Odd Lots - The Real Pain From Rate Hikes May Still Be on the Way

Episode Date: September 28, 2023

The Federal Reserve has hiked rates in rapid fashion, yet the evidence of their impact is scarce. Inflation is still hot (though it has come down quite a bit.) The unemployment rate remains very low. And economic growth appears to be robust. So does this mean that higher rates aren't significant? Or could it be that their impact has simply yet to be felt, and that it's still coming. On this episode, our guest argues the latter case that due to lags, we really haven't felt the pain from rate hikes yet. Julia Coronado, is the founder, CEO and president of Macro Policy Perspectives, as well as a Clinical Associate Professor of Finance at the University of Texas McCombs School of Business. She argues that we really haven't felt the credit effects yet from higher rates, but that they're on the way. In particular, we discuss the delayed impact on commercial real estate and other areas of the economy where debt may have been termed out, but will eventually need refinancing.See omnystudio.com/listener for privacy information.

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Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg television, radio, and wherever you get your podcasts. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, we've been on the road a lot, lately. I know. It's been non-stop trips.

Let's see, we did Jackson Hole, and then we went to California at Huntington Beach. And now we're in Austin, Texas, your hometown. Have you enjoyed Austin so far? Oh, I love it. Okay. I mean, I'm not going to lie, large parts of it do you remind me of Dallas. What? But controversial opinion, but it has its own thing going to like amazing bars, restaurants,

shops. We went cowboy boot shopping at Allen Boots. We've had some amazing Tex-Mex, really excellent barbecue at Terry Blacks. It's been good. Yeah, we were in Jackson Hall. We did a lot of episodes in Jackson Hall. But a lot of them were sort of like these sort of like longer running like academic questions that a lot of the episodes that we did.

We didn't really do too much there on like, okay, but like what's happening right now in the economy with like monetary policy, the impact of the Fed rate hikes, things like that, even though that's sort of on a lot of people's minds. Yeah, funnily enough at a macroeconomic conference, the real economy wasn't the first topic of conversation. Although that's a little bit unfair because they did talk about supply chains and things like that. But you're right. We haven't done a current state of the economy episode for a while, although we've touched on it in various ways. One of the more recent ones was when we spoke to Wayne Dahl from Oak Tree about the credit market. And a big topic of conversation in there was why haven't we seen more of an impact from this historic pace of rate hikes on the real economy? Yeah.

Yeah, it feels like this is still this looming question. And until we have a sort of better idea of what's going on here, I think there's like a sense of unease. And even at Jackson Hall at Powell's speed. even with the improvement in inflation from last year, there is the still underlying sense of unease, which is partly driven by the fact that we've seen improvement, but it's like we can't quit explain why, because drawing that line between the rate hikes to the improvement in inflation is hard to draw. You would expect that, okay, if unemployment had been rising significantly, it's like, okay, well, we can tell the traditional monetary policy story.

Phillips curve is alive and well. Yes, we can't quite tell that story. And then maybe it has something to do with the terming out of the debt that we talked about, Wayne Dahl. And then if that's the case, well, what does that mean then? Are we still going to feel the impact? So it's like there's improvement, but it's like there's like sense of uneas underneath. Absolutely. But the most simple explanation for what's been going on is, yes, we had a massive terming out of debt on the corporate side.

And arguably on some individuals as well, homeowners, for instance. And that's provided a cushion, you know, between 2021, 2021, 2020, and where we are now. But it can only last for so long. And you're sort of getting back to the traditional long and variable lags argument. Like maybe this is just the longest lag that we've seen in many, many years. So we did actually have this conversation at Jackson Hole. We just didn't get it on the record. Oh, yeah, you're right.

We did actually talk about all this. Jacksonville, we just never recorded an episode. But the person who we spoke to in Jackson Hole in Wyoming last month happens to be based here in Austin, Texas. So we're like, in a way, we're going to like pick up the Jackson Hole series with someone who happens to be here in Texas. I like how we've gone to Austin to record an episode with someone we talked to in Wyoming. So I'm very excited. We're going to explore these topics and more or further. I'm very excited about our guest. Second time, I believe, her appearance on OddLodz. We're going to be speaking with Julia Coronado. She is the founder, CEO, and president of macro policy perspectives. She is also

a clinical assistant professor at the University of Texas on business and economics. So, Julia, thank you so much for joining us. It is my absolute pleasure to be here with you. Really simple question, actually, to start. Oh, wait, can I just say, Julia is the first odd lots guest who has ever brought us breakfast tacos. Hey. Which now if you're listening and you want to come on the odd lots, this is now the expectation. Yeah, bring food. Bring breakfast tacos. But Julia, so great to chat with you. Actually, just real quick, what do you do at macro policy perspectives? So macro policy perspectives is a macro forecasting firm. So we work mostly with money managers, people that are managing portfolios, and we provide them a perspective on the U.S. economy.

were U.S. focused, but globally oriented and very markets oriented. So we work with money managers to help them understand this crazy world. So speaking of crazy world, and we'll get to all the dead stuff. Tracy and I the other night, we actually spoke to a group of students here at the business school, at McCombs. And we were chatting about various things. And one of the students said something interesting. They're like, oh, you know, they're talking about CMBS. And they're like, oh, you know, it's hard to know what's in. some of the, they're very smart case. They said, hard to know what are some in some of these assets that people are buying. And what if you're buying stuff that's like Austin, downtown Austin real estate and there's huge vacancies? Is that true? It seems like this town is booming. Is it actually

underneath the facade here in Austin like some problems brewing? It depends. There's a debate. The commercial real estate crowd is inherently optimistic, glass half hole type of people. I think you have to be to take that kind of risk. And they've been printing money for a decade, right? Austin has been booming all of their developments, exceed expectations. And so it's been a great run. But yes, there is an overhang. So you see the cranes all around you, but a lot of these buildings are empty.

So we have very high vacancy rates, very high rates of sub-leasing, which is another indication that, you know, Google or meta builds a building, but then they don't need it. And so they sub-lease a lot of the space. And depending on how you look at it, the estimates of the pipeline under construction as a percent of the existing inventory is by far the highest in the nation and at record highs by many measures. So we've got a lot of supply both in offices and in multifamily that are coming to market in the next 12 to 18 months. And rates are high, vacancies are high, probably the assumptions that went into these projects at the beginning are not going to materialize. So the question is, does that mean just

reduced profits or does that mean outright defaults, delinquencies, and some distress? Right. This was going to be my next question, which is how does distress in commercial real estate actually feed through into the wider economy? Because you see different types of arguments. You know, you see a more optimistic scenario, which is, well, yes, there are pockets of stress, but not everything. You know, thing is dire at the moment. Yes, downtown offices are probably the most affected, but, you know, maybe a multi-use building in the suburbs with doctors offices and little shops, like probably not as huge a deal. And then the dire scenario that you see every once in a while is that we are going to get a bunch of defaults eventually, and that will impact the banks, presumably, and they're going to

have to cut back on lending. So how are you viewing, like, the actual impact of CRE distress? extraordinarily difficult to get a clear idea of or put good parameters around because CRE is inherently idiosyncratic. Every project is different. The financing of each of these projects come in layers and are, you know, sourced differently. So it's really hard to get kind of a macro framing of how much potential distress. You know, I would categorize the banking channel is one that could go non-linear in the sense that we could see more bank failures. Or it could be just a macroeconomic channel of a headwind. Right now, the unemployment rate in Texas is underperforming. It's risen more than the national average. That's unusual for Texas. Some of that is the tech

layoffs, which are part of what's behind some of the vacancies. So as these projects roll off, you're going to see less jobs. You know, people in the real estate industry and the consumers, construction industry are seeing layoffs here, maybe not everywhere, but certainly here. So you'll just see some regular old garden variety economic headwinds, even if it's not, you know, some sort of crisis. It's yet to be felt. And therein are the lags in monetary policy. So I want to get into, obviously, this whole lags debate. But before we do, you know, you mentioned the developers of various sorts in Austin have been printing money and mentioned all the cranes. We don't really see many cranes in New York because I guess it's a city.

We forgot how to build for various reasons. Well, also, even if they were there, they're up pretty high, right? They're up really high. You kind of got to look for them. Right. Because the one thing they do build out those like super tall buildings for the tall, skinny cigarette buildings. Yeah.

But Austin is not alone. I mean, like, is this a broader sunbelt story? And can you talk about like how much of these developments have, a sort of, okay, we're like, we're building this for Google or we're building this for metal or whatever, versus we're building this and it's the sunbelt and someone is eventually going to rent it, but we'll build it without even knowing who. Yeah, there is a lot more build it and they will come activity in the sunbelt that doesn't exist in New York. In New York before you build a Hudson yards, you've got several anchor tenants lined up. That is not the case here. You can actually,

a lot of these developments, you know, the Google and the meta buildings are. are an exception, but there are a lot of developments around town that are built on spec. And is it broader than Austin? Yes. There's a number of cities. Austin is by far got the biggest overhang, but Dallas has a pretty big overhang. Denver, Boise. There are a number of the Sun Belt boom towns, the COVID boom towns in the West where you can build, where it's relatively more straightforward to get from concept to ground. breaking and I would say it is a sunbelt slash COVID boomtown phenomenon, mostly in the west in the south and the southeast.

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So in a sense, how expensive. is this development for policymakers. I mean, you were in Wyoming, you were talking to loads of people. When you talk to them about what's going on in the Sun Belt's construction, maybe slowing in places like Austin, what do they say? And what do they think? That's a great framing. There's a range of views, obviously. And yes, this is an intended channel to the extent that people took risks that turn out not to be viable or have a lower rate of return than they anticipated. That's just, you know, that's life in the big city, right? It's just part of taking risk is you realize sometimes some losses as well as some gains.

So this is an intended channel of policy. The debate is more around, have we seen all that we've seen and therefore we need to do more to slow the economy? Or are a lot of the effects of this still, do they still lie ahead of us? And I think that's where there's a range of views. I really respect and like to hear the views of Chris Waller, Governor Waller, but he tends to be of the view that, you know, the lags are shorter because of forward guidance, because the Fed is very transparent, that markets react almost instantaneously well before they actually raise rates, and therefore it's all priced in. I think if we think about a credit channel, and it's something we didn't really have last time, right? The credit channel was crisis. We didn't have this e-long. kind of tighter credit. How does it feed through into the economy? And because of the refunding that you touched on with your other episode, the lags are probably longer. And this is something that if you talk to European central bankers, they think of the lags as being longer because

of fixed rate financing and more of that and that it's going to take some time for financing to roll over and to feel the effects in employment and activity. And so you have to know that what you've done already is going to keep being a restraining force going forward. So I'm more in the lags are longer camp because of this than the lags are all behind us camp. Joe, this kind of reminds me of some of the discussion around inflation, just the idea that it's been decades since anyone has really had to deal with higher inflation and we're not sure how to deal with it, this idea that like, well, maybe it's been decades since we've had a sharp change in monetary policy propagated out into the economy and we don't really get how it works. And the last example was so

extreme in 2008. I love the way you put that, which is that we think of 2008 as a credit crisis. Yes. But the actual mechanism by which the economy slowed down was not per se the contraction of credit, but oh my God, the world is falling apart. And everyone just slams the break at once. They slam the break on hiring. They slam the break on new development, et cetera, which is not really what people have in mind, this idea that we're just going to pull back on credit and slow things down. Right. This is the key dynamic we want to talk about. But, you know, the realized disinflation that we've seen so far. So at one point, I think we were looking around 9%, maybe we're like closer like three something percent now. But as I said in the intro, no one really knows why exactly. And unemployment

didn't rise like the way many economists would expect. What's your story basically for the last 12 months of fairly nice disinflation. So we are big believers in sectoral analysis, micro to macro, right? So what's going on? Look, sector by sector. What's going on in the dynamics of, you know, how concentrated is a sector? How are the profits panning out? How is consumer price sensitivity in that sector?

And then building, you know, running the top-down macro models, but also building that outlook from the bottom up. And the bottom up is, you know, on the one hand, it led us to be falsely in the transitory camp early. But then we pivoted because the reason it failed was we had more supply chain frictions. We had more waves of COVID. We had Malaysian chip factory shutdowns. We had all kinds of Russia, Ukraine. Russia, Ukraine, these frictions and challenges, sand in the gears that kept inflation.

Meanwhile, also, like very strong demand support. very in price and sensitive demand. When we look out at the dynamics so far, I mean, some of it, yes, when you look at cars, for example, which has been such a key part of the inflation, and now it's been a key part of the disinflation, it's both a macro story, higher rates, lower demand for cars, more price sensitive demand for cars, but also improving supply chains, improving inventories, available chips. So it's both, you know, a supply and a policy story tangled up together, hard to disentangle. But, you know, it's definitely a key part of the disinflation. And if you don't think in those terms, if you're just thinking, okay, economic growth equals inflation, which is

kind of what Powell did at the press conference, then you're going to be untrusting, you're going to be skeptical, part of which is perfectly healthy, but also maybe too skeptical. They're extreme, they have very pessimistic inflation assumptions for the remainder of the year in their forecast. They, you know, definitely seem to be leaning on. We maybe need to do more. And we see a lot of good things happening in inflation dynamics. One of the things we look at, for example, is the diffusion, how many prices are increasing versus decreasing. That tells you, if you look at the 70s, that was 100%. Every single price was going up every single month, quarter, year. All wages were going up. That's not what's happening now. Some prices are falling. Airfares go up and down depending on

consumer demand. Capacity there has totally normalized auto sales similarly up and down. So I think we're seeing a much more dynamic, healthy pricing dynamic, which gives us more optimism that this lower regime, can have some staying power and you don't need to hammer the economy. I mean, we had several cycles over the last 30 years where we had growth and no inflation, but because of the PTSD from the pandemic, there's this equating of growth with inflation almost amongst, and what was surprising about the meeting, the September FOMC meeting to me was how unanimous it seems to be. everybody's forecasts kind of showed a higher funds rate and everybody raised their 2024 inflation forecast or a lot of people did.

There isn't a lot of sectoral inflationists on the FOMC. And I think that gives them a very rigid view of how things are playing out. This was going to be exactly my next question. Actually, you mentioned Powell's speech, which was very macro and sort of traditional FOMC speech-ish. But Christine Lagarde of the ECB gave basically the opposite speech talking about like we are in this weird period

where it feels like the real economy, supply chain constraints, fiscal is more in control than monetary policy and it poses new challenges to economists. How well equipped do you think economists are to start looking at individual industries or looking at specific sectors, as you just pointed out,

versus the sort of macroeconomic theory that many of them have been trained on. There's a lot of good economists, ourselves included, I would say, that are doing this kind of work. So Alan Debtmeister at UBS, Skanda Armanath at Employ America, Omer Sharif, Mike Kanskahl at Roosevelt. I love that most of these are Othotts guests. We've never had Alan Dement. We should have them.

You definitely should, yeah. The Who's Who's of Avalat's Macro. And you know, we engage in this conversation and this debate, you know, in social media. And there's lots of great exchanges and analysis, the seller's inflation. Your point about the ECB is a great one. Sellers inflation. Let's set aside the loaded term greedflation. But the idea of profit margins.

We have purposely avoided saying greedflation. We tried to coin the term excuse flation, which did, some people have been using it. But I think sellers or profit-led inflation. Yeah, profit-led inflation. And if you look at, say, Lagarde's press conference, she breaks down what's been happening in inflation in terms of what's driven by the labor market and what's driven by profits.

Like, as a matter of accounting, you know, there's plenty of ECB officials that are sort of well-versed in, yes, there's the labor market, and then there's the product side. There's the profit side, the industry side. It has to do with concentration and common shocks, et cetera. So it's not like it's a radical, theory, it's not like there's no work out there, it's just like there's nobody on the FOMC that embraces this,

you know, very, you know, overtly. And so, again, I just think there's a common framework at the Fed that is, you know, it's an important framework, it's a useful framework, but it's not the only framework. And you need to have, I would say, it's better to have as many possible perspectives and points of view to understand these dynamics, you know, inflation went up more than even the macro models suggested and at a timing that does not align with the macro models. So when you have an error on your model as a forecaster, you look forward and think, hmm, that error might reverse at some point. I might get downside surprises. Standard forecasting, I'm not saying anything radical. Now, of course, it's not the central bank's job to err on the side of optimism when they're above their target. but you know you can you can talk i don't understand like powell had several opportunities at the press conference there was three or four questions actually Craig Torres uh of Bloomberg asked an

excellent question about the nuances of higher rates and supply side led inflation in real estate um and Powell just won't go there he just doesn't want to go to the supply side and talk about those. I mean, he did, to be fair, he did say we understood that fading pandemic frictions are part of the story. But again, I think they just are very shell-shocked by what they've been through in the last couple of years and are still airing on the pessimistic side. You know, one other thing in that Lagarde speech specifically that you mentioned, this idea of like the price and sensitive demand and the big source of that is the investment that's happening in like green transition and energy infrastructure. And that's going to happen regardless.

We could have a recession. We could have a boom. We know governments are going to spend a lot on this. They're going to subsidize a lot. And, of course, we talk about that all the time on odd lots. And, yeah, this is an interesting dynamic. There's a lot of spending that's going to happen regardless of where we are in the cycle. I want to get deeper into the lags debate because I have this sort of like weird sympathy for the priced in.

Everything's always priced in. Everything's always priced in. Yeah, it's all priced in. Yeah, that's what we saw after the FOMC meeting, right? It was all priced in. Day one. And so like, okay, that's the Waller views you characterize it. Like, why isn't it all price it? What is the case for like why? Like, all right, even if we know that rate hikes are coming, they telegraph it, we're in an age of very aggressively clear forward guidance. The dots didn't

use to exist. That's a modern innovation in central banking. So like, let's talk theoretically and then like let's get more concrete. Like, what is the case for why it wouldn't all just be priced in and why people don't adjust their behavior the moment the central banks give their indication of where rates are going. Yeah, the way I think about it is I break it into two channels. There's the capital markets channel and then there's the credit channel. Okay. And the capital markets channel exactly as you describe the Fed telegraphs its intentions, its perspective on the balance of risks and capital markets price it in. But there's the credit channel side where you've got this, you know, fixed rate financing for a couple of years and you've got time and there's legitimate uncertainty about where we're going

to be in a year in two years. And if you are, you know, again, commercial real estate is a perfect example because they are, you know, glass half full kind of people. And there's been a real conversation and, you know, I talk to a lot of people in the real estate industry. There's a real sense that, you know, if we hold on long enough, rates are going to go back down. And, and, you know, And so I'm not going to mark my losses. I'm not going to scale back my project. I'm going to maybe slow walk that project and not be in a hurry because I think if I come to market in a year or two years and I need to roll over my financing, I'll get better terms then. And that's not irrational, but it does mean that, you know, if they're wrong, which, you know, the market has moved.

One of the things that's happened since the last FOMC meeting in July is that markets did move to higher for longer pricing. Real rates are up 50 basis points. And so we have yet to feel the effect of that last leg of increase in real rates. It just happened. And that was a change in psychology in the market. The market realizing, hmm, maybe higher for longer is where we're going. in which case we need to reprice things, in which case, and then you look at the impact of that, we've seen mortgage applications roll over. We've seen car analysts lower their forecasts for the

remainder of the year because there's less pent-up demand at these interest rates. So all these leading indicators are saying, yeah, there's going to be an effect from that last leg up in interest rates. And the Fed raised its 2024 forecast not lowered it. So the conviction they have on extrapolating the recent good performance into 2024 was surprising to me. Trace, I got to say, it's not lost on me when you think about commercial real estate developers. Is it just the sort of like sheer belief that it will be fine? Yes.

The two most famous developers. And I think I may have stolen this observation from someone, the two most famous commercial real estate developer that everyone knows are Donald Trump and Adam Newman, which sort of gives you a sense of maybe like the sort of mindset of a lot of the people dealing with. Those are the poster children. for commercial real estate optimism. The sheer case, the sheer belief in winning. I realize we've been talking a lot about corporates.

Can we talk maybe a little bit more about household balance sheets? Because this is the other area of uncertainty, and there is a lot of debate at the moment over how healthy the consumer actually is. And you see these charts of outstanding credit card debt, going up to records and people panicking that people are going to struggle to pay some of this back as interest rates. go higher. But on the other hand, there's plenty of discourse that says individual balance sheets are basically in the best shape. They've been in a very long time. So how are you viewing that

particular debate? Yeah, yeah. So first of all, the credit card debt at record highs, you never look at nominal debt. You always scale it by income. The flow of funds for Q2 just came out. Debt to income is right back down. So if you look at including credit card debt as a percent of income came down. So I don't look at households and see a picture of, oh, they're binging on debt or they're leaning on debt because they can't finance their spending with income. I do think household balance sheets are in fantastic shape. We came into this tightening cycle in the best shape ever, both in terms of net worth, but also in terms of delinquencies on all categories of consumer loans. It was the first recession where we actually lowered delinquencies through the recession.

Through all of that fiscal support, people used it to pay their auto loans. They used it to pay their credit cards. So we didn't have the delinquencies we typically have with job losses. That was part of the idea. And so I think there's a bit of a haves and have-nots in the consumer world. If you look at delinquencies, they're coming up off the lows, across categories, auto delinquencies, credit card delinquencies. Mortgage delinquencies are still very low. So you've got, you know, lower income consumers who have been hit by the rental inflation versus homeowners who got to refinance a record low mortgage rates. I feel like this is really the lynch pin. Yeah. There's a real bifurcation. And who's feeling the effects of the higher rates most? People that have to buy, you know,

or the higher used car prices. These are going to be more moderate income consumers. So I think, And that's the other thing that we've been seeing, too, is the labor market is still, like, level-wise, very healthy. But the slowing and job growth is quite pronounced. And so, you know, we've been in the soft landing camp all along. We never have been forecasting a recession. I actually see the recession odds as just as high or even maybe a little bit higher because the labor market looks like it's closer to, it's not just going great guns. The sectors that are hiring have narrowed. The pace of hiring has slowed. Wage growth is slowing. So the nominal income growth being generated by the labor market has slowed quite a bit. Delinquencies have rid. So again, it looks more like a cyclical shift, but it's only amongst a certain segment of consumers.

I'm Francine Lacqua, an award-winning journalist. And I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from. heads of state to fashion icons about the news of the moment. But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts. Well, so this gets to the question. So the Fed, we don't know if they're done

raising rates, but what they are doing or what they are indicating. is they're telling the market that cuts are not forthcoming. Correct. And that is a de facto tightening or it is a form of maybe second derivative tightening or something. And so if you look at their 2024 dots, they're coming up and basically telling the market, if you think there are cuts, they're probably not. And so let's set this.

You say the recession odds are ticking up a little bit because of that nominal income, the labor market is slowing. It's not seeing mass layoffs or anything like that. No. But there's some slowing. Wage growth is probably slowing a little bit. The inflation dynamics you think are improving meaningfully in a way that can be sustained. The Fed doesn't appreciate perhaps that they can be sustained.

The dots are coming up. So talk to us about that risk, that the Fed is still sort of pessimistic about inflation dynamics. It's sort of engaged in a modest tightening still by raising those out dots. And in a backdrop of a time when the recession risk is ticking up. It still is a very healthy economy. I mean, the fact that the corporate side of the world has gotten more optimistic is probably helps labor market resiliency in terms of preventing further layoffs. But I think, you know, if you're extrapolating off of the Q3 GDP tracking, then you're probably going to see some disappointments down the road, right? The growth has ebbed and flowed.

You know, what I see is, if I look at the consumer, consumer spending sort of dropped to trend early last year. And then the quarterly numbers bounce up and down, just depending on where that spending falls and kind of ebbs and flows. So, you know, whatever Q3 is tracking, that's not the run rate right now. We're in for some slower patches of data. And that could be more worrisome and sort of. But there's two things that keep us in the resiliency camp. One is we do believe that inflation is coming down more sustainably. That is a tailwind for consumers.

That gives them more purchasing power. The energy shock is a complicating story to that. That's going to hurt purchasing power in the next few months. But the Fed also has ammo. If things get really rocky, they can cut rates. And we are in a world where there's a credit channel. So you might get a response in housing. Look at housing.

Housing rolled right over. Rates went down because of the recession call expectations early in the year. Then they've come back up. And you've seen housing demand ebb and flow. with that. So there is a lever at their disposal, which is effective that they can go to. Of course, the bar is much higher when you're coming at the inflation target from above. They're very skeptical. But, you know, if we could hit a soft patch and then they could respond and that could keep us back on track. This might be an unfair question to ask an economist, but you are also a clinical

associate professor of finance, I believe. So maybe you can answer this. But one of, One of the puzzling things in markets recently has been the very low spreads or risk premiums on corporate bonds. Right. Even as you see, you know, all the concern about everything we've been talking about in this discussion. One way I can think of justifying it is that maybe markets still think, you know, if rates continue to go up, eventually something might break and then the Fed comes in and cuts. And so the interest rate problem kind of goes away again for a lot of companies.

Right. Is that a reasonable explanation or how would you explain persistently low spreads in the credit market? You know, that's a great question. I think one of your prior guests talked about how a lot of the weak hands got squeezed out during the trade wars. Yes, this is true. And I thought that was a very interesting point because a lot of the sort of riskiest businesses were in the energy sector. And a lot of those already felt their recession before the recession. so we have sort of a higher credit quality landscape.

The other area of pronounced weakness is in the tech sector, and they're just not that debt exposed, right? Their valuation exposed, their valuations are much more volatile. That's where all the speculation goes when people are optimistic or pessimistic. But it doesn't necessarily translate into credit spreads. So it is perplexing that it's still so solid. In terms of a global capital flows perspective, one question I've been asking sort of more globally oriented people is we know that less money is going into China. Where does that money go?

That's a good point. Yeah. Is it possible that developed markets are experiencing a little bit more of a tailwind from money that has to be reallocated to the U.S. or other countries? And I think the answer is possibly yes. You know, you think about what does it mean this sort of structural shift in China? One of the things we think, well, China's been the source of the excess savings glut, maybe that, you know, takes away the subsidy to, you know, treasury yields to some extent. But it might mean more asset allocation from global investors into the U.S. in other asset classes.

So I'm not an expert on that. But I'm, you know, that's something I'm trying to learn more about and think more about. Yeah, that's interesting. Going back to that Lagarde speech and the price insensitive demand, I mean, the other thing that's not going on now is we're like the era of big fiscal. And it's like the opposite of the 2010s where the 2010s we got this pretty, in retrospect, modest stimulus right off the bat in like 2009. Then it died pretty quickly after the Republicans won the House of 2010 that sort of took further fiscal expansion off the table. We had this look. We're in an area where people are talking about strong.

structural deficits for a long time to come for various reasons, including the Inflation Reduction Act, which is, I suspect a lot of, like, high multiplier spending because it's construction and factories and all this stuff that goes into a lot of pocketbooks of construction workers, etc. How are you thinking about, like, the persistent macro impact of the era of high deficit? Yeah, yeah. So I'm really glad we got here because that's another area where I think the narrative is skewed. So the narrative tends to be, we just equate deficits with inflation.

And there's a lot of the fiscal shaming coming back out. But if you look at what we're spending money on, during the pandemic, yes, it was all just giving money to consumers to spend. This is all giving money to builders to build. And Texas is, we've had this conversation, I believe, Joe and Jackson Hole, which was, if you look at what's happening in Texas, we are in the middle of a renewables boom. And that is arguably disinflationary because we've had the hottest summer

on record. And let me tell you, anybody that has lived in Texas for the last two summers knows that we are in an existential change. And we're going to need more capacity. And we thank goodness, have that capacity. So I was like somewhere in July, I'm like, why are we not like experiencing a crisis like we did, you know, during the winter of 2021? And I looked at some of the data from Urquod and the generation capacity. And well, we've just been growing, you know, hand over fist in terms of wind, solar, all the new capacity is in the renewables. Thank goodness. And let's do the counterfactual. I kind of tried to ask this question at Jackson. I'm not sure it came through.

When we think about fiscal, we need to think about why we're doing it, right? Why are we doing it? It's not just random. Oh, let's just spend a lot of money and let's just run big deficits. Why are we doing it? Well, first we did it because we were in a global pandemic and we successfully achieved a much stronger recovery. Secondly, now we're doing it. And Christine Lagarde explicitly talked about this in her speech.

You're going to have to expect the government to play a bigger role when we're in an energy transition because nobody else can engineer that. The private sector won't do it by itself. So the government steps in and provides these incentives and it's working. I mean, it's a story that's hopeful to me that we are getting the capacity we need. It's in renewables. And what would have happened? Like if you look back to 2021, the grid failure in Texas was another friction that brought chip supply shortage made it worse, right? We had chip factories here that were affected. What would have happened if we would have didn't have this capacity this summer? You know, what would have gone down? What kind of capacity, what kind of production would have gone down? We have surge pricing in

Texas. Prices for sure would have gone up more than they did because of the presence of renewables. So, you know, arguably that's been disinflationary already for Texas consumers. And I think we need to think more expansively about what are we doing, what are we getting for this money? it's not all just going straight into demand, it's going into capacity. Well, this was also Biden's argument in the very early innings of the IRA. His whole spiel for it was that, well, we have these supply constraints and we have these choke points in the economy. And so we spend now to solve those. And ultimately, that becomes a disinflationary impulse and the solution to our inflationary problems.

I want to ask just one last question going back to the long and very important. variable lags idea. What are you watching out for for signs of interest rates really beginning to bite in potentially problematic or systemic ways? I know we talked about commercial real estate, but like what are specific things people should be looking out for? It's kind of hard to pinpoint. I mean, the SVB example is a perfect example of, you know, you just don't always see it coming. That's still a possible shock. If you look at the FDIC's latest quarterly report, those securities and loan losses are just as big. Yeah.

If not bigger because real rates just went up. So their portfolios are even further underwater. So it's still, it's a tough road for particularly midsize and smaller banks that are making money on bread and butter economic financing, not, you know, the capital markets, businesses that the big banks have to offset. that. So I think still watching the credit channel and the credit flows, credit flows have slowed and are tighter. The financing terms are tighter. And so, you know, I think that that can affect the economy, not necessarily in a crisis-like way, but definitely slow, continue to slow things down.

Big picture, we've had a generational interest rate shock after, you know, years at the zero lower bound. where is all the leverage in our economy to zero rates? Tech has been a surprising area of sensitivity to monetary policy. Right. Right. They're not indebted, but their valuations sure are sensitive to QE versus QT versus, you know, Fed-Hawkish, Fed-Dovish. It could be that there's a wave of, you know, there's been some relief lately.

Maybe we get further correction there because it turns out that that was when you, you don't have just good old plain safe yields, you start speculating more on things like software and crypto. And crypto is another one that can keep going. There's some leverage in that system that could spill over to the broader financing system. So there's a number of areas that we could see tighten in ways that aren't just a gradual, linear march. It sort of happens all of a sudden when people just can't roll over their funding.

anymore. Julia Coronado, macro policy perspectives. I'm so glad we had this conversation. We were able to make it happen after we didn't get the chance to record with you and Jacksonville. Yeah, practice taco time. Thank you so much for our coming back on oblo. Yeah. Thank you for the tacos too. Yeah. Thank you for the tacos. That was such a good conversation. Yeah. I just want to say before I forget, not all tech speculation is like some of it amounts to something and I know this because I took my first self- driving car drive home last night. So some tech investment actually becomes real. It is so amazing.

This is the problem. You've gone to Austin. You've ridden around in self-driving cars and then you went to like the fund manager who is the ultimate like espouser of the efficient market hypothesis theory. And now you're just feeling really good about everything. You're like it's all priced in.

Tech is great. The future is bright. Let's eat more tacos. Yeah. You know what I really like though? that I thought was extremely helpful is Julia's demarcation of the credit channel versus the asset channel or the capital markets channel. And that was so helpful for me in terms of thinking about like, yeah, like stocks do price in, you know, the dots for 2024 come up and then stocks go down or whatever it is. And then this idea that like credit is just never going to work automatically like that. And there's lengths of credit and there's different opinions and people can

hold out and restructure, et cetera. And so the idea that credit market will respond automatically in the same way like asset valuations will, is like a really helpful way to sort of, at least in my mind, resolve some of these tensions. Absolutely. So two things stood out to me. One was the point that fiscal stimulus doesn't, or fiscal spending, doesn't always have to be inflationary. And I know this was actually a big talking point. Again, I pointed it out at the beginning of the IRA, this was the selling point from Biden, but I think it kind of got lost in the ether with all the discussion and drama

around the debt ceiling and things like that. But we have seen some glimmers of that. You know, there were fiscal attempts to solve the backlogs at the port, for instance, which seemed to have helped a little bit. And then the other thing that stood out to me was the contrast between the 2008 monetary policy changes versus now.

Yeah. And I think this is really key and maybe like one of the reasons why policymakers are struggling at this moment in time, we have not had a huge dramatic shift in monetary policy, you know, for a long time, but not in the shape that we have it currently, where it's a series of hikes in 2008, as Julia pointed out, it was, it was crisis. That was a really good point. Like the idea of like, well, what is a credit channel constraint is like something that we haven't really experienced in while and we're seeing glimmers of it,

We saw it actually play out in housing at the end of 2022, maybe again now with mortgage rates roughly 7.5%. I think the homebuilders have come down. Homebuilder optimism is declined. So we're like seeing that dynamic again. Also, you know, parentheses here, it is sort of an underappreciated point, as Julia pointed out. Monetary policy can now work in the other direction. When we were at ZERP, there was not really much that the Fed could do to stimulate, right? I mean, they could like do more QE, but I think always the efficacy of that is always sort of debatable, they can cut rates now, which is a really interesting dynamic and probably get some juice out of those rate cuts in the way that we haven't experienced in a long time.

Absolutely. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Allaway. You can follow me at Tracy Allaway. And I'm Joe Wisenthall. You can follow me at the stalwart.

Follow our guest, Julia Coronado. She's at JC underscore Econ. Follow our producers, Carmen Rodriguez, at Carmen Armin and Dashel Bennett at Dashbot. Big thanks to Moses Ondam for his help. Follow all of the Bloomberg podcasts under the handle at podcasts. And for more Oddlods content, go to Bloomberg.com slash oddlots, where we post all the transcripts of our interviews. We have a blog, a newsletter, and you can chat about all these topics 24-7

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