Odd Lots - Neil Dutta and Conor Sen on the Chances of a US Soft Landing

Episode Date: January 12, 2023

The most recent jobs report has revived talk that the US economy might pull off the fabled "soft landing." Jobs are still growing nicely and the unemployment rate is at a 50-year low. But wages are decelerating and there are reasons to think that inflation is rolling over as well. So can Jerome Powell & Co. smoothly land the plane, so to speak? On this episode of Odd Lots we speak with Neil Dutta, chief economist at Renaissance Macro Research, and Conor Sen, a columnist at Bloomberg Opinion, about the US macro situation, as well as the rental market and the impact of China's reopening.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, Odd Lots on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, I have to say that at this point, maybe in like my career or this stage in the economy, I can't remember a time in which I feel like there are so many like legit. legitimate divergent views on the direction of the economy. Like some people say like inflation is going to stay high through all of 2023 and the economy isn't going to slow down. Some people are like, okay, we're headed for a recession because the Fed's hiked rates and housing is plunging. And others say, oh, this is going to stagflation because there's entrenched. Like there are many very legitimate views in my perception about where things could head from here.

It does feel very bifurcated at the moment, like two very extreme paths. Like either you get a massive global recession and ensuing deflation or you have this period of 1970s style hyperinflation or you have something even worse, which would be stagflation. And, you know, people used to talk about the prospect of the soft landing. That kind of went away for a while, this idea that the Fed could raise rates and quash inflation. And, you know, people used to talk about the prospect of the soft landing. That kind of went away for a while, this idea that the Fed could raise rates and quash inflation. And, without necessarily engineering a huge knock to economic growth. It kind of went away for a while. I think when the inflation readings kept coming in higher than expected. But we're recording this on January 6th. And we just had a really good payrolls report from the perspective of the soft landing thesis. We had, I think, unemployment dropping, but wages easing a little bit. So we don't have to worry about that wage price spiral that central banks we're all scared about. And so now we have a lot of talk again about the possibility of the soft landing. Yeah. I mean, the way I've been thinking about it is that until unemployment actually really starts jumping, and it hasn't jumped at all, because we're back down to 3.5%

basically the low. Like the historic lows. Yeah, historic lows. I think I saw a tweet that actually if you were like, go out to like the sixth decimal point, it really is like the lowest in like 50 something years now. I don't know. Wow. I didn't fact check it. But you should do a post. on it, if that's true. All right. This is why we need, like, each other, like, in the office so that someone's, like, don't just, like, don't just look at the tweet posting. But in all seriousness, you know, like, until my view is, like, until unemployment, like,

really starts to rise, like, until we, like, really have that, like, the soft landing scenario, like, can't be disproven, right? Because there's always the chance that inflation comes down and employment doesn't go up. Like, it's a hope, like, you know, knock on wood, we all want it to happen. But until like unemployment really starts falling apart that can't be disproven. And then there's the additional layer, which is let's say inflation were to come down and get closer to the Fed's goal. But the unemployment rate refuses to budge. Does the Fed believe it?

Or does the Fed say no? Like we have to keep hammering. We have to keep hiking rates in order to get unemployment up so that we can be confident that this decline and inflation is sustained. I do have to say, like part of me still feels a little weird when we're talking. about the Fed explicitly trying to push up unemployment and also like the idea that, oh, it's good that wages aren't going up in a period of high inflation. We're all kind of poorer, but on the other hand, we don't have unanchored inflation expectations. But setting that aside, the thing I'm getting from this conversation is that we have a lot to talk about. That's right. And we could keep talking

because we have plenty of thoughts. But why don't we talk to two guests who we both had on before that also have plenty of thoughts, some of our favorite sort of like big picture e-com thinkers, a great conversation, hopefully a great conversation to start 2023. Destined to be a great conversation, I'm sure. Yes. We're going to be speaking with Connorsen, a columnist here at Bloomberg Opinion, as well as Neil Dutta, head of economics at Renaissance Macros. So Connor and Neil, thank you so much for coming back on oddlops. Great to be here. Thank you. I'll start with you, Neil, because, you know, I think at some point last summer you're starting to get a little bit more negative on the economy.

These days, I feel like you're a little bit more optimistic. Can we get the soft landing? Like, is this still in the cards? Well, first, thanks for having the Harold and Kumar a fin to it on your podcast. We definitely appreciate it. You got to start a competitor. Start a competitor. I had to get that in there.

But at any rate, yeah, I mean, the news today was good for the soft. off landing bulls. I don't really see how you can cut it any other way. One of the data points that we like to look at is the index of aggregate weekly payrolls, right, which is the sum product of jobs, of jobs, the work week, and hourly earnings. And, you know, over the last three months, that's up, you know, just under 4% at an annual rate. So that's basically your proxy for nominal growth, right? I mean, jobs and hours, that's real GDP and wages you can consider is basically your inflation proxy. You put it all to together, you're around 4%. That's the kind of number that'll make the Fed very happy. And I think lead them away from a more aggressive rate tightening campaign, at least in the short run. But I think to something that you were getting at earlier, the unemployment rate is three and a half percent. I mean, there was a lot of discussion around this sort of yawning gap between the household measure of employment and the establishment payroll figure. That gap basically narrowed,

substantially in December, right? And the unemployment rate is three and a half percent. And, you know, ultimately, it's hard to, for me at least, to push the kind of immaculate disinflation thesis that much if the unemployment rate is three and a half percent. And, you know, ultimately the Fed views the labor markets as the conduit to achieve their inflation objectives. And, you know, by that standard, they're not really succeeding. And, you know, And so, you know, and remember that the inflation numbers will look a lot better over the next several months, right? I mean, you have gas prices coming down. Household utility bills will probably come down.

Food prices will probably moderate. But aggregate incomes growth, you know, are still okay. And so it just means that you have this pickup and real disposable income. So that, to me, puts pressure on capacity, right? I mean, real growth takes away, you know, resources, real resources. And ultimately, as you put pressure on physical capacity, whether it's labor or product and resource markets, that'll ultimately put pressure up on inflation. So I hate to say it, but it may well be that the improvement that we see or the sort of the soft landing bulls having their day in the sun, maybe that proves transitory. So that's sort of how I'm thinking about it right now.

But I definitely think the wind is behind the soft landing bulls is back at the moment. Connor? Yeah, I think right now it's easier to think about what's happening in the economy at the moment and over the next three to six months than to talk about sort of the more abstract, does this level of labor market utilization mean this for inflation and that for a session? I think that's a conversation really for the second half of this year. And right now, because people came into the year so negative, I think the bigger story is just that real growth was very good in Q3, looks like Q4,

and we're kind of entering 2023 with good momentum on that side. And then at the same time, we see inflation really rapidly coming off between core goods, which we've seen for several months now, gas prices, which is just a nominal thing, but still matters to consumers. And then also in the rental market, we're seeing market rents really start to decrease pretty rapidly over the past few months. So the outlook at the moment is very, very good. And we can sort of think about later, later. But I think the story for now is just how good things are heading into 2023. So, Neil, you sort of touched on this, the idea of the first. Fed at some point starting to slow down its rate increases. And we had something else this week.

Again, you know, we're recording it the first week of 2023. We had the Fed minutes where the Fed was talking about the difficulty of tightening financial conditions. And financial conditions, you know, relative to the pace and extent of rate increases, you could argue, have been relatively loose. So I guess my question is like, what would be the catalyst for the Fed starting to take its foot off the pedal if we haven't really seen a big tightening of financial conditions. Well, part of that's implicit in their forecast, right? I mean, to me, I think a lot of this is just optics, right, Tracy? Yeah. I mean, how there's no denying that financial conditions have actually eased over the last couple of months, even as the Fed has been, you know, trying to jawbone markets

and has been hiking, you know, 75 basis points, 50 basis points, signaling more to come. But to me, it's optics. Yeah, I guess my question is more. Or like, when do they feel comfortable stopping the jaw boning? Because it is clear that they're talking about, you know, higher rates for longer and the market isn't necessarily believing them. Well, they're getting there. I mean, they're getting there already. But I don't, I mean, I don't know that that it's formulaic. I mean, it's sort of like a touch and feel type of approach.

I mean, they go around. I mean, Bullard is talking about how, oh, okay, we're getting close to the end. I mean, he was a hawk. He had some comments this week that were read a little bit more doveishly. But we don't know, you know, sort of ex ante, you know, what the right level for the Fed funds rate should be to cool the economy. I mean, it could be multi- I mean, it could be, you know, different rates at different points in time. I mean, this is not, I mean, to me, this is more like, this is not an exact science, honestly. And I just think that you are going to get much softer inflation between now and the March FOMC meeting.

And for me, the tension is think about what the Fed did in December, right? I mean, they raised their inflation forecast and they marked down their growth forecast. So the bar for them has been changed in a way that, you know, right, I mean. You're being very polite, but yeah. You could be, you could easily come back in March and they'll be revising down their inflation forecast potentially considerably. And they're going to, what, say that they're going to accelerate the pace of rate hikes at that point?

That, to me, is a little bit difficult to see. So that's sort of where I'm at. Go ahead. Connor, to Neil's point right now, you've been pretty critical of this, that, like, okay, the way the Fed is talking is we're seeing an economy with accelerating inflation and weakening growth. And yet the actual data seems to be the exact opposite. We seem to have pretty solid growth in the second half of 2022, first quarter of

2023, and declining inflation. Like, what's your take here? What's going on? I think what's going on is that, and, you know, you know, you. You two had on Neil Cash Carey of Minneapolis Fed in maybe August, and he was saying how he was unhappy with the stock market rallying, and they sort of felt like their messaging wasn't being understood by the market. And so at that point, they really changed their messaging to focus on a higher unemployment rate and kind of this, whatever it takes determination to rein in inflation. Markets got the message, and by September, October, they were probably in the place where they wanted to be in terms of what the market was pricing, the level of financial conditions that they wanted to see. And to be fair, at that point, inflation was running really hot and growth was slowing.

And the data has changed a lot over the past three months where, to your point, inflation now looks like it's coming off pretty rapidly. Growth has picked up. But they want financial conditions to stay in this place until they have more confidence on where things are going. So they're kind of sticking with this message that is really out of sync with what's happened in the economy. But since markets are by and large not running away from them, they're kind of okay with it. but it's going to become increasingly out of data. You know, you look at the unemployment rate at 3.5% at the start of 2023. They forecasted it going to 4.7% at the end of this year.

That not only would certainly not be a soft landing. It's just wildly out of sync with what we're seeing in the data. So they're just really not in a place that's in sync with what's happening in the economy. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new Bloomberg this weekend.

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Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. Neil, I want to go back to something you said in your first answer because I've, you know, I don't troll. on Twitter, but I do sometimes joke. Uh-huh. Very, very convincing laugh there. But, you know, that falling gas prices are bad for inflation because falling gas prices mean more money in consumer pockets. More money in consumer pockets mean more spending power.

More spending power means higher prices. But you kind of said that in your first answer. You're like, look, real wage growth with this decline in inflation is picking up. that makes it hard to get any sort of like any kind of landing. So is there something where like falling gas prices and a few other categories is not actually good news for inflation? Well, I think it moves things in place, right? I mean, you're talking about relative price shifting, right?

So if if the labor markets are steady and people see, I mean, it's like saying, I mean, do you think a tax cut is inflationary? I mean, I think most macro models would probably say yes, right? So I think that the fact that the, the fact that gasoline prices are declining, All that does is shift consumer purchasing power to other areas of their goods and services basket, and that drives up the prices for those goods and services. I don't think it has an overall impact on inflation. But again, I mean, the reason I think the Fed looks at it through the conduit of the labor markets is this identity, right?

I mean, so much of economics is identity, whether you're talking about corporate profits or in this case inflation. And for them, compensation equals inflation plus productivity. has basically talked about that equation multiple times over the last year. And if the labor markets are tight and unemployment is 3.5%, that's going to keep compensation growth steady. And we're not particularly in a strong productivity environment right now. I mean, productivity is notoriously hard to forecast, but it's not particularly strong. So that leaves a lot of pressure on inflation. And I think that's one of the reasons why the Fed's looking at the labor market so strongly. And by the way, a lot of the improvement in inflation that we're talking about,

right now has almost nothing to do with the Fed, right? I mean, that, that's, that's part of the issue. I mean, use car prices, supply chain improvement. You know, it's not like people put their rent on on the credit card. So, so, you know, the slowing in rental inflation has almost nothing to do with what's going on with the labor market or tightening credit or anything like that. I mean, it's just sort of, it's happening kind of independently, I think, of what the Fed is doing. So to me, the Fed's got some explaining to do. Tracy, wasn't there some term we were using like in 2021 about inflation coming down for reasons other than monetary policy? Well, okay, this is my new conspiracy theory about financial conditions, which is I believe the Fed thinks still thinks inflation is transitory and is actually comfortable with financial conditions not actually tightening that much because they think the things that are making prices go up are the transits.

transitory supply chain stuff. And so it's just, you know, talk your way out of the period of adjustment without actually tightening too much that would cause a recession. That's my new conspiracy theory. Okay, there's silence. So I guess no one else agrees with me. Okay. Well, Connor, you know, we talked a little bit, I think in private about productivity. And you have seen companies come out and talk about the difficulty of replacing the older workforce that left during the pandemic, and we are having basically this productivity adjustment. How are you viewing that component of it? Because as Neil just mentioned, you know, it is a tough thing to forecast. And so far, all we seem to have is anecdotes about what companies are doing here.

Well, we know that labor market turnover has declined over the past six months at least. And companies say they're better staff. They say they're in a better place. I think supply chain's getting better is maybe kind of squishy, but helps at the margin. Things like being able to turn your capital faster because you're getting shipments more quickly and can sell them more quickly so you're not waiting a long time for orders. But I think the challenge with productivity is, to Neil's point, there's a very standard model of real economic growth is hours work plus productivity. But a lot of what's happening with real economic growth that we saw in 2022, what we're seeing right now doesn't really fit into that framework very well. And for instance, you look, take the rental

market where we added four plus million jobs in 2022, but actually new leases on rentals was negative in 2022 for the first time since 2009 because we unwound some of the excess household formation we got during the pandemic. As a result, rents are falling and shelter is a huge part that goes into inflation. So inflation could come off very, very rapidly for sort of reasons unrelated to sort of standard business productivity just due to sort of households deciding not to get new leases, maybe find roommates again. And it's, I don't know if that's, like if people decide to get a roommate, is that productivity growth? Not really, but it also, freeze up capacity for other people. So I think this sort of standard way of thinking about productivity

isn't very helpful at the moment. So basically Powell needs to go out and say, get a roommate, folks. If we could do this the hard way, you lose more people lose their jobs or the less hard way. Like, get a roommate. Well, I think that does so. I mean, I hadn't thought about it before, but like if two people share a space versus one, that is a kind of productivity growth, isn't it? Yeah. And the scenario that's really weird for 2023, which I think is possible is we, know that sort of that core goods inflation is negative right now. So let's say that's zero in 2023. And it tended to be pretty low heading into the pandemic. And then we know rent growth is negative at the moment. It was about negative 3% annualized in Q4 of 2022. What if the shelter

component of CPI is this flat in 2023? And this is not assuming any job losses, just sort of due to these weird effects going on right now. And then that sort of core services X shelter component, even call it 5%, because maybe wage growth is still hot. That gets you to a core CPI number below 2%. So you could have a soft landing with sub 2% core inflation in a good growth environment. I wouldn't say that's a new normal or anything, but just that's what the data could show based on all these weird dynamics happening at the moment. Neil? I think it's totally plausible. The question is, what does that mean for 2024? Right? You know, look, like let's say everyone decides to get a roommate, right? And you had this big burst of household formation that drove up

shelter prices and now people decide to get a roommate and that, you know, weakens household formation and now shelter costs go down. You're still left with this idea around the labor market, right? I mean, for whatever reason, okay, the Fed views the labor market as the conduit for achieving their inflation objectives. That is the principal issue right now. Powell keeps talking about pain and rebalancing the labor market. If that is what the Fed is trying to achieve, they're not doing it, okay? They're not doing it. And that's why I think maybe where Connor and I disagree a little bit is what does that mean for the interest rate outlook in the back half of the year? And let's just keep in mind, right?

I mean, there is a good reason. I mean, I think there's a pretty, you can make a pretty compelling argument that growth is likely to accelerate over the next several months, okay, because of the loosening of financial conditions that we've seen over the last few months, right? So you get a positive impulse from from housing, maybe. Government spending is a bit better. We talked about real incomes and what that could mean for consumption. So if you have real growth above trend, again, for the next quarter or two, what do you think that's going to mean for the labor markets? It's going to mean continue tightening, which in turn means what?

Potentially higher wage inflation, which in turn will push prices up. I mean, to me, that's really the issue. This is all happening at a time when the Fed is increasingly, not just doves, but hawks like Bullard, that they're a little bit more comfortable with the way things stand and that they're going to back off to 25. And Connors talked about this as well, to the extent that 22 was about them hiking aggressively into a slowdown, what does it mean that they may be pausing into an acceleration? And I think he's right that sort of I can, the data is, sometimes, I don't want to say it lies, but it's sort of not really telling the whole picture

because of lags between various factors. And so, again, I can get to the story where right now we have real deflation because of all these things, freight prices, gasoline prices, core goods, shelter, while employment growth continues to grow higher and income growth continues to grow higher, that's not a sustainable long-term scenario. It's not like we've discovered the singularity, but it's just the way the data is shaking out. But yeah, on the other side of this, we might have a labor market with 3.5% unemployment, good balance sheets, and a lot of consumers and businesses that have been hunkered down waiting for recession, and then they're ready to hit the go switch again. And that could be very boomflationary on the other

side of this if we don't figure out where policy should be and sort things out on that side. So speaking of unreliable data, one of the big debates in 2022 was the surveys versus the hard data and the idea that if you looked at a lot of survey measures, survey-based measures, people seemed miserable, like on the verge of a massive recession. But if you looked at the hard data, it was very much still coming in strong. Can you talk a little bit more about how you're thinking of that discrepancy going into 2023? Because, you know, as Neil has pointed out, there does seem to be an improvement in terms of consumers' ability to spend just by virtue of gas prices going down. And we know that gas prices. I mean, if you look at some of the survey data, like, there is a lot that just

tracks one for one with gas prices. So how are you thinking about the whole, you know, I tried to ask this question without actually saying the word, but the whole vibe session idea. Yeah, I think end demand in terms of consumer spending money remains very resilient. But I think because of all these sort of bullwhip effects and fed recession fears, that's led to the soft data being pretty weak or at least a lot weaker than the hard data. And I think a good way to think about it is Nike, where they have said that they had this big sort of boom in inventory. Part of it is because that inventory they ordered in the spring didn't show up until late past season because of supply chain lags. And then because supply chains have gotten so much better, they got their

holiday season inventory earlier than they expected. So they kind of had inventory coming in at the wrong time on both sides. And they have to work through that. And so while they're working through that, consumer spending is steady. But because supply chains are better now, maybe instead of having to order shoes three months in advance. They can order it six weeks in advance. That's a one or two month lag where they're not doing orders. So if you're a factory in China, you're saying, I'm not getting any orders, but it's just because they have to sell through their inventory, the supply chains are now better, but then things are fine, say, by March. And so that's sort of the real way in which the soft data is accurate. And then just if the Fed's telling you they need

to raise unemployment, we're going to have a recession or people believe that, that's going to change the way that you think about the economy as well. So I trust the hard data more, but I understand why the soft data is weak away is. On April 4th, 2020, around 2 in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco.

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beginning April 16. All right, I want to, you know, we actually haven't done an episode. I think we're doing an episode soon, specifically on rent prices. It's one of these topics that we should have hit sooner. But I know, Connor, you've done a lot of like work and studying of this. And so we do have these measures from some of these private companies like apartment list or Zillow or some of the others. And it looks like rents coming down.

We had that episode last year with Omerer Shereef, talk about the gap between these measured rents versus what's in the government data. But I guess the simple question for me, as a New Yorker who rents, is my rent going to come down? Yes. Really? I think rent growth is going to be negative in 2023. That to me is like the big underappreciated story. So what's going on? What's going on? Like what? How come? What's going on? Like, how come? So sort of a few things. First is that you had this excess household formation in 2020, which finally started unwinding over the past six months. You can sort of think of that as a bullwhip

effect in renting, but just because people sign year-long leases, there's just a much bigger lag there than maybe buying shoes, which can sort of happen a lot sooner. The second is that there's a lot of supply growth in the pipeline. We currently have twice as many apartments under construction as we did at the peak in 2006 on the onset of the housing bust. And that's because, I think to some extent, we've been building apartments for a decade now to kind of meet millennial demand, and there's just been the secular belief in the rental story. And then you have that huge surge in household formation in 2020, which just like e-commerce companies, they leaned into this, this is a new normal for rental demand. And so builders built to meet that.

And they haven't been scarred by a bus the way that single family builders were. In 2008, people got foreclosed upon. They had to go into renting. Millennials entering the labor force were renting instead of owning. So the apartment market never really skipped the beat. But this is sort of a big reckoning, I think, for the rental market, because millennials now are looking to buy rather than rents. So you don't really have that secular growth in renting versus buying. And then you have this rapidly rising vacancy rate and a lot of supply in the pipeline. I would just point out that if we're talking about a secular increase in homeownership, homeowners tend to spend multiples of what renters do, not on things just inside the home,

but dining out, travel, you know, leisure, that sort of thing. What does that mean for inflation? At the end of the day, all we're doing here is just pointing out, okay, look at this area, look at that area, this price is going down. But you're talking about still a growing pie, right, ultimately. And I think that's the principal issue, right? I mean, everything we're talking about in terms of the improvement in inflation is primarily looking at it through the rents of relative shifts and prices. Okay, so shelter prices will come down. I mean, Conner's probably going to be right about that based on what we're going to. we're seeing with new lease growth.

Connor's probably going to be right about use car prices and the things related to the improvement in the supply chain. But ultimately, that's just a relative shift in prices. A good way to think about this is what happened with gasoline prices in the mid-2010s, where because we finally had that sort of excess from production relative to demand, gasoline prices and oil prices plunge globally. And for a while, that led to worsening sentiment for manufacturing. there was a bust in investment on that side.

But if you're a U.S. consumer, that was a big boon to you because you got cheaper gas. And we're seeing that in like almost everything on the good side and maybe the rent side as well. So that can lead you to think that inflation is getting better. You have some downturns and surveys if you actually produce some of these things. But if you're a consumer, you're just getting a huge burst in your purchasing power because everything's getting cheaper. Core CPI during that period actually rose. It accelerated in terms of growth rates. And so if you look at the long history of just food and energy CPI versus core CPI,

the contemporaneous correlation between those two series is basically close to zero. Because it goes to the point that Connor was making, which is, you know, all you're doing is talking about relative price shifting. That's, again, I mean, I don't make a judgment, Joe, as you know. Like, you always talk about how you're a journalist, you never read opinions. That's right. That's right. Well, hey.

No one here has any opinions, judgments, or forecast. And I'm the same way, Joe, as a business economist. I don't know whether it's right or wrong to look through, look at inflation through the prism of the labor markets. All I can tell you is that's what the Fed is thinking. And that's what drives our calls on the economy and markets and so. Actually, I just want to press on this point because I think you're absolutely right. And it's something that we heard from Tim Dewey as well on a recent episode. But like, why do you think that is?

You don't have to opine on whether it's right or wrong, but why do you think they've taken that, you know, tact? Because sort of an ironclad rule in macroeconomics is that compensation equals inflation plus productivity. So compensation growth is what drives the inflation outlook. So, I mean, remember, one of the reasons why we had the soft landing in the 90s was because Greenspan nailed the productivity call, right? When was that? I mean, remember, at the time, actually. actually, if you go back to the transcripts during that era, you know, Yellen was basically saying that Greenspan may have been making a mistake, right? And Greenspan got that call right. Maybe, Joe,

one benefit of not having the PhD. But, but, but I think, I think that that's, that's something we need to keep in the back of their mind, right? I mean, so we didn't have a formalized inflation target of two percent back then, and we had a rapid increase in productivity. And so that helped you, achieve the soft landing. Are we going to see that again? I mean, we obviously have their form. They've, they've said that they have an inflation target of 2%. I mean, Powell sort of hinted at maybe a longer term project to look at that. I mean, maybe that was a, you know, a slip of the tongue. But really, it comes down. I mean, productivity. I mean, why should productivity be a lot stronger now? I mean, with younger people in the workforce, there's more churn in the labor markets.

You know, you have a lot of the experienced workers leaving. So what's the case for stronger productivity? Has capital spend in been booming relative to hours worked? Have we seen a lot of capital deepening? We haven't really. You know, I think, I think so that that productivity call is a lot harder to make, I think. So we've talked about, okay, headline inflation, gasoline prices coming down. We talked about rent and all that. But, you know, in the last Fed press conference, Powell made a point. And it's interesting, too, because like, you know, it, feels like the area within inflation that the Fed pays attention to is always shifting. Earlier in 2022, they're really big on headline inflation because headline inflation informed expectations. And no one really talks about that anymore. But now the big thing is the non-shelter component of Core PCE is like still hot. So, okay, even if rent comes down, even if gasoline prices come down, et cetera, well, the real signal is from this non-shelter component of Core PCE. Neil, what is that, that what else, what are the big things in that basket and why, you know, how do wages really like drive those numbers? Like, can you talk a little bit about how we should understand this part of PCE that seems to have become so central?

Well, you're talking about personal care services as an example. So going to the laundromat, the barber, I think recreational, recreation services, right? Sporting events, things of that nature. And the reason they're focused on it is because that's an important channel for how the labor markets affect inflation. Right. I mean, inflation is multivariate, right? There are lots of things that drive inflation. And labor markets are one part of that. And labor markets show principally in that, you know, that ex-shelter services area. So that's why Powell's focusing on it. But I do sympathize with you that they have, they look at different things at different points in time, right? And remember, nothing stops them from doing that this time. Right. I mean, if global growth picks up,

and oil prices start to pick up. And I know you've had a lot of people on your show talking about the lack of investment in mining capital, CAPX. What does that mean for oil prices? The Fed can be right back where they were in June and July talking about, well, gas prices are back up, short run inflation expectations are high, and that could mean something for wage inflation. Yeah.

Where I would sort of split the difference here is I think that to the extent that I'm right about the inflation data in 2023 and for various technical reasons, it comes in very, very low. If the unemployment rate is still 3.5%, that might not make them hawkish, but it certainly won't lead them to cut. So I think to get rate cuts, you're probably going to need to see, at least some normalization in the labor market data, because they're not going to trust that a 3.5% unemployment rate is consistent with 2% inflation. So speaking of services, we just had another headline. Again, we're recording this on January 6th. We just had the ISM services PMI coming in a lot lower than expected, kind of weird, at 49.6,

versus an estimate for 55. And then earlier in the week, we also had a slightly lower ISM manufacturing headline. Can we talk a little bit more about the manufacturing outlook? Because there are a lot of questions about how much you can read into the PMIs. But Connor also made the point about inventories and how much of a role they have potentially played in 2022. So can we just talk more about what you're seeing there? Maybe let's start with Connor. Yeah, my view on the manufacturing side is that the weakness we're seeing is more about inventory corrections and improvement in supply chains, meaning that there's less pressure on producer or I guess the consumers of manufactured goods to order things in time rather than a big investment downturn. And so I think that a big investment downturn is

when you see job losses and that's sort of more your classic recession scenario, whereas to me this is really more of a bullwhip supply chain inventory story that'll be cleared out by the the end of the first quarter. Neil? Yeah. So. Neil is a huge fan of taking the ISM manufacturing report as gospel. Right. I mean, those of those that follow my work know that I think that the ISM is, you know, a useful, rough and ready indicator, but not a good substitute for hard data. I mean, as an example, what's, what's a better sign of confidence? The fact that 300 purchasing managers, you know, are feeling a little bit more grumpy about their industry or the fact that or the fact that hundreds of thousands of establishments that were just surveyed by the Bureau of Labor Statistics are adding

manufacturing jobs. I'll let you be the judge. Obviously, it's the latter, which is why in the long history of the ISM, it tends to give out a very large number of false signals. And it tends to be as early in signaling a bottom as it is late in signaling a peak, right? I mean, it's not a particularly good timing tool either for the economy. So if you go to the 90s, I mean, you had multiple, multiple times that it fell below 50. And if you look at the data, I mean, manufacturing production during that time was steady. After the financial crisis, same story. And that's what's going on now. Right. I mean, what matters for manufacturing? The ISM or the fact that Boeing is going to build a bunch of planes for a while? They have a huge pipeline of orders that they need to work through.

The same holds for motor vehicle assemblies. You're talking about autos and aircraft. That's about 10 to 15% of U.S. manufacturing production on its own. Forget the downstream effects. I mean, obviously, when those two industries are clicking, it's going to create a windfall for other areas in the manufacturing sort of value chain, right? I think that matters a lot more than ISM. It's an oscillator.

And for market participants, how has using the ISM been useful? for you in making a market call. Just pull up a chart of industrial stocks over the last few months. They've been beating them. They've been outperforming the market. So, you know, there's this cottage industry in Wall Street, you know, looking at the ISM as a timing tool and so on and so forth. And really, it's just, I think it's a waste. And I think it's better to focus on the actual data. And you mentioned the services number, Tracy. I mean, again, there's a great example. I mean, look at dining reservations, look at, look at flights, look at people's appetite to go out and do things, look at avatar, you know, beating out Top Gun Maverick, right? I mean, don't,

don't talk to me about the ISM services. You know, so, so. This is exactly why I wanted to talk to you about ISM. But I do think, I do think you sort of raise a good point there about like it overshooting and undershooting, like key turning points. Because I think maybe. Maybe that's what we're seeing in a lot of the survey data, which is like surveys just are not that good when you have cycles that are like twisting and turning and extremely fast as this one has been. Like maybe they're extra unreliable in these periods of time. Right. It's a diffusion. I mean, so let's put it this way. Let's say in January, GDP growth is 7%. And in February, GDP growth is 7%. What does the ISM do? It goes to 50. Is that bad? I mean, by the people, by the ISM cultists that are all over the market, maybe it is, but I think for a thinking person, no, it's fine. So, so I think, I mean, you have to understand like how these indicators are constructed.

All they're asking you is, are things going up, down, or sideways? And the one thing I'll point out to people is if you take a look at the global manufacturing PMIs, formerly known as market, you know, I look at about 35 of them. And if you look at new orders, only, you know, maybe a fifth of them are in expansion territory. And that's happened maybe, you know, maybe a handful of times in the last 20 or 30 years, like LTCM, the tech rec, obviously the financial crisis and then the European debt crisis. So you can count the number of times on one hand where you've seen that happen. And in each time, what's gone on? What's happened next? It turns up. So it goes back to this idea that it's a momentum barometer. right? I mean, so the moment, it's not like the thing goes to 100 or it doesn't go to a zero. So, you know, the lower it goes, the more bullish you should give. In the spirit of explaining the data, we had an economy where nominal growth slowed from about 12% at the end of 2021 to more like 6% at the end of 2022. And then you had multiple cyclical sectors that went into contraction for sort of bullwhip related reasons and then housing due to the Fed. So I think that the nominal level of growth has arguably stabilized at this point. And then some of those industries that were in contraction for much of 2022,

could actually inflect higher in 2023. And again, that could lead to acceleration and growth when the Fed is expecting a deceleration. Well, Connor, speaking of manufacturing and where there's potential growth, we recently got the awards auto sales, I think, in December. GM had a good month. Toyota had a good month. We had 13.3 million annualized rate of new car sales. But that's still well below, like, where we were regularly printing pre-pandemic, which

was like more on the 17 million annualized. rate. So is there still like a big, like, what's going on with cards and chips and all that? Is there still an opportunity for the big automakers to kick up production into a higher gear here? Yeah, I think everyone expects that number to go up in 2023 just because, again, it was our sort of lower than we would expect due to supply chain reasons. We probably missed out on 6 to 7 million vehicle sales over the past few years due to supply issues. Production's going to pick up and automakers will cut prices if they have to, but if they produce cars, they're going to sell cars. And then there also could just be sort of a weird dynamic where electric vehicle demand and production is picking up, sort of demand for conventional gasoline powered vehicles is going down.

And maybe you're thinking, well, the EV I want isn't available yet. So I'm just going to wait for a little while longer. But I'm not going to buy a gasoline vehicle in the meantime. So it just there's sort of pent up demand for EVs, which would explain overall level of sluggish sales as well until that picks up. So I know we've been quite U.S. focused in this conversation so far. But the other big thing for the global economy in 2023, it would seem to be, is what's going on in China with the reopening. And also more recently, a lot of policymakers seemingly rolling back some of the restrictions and crackdowns that they had on certain sectors like technology and real estate. And also, you know, you have some early signs of them potentially opening the floodgates of credit again and trying to boost economic growth at a time when a lot of the population is quite frustrating.

How are you viewing that? Because on the one hand, it would seem that China explicitly trying to boost consumption might be another inflationary impulse for the year. On the other hand, you know, maybe it's a good thing for the world economy. If China is really focused on growth, maybe we get something like a repeat of what happened post 2008 with the financial crisis when China really kind of came to the global economy's rescue. But what are you thinking about China at the moment? Well, Tracy, I mean, as you know, I do, focus more in the U.S., but what I will tell you is that you talked about the vibe session before. Well, in some respects, I think the FX markets are very vibe.

You know, they, it's how people, it's like basically a beta play. And if China is reflating, which I think it is, I mean, if you look at, you know, the Hangsang, the Chinese equity markets, you know, I was reading that, you know, obviously transit uses up. So things are getting back to normal. I mean, it's going to look bumpy, reopening. always do, as we know, but demand is likely to pick up. That's introducing an incremental source of demand to the global economy. That, I think, will put downward pressure on the dollar.

And I think that that's important, obviously, because the dollar has a very mechanical impact in inflation dynamics, right? I mean, the Fed's workhorse model of the economy assumes that every 10% drop in the dollar pushes up core inflation by about two to three-tenths of a percentage point a year later. So that's the first point. The second point is, I think that the improvement in China is going to mean a lot for Europe. And that's because Europe is a very large open economy that trades a lot. And if China is improving, it's almost certain that Europe is going to look better next year too. Right. So it's sort of, I mean, you're talking about the same coin, two sides of the same coin. Europe and China are in some respects tied at the hip through trade.

And if you have those two economies looking a little better next year, I think that's going to put downward pressure on the broad dollar exchange rate. At the same time, China's been, you know, a mess in 22, as we all know. But during 2022, what did we also see? The rest of the Asia EM complex looked okay, right? It looked okay. I mean, look at India. I mean, India activity was doing reasonably well. Parts of EM Asia look better. I mean, a lot of the final assembly, frankly, has already leaked out of China. But, you know, a lot of the other Asian economies that are around China did okay. The same goes for Japan. So, you know, the fact that China is now participating, I think, it just elevates all these

sort of economies around it, right? Sort of a gravity model of activity. So I think it's, I think what you're talking about, really, I mean, just bringing it back to the U.S., I think it's dollar negative. And, you know, just, I know we wanted to put a pin on the manufacturing discussion, but obviously if the dollar's weakening, that's going to push up, you know, the exports of, of, of, you know, manufactured goods. Close to wrapping up here. But Connor, any other thoughts, either from the international thing or just sort of other dynamics looking into 2023 that are on your mind?

I think just the real question is that everyone is wondering about is, are we going to have a recession? And so I think for me, it's sort of you try to think about all the components that could lead to recession. So it's global manufacturing, housing, consumption, financial conditions. And it's just hard to point to any one thing that's out of balance and likely to, be a lot worse in 2023 than it was in 2022. And if you can't identify anything at that level, then maybe you should be a little more uncertain about how bad things are going to get. And, you know, as we've talked about on this podcast,

it's much easier to identify areas where things could pick up, at least for the next six months. Connor and Neil, thank you so much for joining us in my mind that lived up to the hype. I learned a lot and plenty of things to think about going out through the year. So thank you both for coming back on Oddloft. Thank you, Harold and Kumar. Thanks Joe and Tracy Thank you

Joe we need a nickname I was just going to say the same thing We need like our own like We need our own pair Body and Pug No those thieves Take care of Okay so my big

takeaway is that If Avatar is outgrossing Top Gun Maverick Then I'm not going to pay attention to the ISM then rents are going down as well. I don't care about rents.

I don't care about gas. I don't care about the ISM. I don't care about the dollar. It's like, how well is Avatar doing that's going to inform my view of the economy? Well, I think, I mean, I know you mentioned that you tweeted ironically, possibly trollingly about gas prices and the consumer. But this is a point I made somewhat more seriously, not on gas prices, but in one of our newsletters, which is just like, I actually think like over the past. year forecasting inflation has been difficult, but I actually think like we're kind of entering the hard part now because all the parts are like so in motion in potentially different directions.

It's going to get like pretty difficult. And then the other thing I would say there's there are so many takeaways from that conversation. One thing that struck me was Connor talking about the inventory buildup in 2022 and the idea of that feeding into some of the surveys because quite frankly, that was something that we heard in a recent conversation with Ryan Peterson at Flexport as well, this idea that, well, everyone was overordering because transport times were so crazy. And then once transport times started normalizing, they realized they had all this stuff and they had to start working through those stockpiles. And now, as some of that starts to revert, as some of the shipping times start to normalize, maybe we see some improvement there. You know what I thought was a really interesting point in the conversation that we really need to talk about like rents and multifamily?

Yeah, no, I agree. And I know we have, I think we have an episode coming up soon, but I had not thought about this point that Connor made, which is that for the multifamily builders, the builders of, you know, apartment complexes, et cetera, they never had that scarring the same way the single family homes did. It was just like there's been this huge secular bull market. in demand for multi-family. They didn't have that big bust the same way, quite the same way after like 2008, 2009. Everything always seems to line up. Everyone's moving to the cities.

Young people don't want homes, et cetera. And so this idea, it's like, oh, could we have like, you know, like a Minsky moment, basically, for multifamily where just when everyone thinks you cannot lose building more apartment, could this lead to like a real like reversal is like a really interesting sort of both short term question because it affects what rents are going to do, but also like pretty long-term question because like, what if there were a bust in this sector? Well, maybe, I don't know, maybe we'd get, no, we wouldn't. I was just thinking like, I guess we'd get a big decline in productivity as well because

everyone would be able to afford moving out from their roommates and getting their own apartments, right? So it would be bad, Joe, it'd be bad. Well, this is, I hadn't even thought about that. Right. So we're just like, okay, thank you. We're all, we all have roommates again, saving money. Oh, rent prices come down, move back out. But this also, you know, this sort of general equilibrium style thinking, which Neil talked about a lot, which is that a lot of what we've discussed, are these sort of relative changes and more money in people's pockets because of one thing going down means more spending elsewhere. And if that is sort of a useful framework. But this is the moving parts thing, right? Like, it's so difficult to predict at the moment, I feel like, because.

like one thing happens. And because so many of these moves have been extreme, which we talked about in relation to a lot of the survey data, their diffusion indexes, so they tend to overshoot and undershoot, because everything has been so extreme and in such a compressed time frame, it just feels like a lot of our traditional forecasting models are terrible at dealing with this. And, you know, and again, a theme all of last year is like, you know, and you've written about this recently that like we'll you know people talk about the 70s or whatever what if it's the Spanish flu and something and all these like cycles that look like business cycles but aren't really cycles because it's just part of normalization I think it's going to it'll be an interesting

year we'll have plenty to talk about I think we've come full circle to the beginning of this conversation which is like there are some extreme possibilities and opinions out there and it's very difficult to choose directions and paths at the moment so on that note shall we leave it there Let's leave it there. Okay. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway.

And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. Follow our guests on Twitter. Connerson. He's at Connorsen. Neil Dutta, I think he doesn't actually have an account, but at Renmac LLC. Well, at RenMack LLC is firm. And I have a sneaking suspicion he's doing all the tweets.

I'm like, you can read them. I was like, yeah, that's a Neil tweet, even though it's his firm. So check out RenMack. You can actually imagine it in Neil's voice. It's only, they're all in Neil's voice. You can tell. RenMack LLC, follow our producer, Carmen Rodriguez, at Carmen Armin and Dash Bennett at DashBot. And check out all of our podcasts at Bloomberg under the handle at podcasts.

And for more OddLod's content, go to Bloomberg.com slash OddLots, where we post transcripts of all the episodes, blog, and we have a weekly newsletter that comes out every Friday, go there and subscribe. Thanks for listening. June Grasso, inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases, the latest actions from Congress and regulators, and the legal moves driving the markets. From corporate law to constitutional law and from state courts to the Supreme Court.

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