rates into next year. Yeah. But on anything discretionary, right?

Travel tourism. Well, not in the baseline, I would say. I mean, I think that would, if you get into a full-blown recession. Oh, okay. Sorry. Yeah. I'm thinking of my recession. I'm thinking of my

forecast. Yeah, I mean, if we're skirting a long bottom, that means there's a fair number of sectors that are growing and doing reasonably okay. And I think in that discretionary might hold up okay. It's not going to be gangbusters, but okay, just giving all the pen up demand for travel and restaurants and ball games and that kind of thing.

Yeah, and definitely at the higher end. Right. The higher end. It's catering to high-income households, right? Where there's resources, financial resources. Yeah, that makes a lot of sense. So let's go back to the 70% and the 55%. And then I'll throw in my three cents as well.

That 70% is an important threshold because in our forecasting, in our work, and I've mentioned this a number of times before in the podcast, For us to make a change like this one, a big change in our forecast from no recession to an outright recession. And maybe we should talk a little bit about what an outright recession means in terms of numbers, but typically. But that's a pretty big change, right? I mean, maybe I'll do it now. In the current context, if we suffered the typical recession, say go look at the 12 recession since World War II, look at the average length, look at the average decline in GDP, peak to trough, look at what has. into jobs and unemployment, the typical recession last 10 months, GDP falls almost 3% peaked

to trough. In the current context, meaning the current size of the labor force, we'd lose almost 4 million jobs probably, 4 million. And so that's a lot of jobs. You know, you'd see months where you're down 3, 400,000 jobs potentially, you know, something like that. That's a big difference from that in our baseline of zero. Unemployment would go to 6%. Now, It doesn't mean the recession that's dead ahead of us is going to be typical. It could be less severe, and we should talk about that as well. But that gives context. It's a big deal to go from no recession to recession.

And for us to make that change in our forecast, our baseline forecast, and again, we do a bunch of all kinds of scenarios and downside scenarios. So we've got that covered. But for the baseline, the headline, the headline forecast, again, kind of sort of the middle of the distribution, the modal forecast. we have to have a very high conviction of that. That means, to put a number on it, over a two-thirds probability that that's going to happen. So you say 70%. Yeah. That's more than two-thirds.

So you are now chief economist and you're running the ship and you're saying, we've got to put a recession in our forecast. That's what you're saying with the 70%. So that's a, that's an important number. Okay, given that, characterize that recession for me. How long, how deep, you know, when, you know, exactly, because again, you have to put pen to paper. You can't be waving your hand and say, oh, yeah, sometime in 2023, we're going to, we'll see things go bad. Now, you could do that, but you also have to say, here's the numbers. These are the numbers.

So give us the numbers. Yeah, absolutely. So I think very important to characterize that average distribution. I'm advocating for something milder than that average. So in terms of what this recession looks like, my leading hypothesis is that it is caused by the tightening that we've experienced in the economy, that that does catch up with us in 2023 causes consumers and businesses to pull back, losses on credit cards and other. credit instruments start to rise and that leads to the actual recession, the broader recession. So I'm thinking of something around Q3 in terms of a start. The duration will be shorter than that 10-month average you mentioned, right? So I don't think it'll last that long for some of the positive aspects that I'm sure we'll get into in terms of the strength of consumer balance sheets and business balance sheets fundamentally.

So there are some reasons why this wouldn't last a particularly long time. And then the depth, I don't see it as being particularly deep either. So in terms of job losses, I can see a million or two million lost jobs, which on the surface is still devastating, right? That's still a lot of people losing work, but it's not the typical recession. For that, one reason why I'm not at something higher than 70% is really due to that job market figure, right? If I'm only suggesting a million or two million job losses, there's a chance that MBR comes along, MBER comes along the committee, you mentioned, and says, well, that's not

broad enough or that's not pervasive, that's not deep enough to really define a recession. So that's why I vacillate a little bit because I think we'll be right on the edge of what they might consider a recession. But at the end of the day, I think they will, because I do expect it to be fairly broad based here. So the recession, second half of 2023, kind of less severe than the typical, maybe half length. Yeah, let's call a half.

Half length. So basically the second half of the 23 and half the severity, if you measured in terms of jobs. Right. And the unemployment rate doesn't go to six, it might go to five. Five, five and a quarter,

something like that. Yeah, five and a quarter. And you got negative, quarters of GDP growth in your scenario, Chris? You do, but they're not very deep. Barely negative. And the recession, as you described it, is not caused by any additional shocks or mistakes or it's baked in the cake, so to speak.

That's what it felt like you just said, that given what the Fed has done already, even if the Fed stopped today raising interest rates. So they raised rates a half a point when they met a week or two ago, the funds rate target, which was at zero at the start of 2022, is now four and a quarter to four and a half percent, given that increase in rates. And, of course, they've been, they're articulating more rate increases to come. And the expectation in the marketplace, and it's consistent with our baseline is another half point to put the fund's rate target, the so-called terminal rate, the highest of the rate we're going to get in the cycle at four and three-quarters to five. you're saying, you know, even if they don't do that, or maybe you're saying if they do do that. I'm assuming they do do that.

Oh, okay. So they follow through and they get to five. Yeah. And that's the end of the story in terms of the rate increases. And then that's enough. The die is cast at that point. That's right. Then it takes, you know, quarter or so for that to fully be digested.

And that's what causes or leads to the last straw, if you will. Right. Right. And it doesn't take anything else happening. Oil prices don't have to go up. The pandemic doesn't have to come back. China doesn't have to shut down again. I'm making stuff up, you know, obviously that are top of mind.

No, if those things, that's right. I think that the scenario I've described here is really, it can be realized. It's sort of a dodging. It's sort of already built in. It's baked in the cake. If we get some of those other factors, then it argues for a deeper, more severe recession, right? Or maybe faster even, right? Those would be...

In fact, I would go back to the Fed. The market is already expecting five. So that's already built into financial conditions, and that's already cursing, the effects of that are already coursing through the economy already. So even if they go to five and stay there, that's effectively is already being brought into the marketplace and affecting the economy.

It is. It hasn't been fully realized. So banks are certainly tightening their standards or reacting, anticipating that path. But, you know, until business really have to go refinance their loans or households really have to pay their bills, the real effects on the economy won't appear. That's a part of the lag here. Yeah. By the way, this is an adjustment in the way you describe things, right? Because we had a bit of a, you know, I'd say it's kind of an account.

economist TIF back a few weeks ago around what would cause the recession. And you kind of went back on, oh, there's going to be some other things that go wrong. And because the economy is so fragile, that would be enough to push us in. But what I'm hearing you now say is we don't even need that. It's kind of baked. It's happening. Regardless of whatever happens out there, even if even everything sticks to script, there's no shocks, no nothing. We're going in.

That's what I have. Yes. Yes, although my caveat here is how I've described the severity, right? So again, those other shocks would, yeah, then I think there's no question. If we get some other shock here, then I think there's no real question for NPR, right? It depends on the shock, obviously. I mean, no one would argue with that. I mean, I would argue with that, right?

But then we're getting three, four million job losses. Then I think there's no debate, right? The NBR would come in and say, yes, that is a reset, right? It's broad-based. I think there's no real question there. What I've described today, this more of this milder version, right, that's where I think there's that, that room for discussion or debate. Okay.

I just go on a little, no, I don't think I'm going on a limb here. If we lose one to two million jobs, I'd be shocked if the NBER doesn't, you know, because if you lose one, two million jobs, unemployment is, that's closing in on five. I would be pretty surprised if they don't label that a recession. I'd be pretty surprised. No? Yeah, but if it's concentrated, you mean,

you can argue, well, it's all in the tech sector or just in certain areas, just in housing. Boy, but a million two, you're losing jobs in lots of places. Yeah,

that doesn't typically happen. Yeah, it doesn't typically happen, right, okay. Okay, you see, somehow I feel like he's finding a way out.

No, He's trying to, I haven't quite figured it out yet, but he's trying to find a way out of this thing. No, no. No, no. Okay, okay. We'll make the dollar bet at the end and, yeah. I hate these dollar bets. I do lose the dollar bets.

That's why I haven't made a dollar bet on this one because I always lose a dollar bets. I'm too cavalier with a dollar. Make it a million. Then we're going to really know. That will know. Chris Lone's going to pay that. That will know. They will know.

So Marissa, you're at 55%. So you would hold on to the baseline. You would not change the baseline. Yeah. So I think Chris is on one edge of the baseline and I'm on the opposite edge. So I think that we're going to avoid this that I agree. So obviously financial market conditions are tightening. But I think the Fed has done a good job of transmitting this well in advance. They may have been. on the late side starting to raise rates, but at the end of 21, they telegraphed that they were going to go from quantitative easing to quantitative tightening. They've been talking quite a bit. I think market expectations have been very well anchored through most of this whole thing, except with like a blip when during the Russian invasion of Ukraine. And I think, as you said, two, maybe three more rate hikes are baked in now to market expectations. And the Fed has, at their last meeting with their dot plots, right, they've pretty much said we're expecting

a terminal Fed funds right now of just over 5%. I think that that's been so far well tolerated by financial markets. Sure, things are tightening. We do see tightening and lending standards for things like credit cards, a little bit for autos, mortgages a tiny bit, interest rate-sensitive segments of the economy are slowing. But I do think households have maybe never been in a better position than they are now coming into this in terms of excess saving that they have. The labor market has held up. Sure, there's evidence that it's cooling off, but so far we see that in employers pulling back on hiring or canceling open job positions, but not really laying people off, with the exception of, you know, these announcements in the tech sector, right, that have

made headlines, but we're not really seeing that in other parts of the economy. And business balance sheets are also very, very healthy. Households are, on the whole, locked into fixed rate, low interest rate loans and mortgages. So if you're going to see pullback among households, it might be in things like, you know, credit cards, right? Things that are variable rate and can change over time. And maybe we'll see some pullback in spending there. But it just feels like my assumption is that all the things that will happen that Chris just laid out will happen.

But on the other side, we'll get through it without a response. I think the job market's going to slow. I think job openings are going to come down. We're already seeing that, but I don't think there's going to be massive layoffs throughout the economy. Yeah. So that all makes sense to me. And that's kind of how I think about it when I'm still at 50 percent, that the, I just don't see the kind of underlying weaknesses in the economy that typically prevail before recession. And the thing that would suggest that doesn't matter at all, but don't worry about the fundamentals is if inflation remained more persistent and the Fed had to raise rates more than what we're expecting. Yeah. Markets are expecting. And I don't, at this point,

given the better inflation statistics, I'm increasingly confident that a 5% funds rate target is going to be sufficient to slow things down so that, you know, inflation comes in and they're reasonably or early way, and that's not going to be the problem. And if you ask me, Mark, if you're wrong, you know, what would it take for you to think that a recession is going to occur? I would say that inflation is just going to be more persistent than anticipated. But I feel, I feel increasingly more confident that inflation is going to come in and we can talk about that. But the fundamentals are pretty darn good. And you mentioned consumers. They're pretty good financial health. Again, we should all say we're paying with a broad brush here. I mean, there's a lot of

things underneath that. I mean, low-income households are struggling, but middle-income and particularly high-income households are doing just fine, thank you. They've got plenty of cash sitting in their checking accounts built up during the pandemic, and they're using that. Businesses are in good shape. The GDP is stable. Businesses have done a great job locking in the low rates like households have. The financial system feels like it's pretty good. I mean, There have been some cracks here and there. The biggest one was overseas in the UK with their pension plan, but that was a footfall of a mistaken policy. And, you know, banking systems highly capitalized, very liquid post-financial crisis.

Just feels like the system's in a good spot. You talked about real estate markets. I mean, housing is underbuilt. It's not, you know, vacancy rates are pretty close to a record lows, at least in the home ownership. market. Yeah, office, but, you know, that's small in the grand scheme of things. I don't think that. And it's not like, it's not like vacancy rates are high in office because of construction. It's just because of the shift and preferences to remote work and lack of decline. And state local governments are flush. You know, they raked in a lot of tax revenue and they got a boatload of cash from

the American Rescue plan that they can spend out through 2026. And then here's the other thing. fiscal policy, you know, federal fiscal policy, hard to believe this, but it was a major headwind to growth in 2022, right? Because we got all that juice with the, all the support during the pandemic, ending with the American Rescue Plan in March of 21. That provided tremendous fiscal tailwinds in growth in 2022. But by, excuse me, in 2021, but by, but now by the second half of 2022, that's turned into a bit of a headwind. And that's not going to be, that's going to be now increasingly turning back into a bit of a tailwind is the other pieces of legislation passing the Biden administration are going to kick in. The most obvious being the infrastructure

bill, that's going to start adding to growth in the second half of 23 going into 2024, just when you think the recession is going to hit Chris. So not a lot, though, right? Not a lot. Not a lot, but I'm just, but on the bar, yeah, that's in my litany of reasons. Yeah, yeah, I hear you. reason. So, you know, I look at those things and I say, really, this doesn't feel like the fodder is in place for an economic downturn. So, so, Marissa, back to you. I mean, did I miss anything in that litany? I just want to say two more things that I thought of while you were talking. One on the housing market, we've been saying the housing market's in recession. But from a household

perspective and a wealth effect perspective, really unless you bought a house and probably overpaid for it in 2020 or 2021, even unlike in the financial crisis, even if house prices fell 10% for most people that's still going to put them above board on what they owe on their home, right? So if you bought a house in 2018, 2019, and you lose five to 10 percent of value in that house in most of the major housing markets in this country, you're still up from where you started because house price increases were so astronomical. So unless you bought a house very recently, I think the wealth effect here is not as much of a concern to me in terms of housing. Okay, so just to put, just so listeners understand where you're coming from because you kind of went back.

I did that. Yeah. And what you're saying now is, okay, one reason why you might be nervous about a recession is what's going on in housing. Housing is getting crushed because of the run-up and mortgage rates and the lack of affordability. House prices now are rolling over and starting to come in. And the concern is, well, with people losing housing wealth, that the so-called wealth effect will affect their spending and savings decisions. And that is a reason to be concerned. And you're saying, well, not so much. That's the point of what you're just saying. Yeah. I'm saying for the majority of

households, even if we lost, even if the value of my house falls 5%, I'm still in a pretty good position. Okay. Now, before we go on to your second point, I heard you said you had two points. Chris wants to say something. He wants to say something about housing, for sure. By the way, he is the expert of Mercer. I'm just saying. I'm just saying, you're now in his territory. I've picked the wrong fight. Oh, no. All good. I think you're right in terms of the chances of default, right? People are still a positive equity position. There's no reason to default. They've locked in these low mortgage rates. They have to live somewhere. But I think there is still a wealth effect there. In terms of savings, additional savings versus spending, right?

If I was counting on that appreciation for my retirement, I was cutting back on my savings, now that has to reverse and I have to start saving again to build up or replace that that loss of housing wealth. So I do think that that psychological effect is also at play here in terms of where we go and how the recession play out. I think that's a whole other podcast to tell you the truth. I've got so many things I'd like to say about that on the housing wealth effects. But that's definitely a podcast.

You know, we could get someone to come in and yeah, definitely a podcast. What's the second thing you were going to say, Emerson? The other thing I was going to say is the reason I'm at 55 and not at 50 with you, why I've been a little bit higher, is just that I do think we're in a fragile position. And I do think there is a chance that we get some sort of exogenous shock or something happens with supply chains. The COVID situation in China is really bad now. the more I read about it, the more I'm nervous about something emanating from China to really slow down the global economy more than we're expecting. And I just think if there's something like that happens, if the situation in Ukraine gets worse, Russia does something, you know, off the grid here, I just think it's going to be very, and I think we all agree, it would be very difficult for the U.S. economy to avoid a recession in that case. And I guess I'm just a little, bit more pessimistic about the possibility of something happening in the rest of the world.

Yeah, I'm actually sympathetic to that argument. And I like, you know, that's reasonable to be at 55% with that argument. It's hard to have that argument and be over 66% and change your baseline. Because once you change your baseline, then you've got to define exactly what the shock is. And that, this is back to that TIF that Chris and I had back. Listener, you should go back and listen to that. That was a pretty, I'd say for us, a heated exchange. So on this issue, that's hard to build in. But I'm sympathetic, you know, to that argument.

So, Chris, to you, back to you. Yeah. What would it take, what would have to happen for your probabilities to fall from 70 back below that 66? And let's say all the way back to, you know, 50, you know, something like that. that meaningfully lower. Let's put it that way from the 70% that you have today. Your baseline would go back to no recession. Yeah, I'd say that certainly those global risks, right, if we got an upside shock from one of them, that would certainly reduce the odds of the U.S.

recession considerably. So if there was some type of ceasefire resolution of the war in Ukraine, right, that certainly would help energy markets, would help Europe, would help Asia, and would help the U.S. by extension in terms of stabilizing energy prices, getting a little bit more certainty going forward. Chinese, I agree with humorous. I think that there's a lot of concern around the Chinese economy right now. So any type of resolution there in terms of COVID, right? My plan is to give all the MRNA vaccines we can to China, get that population. vaccinated as quickly as possible.

I think that would be a great outcome of not only for the Chinese economy, for the globe. So that would certainly getting COVID under control in China would be a significant upside risk, would help the supply chains. It would help their domestic demand. It would certainly help to cool some of the social unrest that they're experiencing as well. So I see that as a positive. And I do remain quite concerned about Europe. I think I've said this in the past in terms of.

of energy related to Ukraine, but even more broadly, I think they'll get through this winter just fine. But as we get into the spring and summer and they're looking to replenish their gas stocks, that's a downside risk. If there is accelerated movement in terms of LNG or other types of fonts of energy into the European economy, I think that could certainly be a positive factor as well. that could also help. Again, bringing those energy prices down, bringing inflation down faster, I guess, is at the root of this.

Those would be all upside risks I could see here. Yeah, I mean, you're, that's interesting. You're saying you need a positive shock for you, for it to come, for your probabilities to come back in. It's not something in, indigiously determined in the economies that will allow, Like if I told you inflation is going to moderate more quickly at this point than is anticipated by most forecasters. And just the level set there, consumer price inflation year over year is about 7%.

I think it's 7.1 to be precise in November. The peak was about 9 in June of this year, 2022. We've got it coming down to probably half of what it is today by the end of 23, say 3.5%ish. and then by mid-2020-4 is back within spitting distance of the Federal Reserve's inflation which on CPI consumer price inflation by our calculation is probably about 2.5%. If inflation came in faster than that, not related to lower a positive supply shock like end of Russian aggression, oil prices come in, but it's just coming in faster. You know, it's easier to get service price inflation down than is the case right now.

Okay. So wages moderate. Yeah, wages moderate. Yeah, the wages aren't as sticky as people think that it was all inflation expectations driven with oil prices and gas prices down. Inflation expectations come in. Wage growth comes in, service price inflation moderates. And we're back to the Fed's target by, let's say, the end of 2023 going into 2024. You're saying at this point, doesn't matter, you know, that we're going in.

That's not enough to, it has to be some kind of positive shock. I mean, so I guess you're saying my, if my behavioral assumptions are wrong here, that inflation comes in a lot faster than what I'm anticipating. Yeah, that would be a, that would be a cause for me to reevaluate and lower the recession probabilities, right? But it really shouldn't, though, right? Right, because you're saying the 5%, I'm getting a 5% on the funds rate target by, you know, presumably in the next few months.

that's the end of the story. And we're going into recession by the second half of the year. It doesn't feel like there's much that can save the day here other than some kind of positive shock, something that goes right for us as opposed to wrong. It's not something, the die, I guess the point I'm trying to make is the forecast you're giving, it feels like you're saying that die is cast unless there's some major event that saves the day here. Yeah, but I'm presuming a certain path for inflation, right? I'm presuming a number of effects here. I could be wrong.

I want to be humble, right? I could be wrong about that. Maybe inflation, to your point, maybe it comes in a lot faster than when I'm anticipating, and therefore the Fed doesn't need to go to 5%. And in fact, they can start cutting at the end of the year and give support to the economy, right? Just at a time when I'm thinking it's going to be particularly weak. So that would be, that would certainly be an upside risk as well.

That I've, I'm not reading the two reliefs properly or there's some other adjustments that, that the, that businesses and households make behaviorally that bring in inflation at a much faster pace. Yeah. Maybe there's more exploration of oil in the U.S., right? More fracking, whatever it is. So that supports energy prices coming down, coming in faster. Yeah. Okay.

Well, for me, the thing that would drive my odds up, you know, the recession probability is up and for us to change our forecast, abstracting from the negative shocks, I just, I agree that probability that's high and we may go into recession. That's why I'm not arguing. I wouldn't argue strongly with anyone who says we're going into recession. I just can't build that into a baseline forecast. I don't know how to do that in a reasonable way at this point. So the thing that would make me. ultimately change the forecast to have recession in it would be the most likely would inflation would just have to be more persistent than I'm anticipating and that the Fed would have to continue to raise rates that they can't they take it to five they look around they see oh my goodness inflation's not coming in wage growth is not moderating job growth is not slowing sufficiently to get wage growth moving south. Also, you throw in if inflation expectations start rising again, then I have no choice here. For me, the necessary condition for a well-functioning economy is, it's not sufficient, but a necessary condition is low and stable

inflation. So I'm going to five and a half. I'm a million go to six. I may go to six and a half, and, you know, that will break the economy at some point and we'll go into a recession. So for me, that's what it would take, you know, to change, that we get into next year and does the inflation statistics look, just don't look good? You know, we're not getting like we got last month, a couple tens of a percent. By the way, just throwing it out there, the December CPI report that we're going to get, that's going to look primo. That's going to look really good. Another good CPI numbers coming. And that should help. But if you get in an early next year, year we start getting 0.3, 0.4, on core, 0.5, I think, you know, at that point, I'd say,

I've got to pack it in. We're going to funds rates going higher, and we're going, we're going into recession by the end of 23, going into 24. And you're really pointing to wage growth as the causal, a major causal factor. Only because that's what the Fed is most focused on. I mean, by the way, that's another podcast. I'm not sure why we're so focused on that. I mean, anyway, I don't want to go down that path. But we should talk about that. We should talk about it. Yeah, the Fed is focused on. That's the one thing they can control or they at least they think they can control. Right. So they're focused on that. And if they can't get wage growth down, they'll keep pushing rates up. If they keep pushing rates up by definition at some point, we're going into recession. It's just going to happen. I mean, at some point, the rates are going to be too high for too long and something's going to break and we're going in. So if we're seeing that still in February, March, right, elevated four and a half, five percent wage growth, then you would contemplate. Yeah, I mean, first, first principles is the inflation statistics. I mean, if what, yeah, that's the most important. Inflation statistics are bad. You know, it doesn't matter. The inflation statistics are good. Then I go take a look at the wage growth. And if that feels like it's rolled over and coming in, then I feel good about my forecast, the baseline forecast. If that's, if it's not coming in, then I'm thinking, you know, we're going to have a problem. The problem with wage growth, the reason why I'm hesitating there is the data sucks. You know, It's just not good. It's very difficult to, at least the timely data, right?

Yeah. The average hourly earnings you get every month, it's very hard to interpret. It gets revised. It's seasonal adjustment issues, timing of the survey, composition. It's a mess. Yeah. Employment cost index, which I do trust, in the only thing I really trust, that comes out quarterly with a long lag.

So you're saying, if it comes into February and March, I'm saying, well, I don't, I'm not going to get that data for Q1 until, what, May, you know, something like that. So, you know, it's hard to know exactly when, you know, I would change my mind. So that's part of the crux of my thesis then in terms of the Fed, right? And whether it's, I hate to use the word mistake because they're just reacting to the data that they have. That certainly could be a condition for them to continue raising or not to cut because of those long legs in the reliable data. They only have the hour of learning, so that's the best way they can do when they're making their decision.

Okay. That's a great segue into the listener questions. So new feature of inside economics. We're going to take a few questions. And again, strongly encourage listeners to fire away, help economy. That's one word, help economy at moody's.com. Or go to economy.com, the website, and there's a place for you to put your questions in there. Or, you know, you know how to get us.

Just send an email. Twitter, LinkedIn. Twitter, LinkedIn, whatever. Twitter, at Marks Andy. I'm just saying, at Marksandy. Oh, it's been a while. It's been a while. Since I've hawk that Twitter,

what do they call it, handle, Twitter handle. Is that a Twitter handle? I think it's Twitter handle. Yeah. I don't think it's fashionable, though, to be doing that these days. I was going to say, are you backing off the Twitter promotion? I'm not really following this very carefully. probably should.

Okay, first question. How would you rate the Federal Reserve's conduct of monetary policy? Give me a letter grade. That is from a listener. And, Marcell, start with you. How would you rate the Fed's managing conduct in terms of managing policy? We're talking over the past. You define it.

That's the question. Yeah. So you define it. I know how you want to answer it. B minus? Okay. I'm sure the Fed will not take that as an answer. They will want to know why. I want my notes. Yeah. Okay. B minus. Why not a B? Why not a C plus? I think they, I think they started too late. I think the reaction on monetary policy was too late. And I worry that it was late enough that it's, it's,

it's going to be difficult for them to truly get inflation under control in the time frame that they want to. Now, it looks like that's happening. I mean, certainly looks like the inflation data are rolling over. But that doesn't mean that it's not happening too late just based on the way financial markets are reading it or households are reading it or businesses are reading it. Talking about wage growth and setting wages are very sticky, setting employee wages for the next. year, once you give somebody a raise, you can't really take it back, right? So I think they've done well in the communication of what they've done over the past year, but I just worried that they got started too late. So you're saying, back to the start of 2022, the funds rate target was still

at the zero low bound, that they were still buying bonds, QEing, quantitative easing. And at that at that same point in time, given inflation, given how the job market was performing, given financial conditions, the value of the dollar, all the things they look at for gauging the appropriate stance of monetary policy, they should have been raising interest rates much sooner than they actually did. That's what you're saying. And therefore, it can't be an A, it can't even be a solid B, that's a B minus. Because of that. Yeah. I mean, granted, in retrospect, we'll see how they did. Well, what if I push back a little bit and said, well, a little, and I don't want to be a defender here. Yeah, yeah.

Yeah. I mean, they would say, and I think with some legitimacy, hey, did you know about the Russian invasion of Ukraine? You know, that didn't happen until February of last year. And, you know, moreover, and that's when inflation expectations really took off. It's when Russia invaded and oil prices spiked and gasoline went north and food prices started to rise because of higher diesel costs. and you saw this this untethering of inflation expectations and that's what ultimately that's the inner reaction function that's one of the criteria they look at and they said oh gosh now we got to go

because but that wasn't the case until Russia actually invaded me you know you could see oil prices started trending higher back in December of last year when it started go on the radar screen but it you know there wasn't really on the radar screen in the effective way until then can I get a B please no yeah But there was evidence even before the invasion that there were inflation issues rearing their head, right? Both in energy markets and caused by supply chains. They knew the job market was really strong. They knew households had all this excess saving from the pandemic.

They were at zero, right? I mean, they could have started slowly inching up, I think, prior to the invasion. again, this is all Monday morning quarterbacking here. You're right. I mean, certainly, if you look at market inflation expectations, they didn't really pop up above that Fed target until the invasion and the acute spike in oil prices. And then the Fed started reacting. But I still think they could have, they should have anticipated some uptick in inflation given what was going on even before that. Okay. All right. B minus. Chris, what's your grade? So I give them a B plus on the Fed funds rate policy, but I give them a D on the quantitative easinging. That's interesting.

So overall, what is that C plus? C plus. Oh, explain, please. Yeah. So I think they get a, we give them a hard time in terms of the Fed funds, right? Yeah, the timing you mentioned. Also, If we look back, there was unemployment was still high, relatively high. I was coming down, but still relatively high in 2021. So what are we talking about in terms of when exactly they would have started? Are we, instead of starting in, what was it, March, they would have started in January? January. I mean, it's a few months.

It doesn't really change the contours all that much, I would argue. And there was enough uncertainty that I can't really fault them for those. policies, but I do fault them for not ending the quantitative easing sooner. And certainly the MBS purchases went on far too long and I think stoked the labor, the housing market and, you know, cause house prices to rise even further than the necessary throughout this period. And that, I think, does contribute to the inflation where you're still experiencing now those rent increases, the house prices increases in the CPI.

So I think that was bad policy. I don't see why that they felt the need to continue those policies. Yeah, I mean, funds rate, I think. Again, there's enough uncertainty. Just a little pushback there, just a little bit. I mean, it's just, it would have been difficult, not impossible, but a little difficult to stop the QE without raising the funds rate at the same time.

I mean, you know, I think the framework for the shift in policy was, you know, they could roughly have to happen. They should happen at the same time. Maybe I've got that wrong. but it would have just been a little tricky for them to say, oh, I'm going to, well, maybe, maybe right. It would have been tapering much longer. Yeah, maybe. I don't have to go to zero.

I mean, in fact, it would have been beneficial to into it with more tape, a longer horizon. Yeah. And that already, I think that already sends the signal, right? That's a, you're telling the market, look, I'm coming. I'm on the case here. Right. Right. Especially given what we were seeing in the housing market, right?

To Mercer's point, there was data there. It was no lag. We saw prices going up at double-digit rates. Yeah. Well, I'd give them a solid B. Can't get an A because you didn't get it right. I mean, you know, your fault, not your fault, you know, hard to know. I'm sympathetic to the argument that this was, you know,

the Russian invasion wasn't on the radar screen, therefore, you know, how could I gotten this right? Fog of data, you know, lag data, all those things that, you know, or make it difficult to conduct policy. But at the end of the day, you're not going to get an A unless you get it right. I mean, you can't just not, and you didn't get it right. You got it wrong. But I can't see getting them anything less than a B because so much was out of their control. And policy 101 says if there's a lot of uncertainty.

And at the time, there was hard to remember, but the pandemic was still a big deal. You know, we're, Amacron was still scary, you know, we were so worried about that. And we still are worried about it. We're still talking about it. But back then, still top of mind. I didn't, Zandi family didn't have Zandi Christmas, you know, where we bring in all my brothers and sisters last Christmas, hard to believe because we were fearful of everyone

getting sick. In fact, some of us had gotten sick, you know, right before Christmas. So policy 101 says if you have, if there's a lot of uncertainty, err on the side of doing too much, not too little to support the. economy and I think they were following the textbook, the policy, man, tech policy conduct, monetary conduct.

What do I want to say? The conduct of monetary policy textbook or whatever it is, they were following it. So now, now having said that, I'm not sure what great I'd give them for the conduct of policy right now. You know, um,

I'm, you know, my sense is that if I were them, I'd be using two things to kind of gauge the appropriateness of policy. One is inflation expectations. The second is the shape of the curve. Now, I wouldn't be a slave to it, but I would be thinking about it and using it. And if inflation expectations are, and I use the bond market expectations, the one year, five year forward. I look at them all, but that's the one I would be most focused on because that's the one I can

control most clearly. If that's above two and a half percent, probably closer to three, then I'd say, okay, I got to keep raising interest rates here. And I got to keep signaling to markets. I'm going to raise rates. I got to keep financial conditions tight. I got to get that is inflation expectations now. But right now, the bond market inflation expectations, no matter how you measure it, is right on the Fed's target.

I mean, I just looked at one year, five-year forwards. That comes out of, you know, inflation protected securities and swaps, two and a quarter percent. I think the five-year, five-year-year forward, two-and-a-quarter. quarter percent. The five-year break-evens, I think they're less than that. I think they're two. You know, this is CPI inflation. So that says, I don't, you know, I don't know that I need to be overly worried. I don't need to be hawkish. I don't want to be sending signals. You know, I'm in a pretty good spot. I don't want to give people a sense that I'm not going to

five. I told people I'm going to five and that's embedded in those inflation expectations. But I don't think I need to do any more than that. And I'm also now starting to err on the side of doing too much going back to the yield curve. When the curve gets as inverted as it is, that goes to policy. The bond market is saying, oh, the Fed's really jacking up interest rates and at some point that's going to really weaken the economy. In the case of a current version, historically, that's a recession. So that would be a signal that, you know, hey, guys, you know, that's a little too much. First thing I look at is inflation expectations, whatever that says, I'm going to do. But if they're anchored, then I'm going to sit, look at the yield curve, and then I'm going to say, okay,

That should be the end of the story. So I think if they go to five and stay there, you know, fine. But if they keep on going, I'd get pretty annoyed at that, you know, because I think they're, at that point, they're doing too much. So for their policy up to this date and point, I'd give them a B. Still not clear, you know, what their ultimate grade will be. But I'd say I'm a little nervous about that at this point. Okay, we discovered a lot of ground.

we got a bunch of other questions. Ask one more, and then we'll call it a podcast. And that is around the value of the dollar. As you know, the dollar has been strong throughout much of the pandemic, flight to quality. And the Fed, of course, in 2022, has been raising interest rates a lot faster than other central banks. Because of the higher rates here compared to the rest of the world, money's been flowing in and the dollar's been strong. I think if you go back a couple months ago, maybe it's a month ago, the dollar was at its peak. So, you know, one point it was pretty close to parity with the pound.

It was beyond parity against the euro. It was closing in on 150 to the yen. I think it was 150 to the end. It was strong against the Chinese currency. It's come in now more recently. You might have seen in the last couple days the Bank of Japan announced a shift in their policy around the yield curve control. and that's called the, that's somewhat of a tightening in policy. So we've seen the yen, you know, appreciate a bit in value.

So the dollar's off its peaks, but still very, very high. The question is, where is the dollar headed, broadly speaking, you know, up down all around? Where do you think it's going? Chris? Depends on the timeline, of course. So short term, I think it stays strong because of the relative strength of U.S. economy compared to other parts of the world. There's a lot of uncertainty, flight to quality.

I mean some adjustments here as all central banks are reacting to each other, but I don't see the dollar really losing ground for a while until we get a bit of stabilization here. So I'd say the dollar remains the best bet out there and continue to have strength. What about a year from now when we're in recession? in your recession. We're in recession. Well, we're in recession.

It's got to be easing at that point, presumably. Yeah, that's right. So we're in recite, but it's, again, it's all relative, right? Also, the rest of the globe is in recession as well at that point. So even then, right, the dollar is weaker, but it's not, it's still relatively stronger compared to other currencies. I think it's not until after that recession and things stabilize that the dollar actually comes back in, gets closer to its equilibrium.

Right. And do you think there's any chance the Fed, excuse me, the U.S. loses its reserve currency status or even the reserve currency status is diminishing. You saw the, this was another question about the Russian and Chinese are now trying to buy oil. I don't think, it wasn't, not with dollars, but maybe their own currencies. Yeah, their own currencies. And of course, the fact that oil and most of the currency, and most of the currency, Most commodities and most goods are traded in dollars gives the U.S. dollar reserve currency status, which is very important, very significant privilege and gives us a lot of economic benefit. Do you think there's any chance that that will be significantly diminished any time in the near future? I don't see it. And with actually with the crypto currency crisis, I think it even strengthens the dollar's position, and more, right? People, even consumers now, retail investors, are thinking about safety of currencies.

And I think the dollar remains the champion there. Got it. Yeah. Mercia, any other interviews on that? Do you have any strong opinions on that question? I completely agree with everything he said. I mean, I feel like as an economist, we're getting that question about the dollar is the reserve currency for years and years. and it's just still, if you look around the world, one of the least risky places. So, yeah, I agree with Chris's assessment. Yeah. I guess that's the answer.

I mean, what's the alternative? Right. Really? The pound? Mm, the yen? The one? Huh? The euro?

We could still screw it up with the debt ceiling. Yeah. Well, a lot of this came, you know, was precipitated by the decision to, to, to, when you, when, Russia invaded, the U.S. froze dollar reserves of Russia. And so that sent a signal that, you know, those dollars are not sankrosanct. They can be, they can be frozen. And so I think, obviously, that's one of the reasons why Russia and China want to get off the dollar as fast as they can, but I don't see how that happens. Yeah, it would be very difficult. Okay. Good. So what did you think of this, this new feature of the podcast? This listener question. That's great. I like it. You do? Okay. All right.

Okay, we're going to do this going forward. So, listener, you're on. Give us and try to stump us. And you should know, I did not tell Chris or Marissa the questions beforehand. So these were answers. Maybe you're disappointed. I didn't tell them beforehand. Maybe we wouldn't have better answers.

But I think it makes it more interesting, you know, more spontaneously. You get, you know, people's true feelings, I think, if we don't let them think about it. So they got to respond. But please send in your questions. Well, hey, guys, this is the end of the podcast. I want to wish you a happy holidays. And I'll see you on the other side. Take care now.