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Moody's Talks - Inside Economics

February 22, 2023

Bonus Episode: U.S. Economic Outlook Q&A

Mark, Cris, and Marisa answer questions from their recent U.S. Economic Outlook webinar where they discussed that the economy will struggle in 2023 with halting growth and higher unemployment. Recession is a serious threat, but the Moody's Analytics baseline forecast-the most-likely outlook-holds that the economy will avoid a downturn.

Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight

Mark Zandi:                      Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and this is a special bonus podcast. We did a webinar on the outlook for the economy a couple weeks ago. Got a ton of questions. I mean, when I say a ton, at least several hundred questions. I think there were, I'm trying to remember, I think there was 17,000-1,800 people on the webinar. Got lots of questions and we taped a Q&A, myself, Chris deRitis, the deputy chief economist, and Marisa DiNatale, senior economist, and responded to those Qs and thought, Hey, this might be a pretty good podcast, people might be interested in this. If our clients are asking these questions, our listeners to the podcast are probably doing the same thing. So here it is. Hope you enjoy it. I hope you find it of some value and let us know. So here we go.

                                             Hello everyone. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by my two colleagues that were in the webinar earlier this week, Chris deRitis. Chris is the deputy chief economist. Hey, Chris.

Cris deRitis:                       Hey, Mark.

Mark Zandi:                      And Marisa DiNatale. Marisa keeps the trains on the tracks and also participated in the webinar earlier this week. The purpose of this conversation is to go over the blizzard of questions we received on the webinar. We answered a lot of the questions in the webinar so we won't reprise that but there are a lot of other questions that we didn't get to and we'll do that here. And the way we're going to do this is we kind of categorized the questions that people asked and we're going to talk about them in those categories. And I'm going to ask first Chris a question around housing in mortgage markets, and I should say this is kind of in no order of particular importance, so don't mean to say this is the most important kind of thing that we're talking about here, but just to get the conversation going, we're going to talk about housing and mortgage finance.

                                             And Chris, the question that many people asked was how, we have a correction in our baseline forecast, a house price correction, down based on our repeat sales, Moody's Analytics repeat sales index, down peak to trough, I'm rounding, but 10%-ish. Prices rose 40% from the start of the pandemic to the peak last summer. They're down maybe a percent or two since then and we're expecting all in when it's all said and done. By the end of '24 going into '25, the prices will be down nationwide by about 10%. So we're going to retrace one fourth of the price increase that occurred earlier in the pandemic. And the question is, well, why 10%? What's the logic behind that, and why not something more severe? Why won't we experience a crash, which, no hard definition of a crash but if you use the financial crisis as a gauge, prices were down, say, 25%-ish depending on the price index. That would be, in my nomenclature, a crash. So why not down 25 in the baseline? Do you want to take a crack at that?

Cris deRitis:                       Sure. And it's a good question because we did go up 40% over two years which was much more than we actually did during the housing boom. So if you just extend the analogy, you would expect, why not retrace most of that? And I think it comes down to the supply and demand factors in the housing market today relative to what we saw back then, right? So we still have a very large housing deficit. There's more demand for housing today than the actual supply. So in order to get an actual sharp decline in pricing, you would expect that demand would have to pull back significantly. And we just don't see that. We see that there are many young adults in particular are still living at home who want to buy a home or rent a home, they're just not able to. If prices start to correct just a little bit though, provided the labor market holds up, you would expect some of them coming in to provide support.

                                             Right, so that's one factor. The other factor, perhaps you can classify this a bit more on the supply side in terms of existing homeowners. They're actually in a much more solid financial condition than they were back during the housing bust, right? Homeowners today have much more equity in their home. Mortgage standards have been very tight so they've had to come up with large down payments. If they were getting a mortgage, they have to be super qualified. They're no liar loans or no exploding arms, right, so we have more traditional fixed rate mortgages, at this point, locked in at very low interest rates. So there's no real impetus for existing homeowners to default on their mortgage, or I should say there's less impetus for them to default on their mortgages, and you really need a steady stream of foreclosures to really cause prices to fall dramatically, at least in the short run.

                                             So for those reasons, I'd say the likelihood that we actually see a very sharp correction is pretty low, unless we get hit by some other shock and unemployment goes up to 10%. That's a different story, then you will get that type of foreclosure activity. So our forecast, why it's 5/10% peak to trough decline, it's really more of a gradual adjustment period here. We got ahead of ourselves when it came to prices over the last couple of years because low interest rates juiced demand, but again, there's no real need to sell. So it's going to take some time for the prices to adjust gradually to a point where incomes and home prices are better aligned, so that's the nature of the forecast but it does assume that lots of things continue to work in the economy when it comes to labor market and incomes.

Mark Zandi:                      Good. Good. So a correction but not a crash.

Cris deRitis:                       Yeah, correct.

Mark Zandi:                      Yep. In the baseline. The baseline is a soft economy, the job market essentially going sideways, unemployment moving up a bit, but not a recession. If we had a recession, then the kind of a typical kind of in terms of severity and length, then the price declines would be more significant than that, right?

Cris deRitis:                       That's right. I'd even argue that it would actually have to be a pretty substantial recession because of that imbalance in supply and demand. The other thing that makes today so different is that just the demographics are very different. We have a very large number of young adults looking for homes that we didn't have back in the housing bust. So you'd actually need unemployment to rise substantially in my opinion to get that type of real significant decline in home prices.

Mark Zandi:                      Got it, got it. Related question turning to mortgage credit quality. So obviously if you're in a declining house price environment with rising unemployment, that would suggest more credit problems, more delinquency default. But the question is we haven't seen that yet so far. I mean, unemployment's very low, layoffs are non-existent. Yeah, house price has kind of gone flat here, downed a little bit, but people have built up a boatload of equity. Why are we seeing mortgage delinquency rates tick higher here? And the data I look at would be the data that we banked from Equifax, the credit bureau, which is a census of all the mortgage loans outstanding, and I was just looking at that through the month of January and you are starting to see a tick up in delinquency. Did you want to comment on that? Why are we seeing any pickup at all in delinquency here despite the better conditions, the good conditions?

Cris deRitis:                       Yeah, it's a great question. We saw, you're right, in Equifax data, you can see we just had the MBA delinquency rate series come out today as we're recording this.

Mark Zandi:                      Oh, is that right?

Cris deRitis:                       That also showed some uptick here. And when I think about it, a couple reasons. One is just normalization. In some sense, we had artificially depressed the delinquencies with moratorium, with stimulus check, made it easier for folks to make their payments. They didn't have to make their payments for a while. They didn't have to make student loan payments, so there were reasons why the delinquency rate was depressed during the pandemic, which was beyond normal. That wasn't equilibrium. So you take off some of those supports and naturally you're going to come back up to some increase in delinquencies. And of course, people go delinquent on their mortgage for a variety of reasons. It's not just unemployment necessarily. There are other life events, other things that happen that cause people to be unable to make payments and actually go into foreclosure. So that's part of it.

                                             I do think that even within the homeowner community, you have a lot of variation in terms of demographics. You have folks higher income obviously, but you do have folks at the lower income and at the distribution, and they are running out of their savings as we talked about on the webinar, so even if their jobs are plenty, they are facing financial pressures due to high inflation. So unfortunately, there are reasons why folks are going delinquent. The delinquencies are ticking up so that's definitely something to monitor, but they're still low relative to prior to the pandemic. So again, at this point, I still see this more as normalization. Even prior to the pandemic, delinquency rate was very low so I'm not terribly worried quite yet. Let's talk in a couple months if we continue to see this rise very dramatically, but something to keep your eye on, but I wouldn't overreact at this point to the trend.

Mark Zandi:                      Yeah, correct me if I'm wrong, but most of the, I think, tick up and delinquency has been for FHA loans, right? It's still not-

Cris deRitis:                       That's right.

Mark Zandi:                      ... a significant degree for Fannie and Freddie loans or non-conforming loans. Do I have that right?

Cris deRitis:                       That's right. So FHA, which do tend to skew lower in terms of income and credit, so that kind of makes sense. And I'm sure if you dig into even the conforming, you would see that pattern as well. So again, it seems all going according to script in terms of what you would expect in a normalized economy.

Mark Zandi:                      Yeah. Okay. There was also a question that we put into this housing block around rents. I made a point to say that rent growth has gone flat to down here in recent months. Given that we're getting more supply and supply chains Zs, a lot more multifamily units are getting completed and we still have a lot of units, a record number of units in the pipeline going to completion that will get completed over the next year or so, so more supply and demand has been hit by the previous surge in rents. Rents surged with house prices and the rents are so high now that people can't even afford those and so we're getting what economists called demand destruction. People can't afford households. So it's less demand, more supply, rents are weakened, and that's really key to the outlook for inflation because particularly consumer price inflation, because a third of the CPI index is the cost of housing services which are tied back to rents.

                                             But the question was, when I look at the CPI for housing services, rent of shelter, I don't see this slowing that Mark talked about. Do you want to comment on that just to square the circle there for people? The link between market rents that we're observing now and the CPI for housing services.

Cris deRitis:                       Sure. So to keep it simple, it really comes down to whether you're looking at rents across the entire housing stock, the entire rental market, including people who are already in their leases, they're not facing rent adjustments month to month, they're facing rent adjustments once a year. So you want to measure how rents are moving across the entire housing market, or do you want to focus on how rents for new units, new units that are coming online for rental, how those rent prices are moving? So the CPI, the Consumer Price Index, is looking across the entire market trying to account for the cost of shelter in the economy overall so it includes a lot of rents that are not moving month to month. Most of them are actually locked in so it takes time for any type of adjustment on the new lease side to actually make its way into that broader index. So what you were referring to is that data that looks at changes in asking rents or effective rents on new leases and that clearly is slowing and is actually negative or declining in certain markets. So that's the distinction, right?

Mark Zandi:                      Yep. Okay. Very good. Okay, let me hand the baton to you, Chris, because I think you're going to ask Marisa some questions around the job market and wages and jobs and all those kinds of things, so take it away.

Cris deRitis:                       Yeah, there are lots of questions related to jobs and wages as you can imagine. That's a pretty big part of our topic and the outlook right now. We really didn't touch much on the January jobs report, and so we did have a question or two here related to that report which showed this tremendous job growth. And the question to you, Marisa, is well, do you believe that? Do you expect that to get revised? What do you think is the right number or the number that it will be revised to?

Marisa DiNatale:              That's a great question because it was such an outlier. It showed that in January, over half a million jobs were added on net and we were expecting something a little north of 230, 240, something like that, as were most economists. So it was almost double what people were expecting.

Mark Zandi:                      I think Chris was at 180, if I recall correctly. So I'm just pointing that out.

Marisa DiNatale:              Some economists were even further off. So yeah, I mean, it was-

Cris deRitis:                       Let's see. We were talking about the revisions though. Let's see.

Marisa DiNatale:              All right. We are talking about the revisions. Okay, so we'll come back in a year and we'll see how you did. Yeah, I mean, so like all economic data, the employment data get revised multiple times. So there's a first release, there'll be two more revisions in the next two months and then we have these annual benchmark revisions, which actually were just released in January benchmarking the March '22 data. So you get all kinds of revisions, first of all. So yes, it will definitely be revised. The question is to what extent it will be revised. I mean, I think there's a few clues that it could be overstating certainly job growth. I mean one, it's just so far out of bounds of what we've seen from month to month, so what would've happened in January to make all of a sudden the labor market turn on a dime so suddenly? One was it was much warmer in many parts of the country, particularly in the Northeast and the Midwest than it has been for past Januarys. That introduces all kinds of seasonal problems when the BLS tries to seasonally adjust the data.

                                             So things like construction where any sort of industry that happens outside, you usually see a big drop in employment in January and if you don't get that big drop because it's warm, it pushes up the job number. Other things like retail which had been really weak in December but it had been stronger in the fall, that could be off because perhaps not as many people were let go after holiday hiring surge as they normally are. Another thing that I was looking at was the number of people out sick obviously has been extremely elevated each January since COVID began. This January, it was almost back to normal, surprisingly, despite the fact that everyone I know is sick. If you look at the past two Januarys in 2020, 2021, 2022, this January '23 was almost back to a pre-COVID level of people that were not working because they were sick. So I think there's again, some seasonal adjustment perhaps issues going on with trying to account for patterns in recent years.

                                             The other clue, and I think this is another question you maybe were going to ask me but it's along these lines, is another clue we have is, as I mentioned, this benchmark revision for March of 2022 was released and that showed that actually more jobs were created between April '21 and March '22 than the BLS was first estimating. But there's been more recent data from the quarterly census of employment and wages that goes through June of 2022 that suggests that at least between March and June, job growth looks like it was overstated by BLS and that there will be downward revisions during that period. So we could have entered a weak period, it could have been relegated to last summer. This was after the Russian invasion of Ukraine in late February. This is when inflation really started to take off. The pace of inflation doubled between March and April alone. So it could have been sort of a summertime weakness but it could also be suggestive that just kind of all of 2022 might be overstated a bit. So that's a very long-winded way of saying, yeah, it's going to get revised likely down.

Cris deRitis:                       Okay, down a lot? Do you think that there's still underlying strength?

Marisa DiNatale:              Absolutely. I do. I think all these other indicators that we have on the job market point to the fact that the job market is still quite strong. Pretty much everything else that you can point to shows that it's strong. So I don't think it's going to look like job losses by any means, but I don't think that half a million jobs a month is our underlying pace of job growth. I think it's probably about half that.

Cris deRitis:                       Okay. Okay. I guess related to that and also key to the Fed's outlook is wage growth. The question was on what are your thoughts or expectations for wage growth in 2023 and 2024?

Marisa DiNatale:              So wage growth right now by a bunch of different metrics is running at about 5% year over year, and we think by the end of this year, by the end of 2023, it's going to be about 4% or maybe just under 4%. So we're going to come down a little bit. The Fed would like to see wage growth as measured by the ECI at about 3.5%. So even by the end of this year, we're still going to be a bit above the Fed's target when they look at wage growth, which is really key to them because that goes to growth and prices of core services, the biggest input cost of core services is labor. And so if wage growth is very, very strong then companies are more likely to raise their prices to offset that strong increase in wages.

                                             So by the end of the year, we think we get down to around 4%. It continues to slowly decelerate through about the third quarter of 2024, and that's about the point when it hits 3.5%. So you're looking at probably middle of 2024 before we get to that 3.5% mark. But we have seen evidence in recent months just since the fall through the data that we're getting now that wage growth does seem to be cooling off a bit by all different metrics. So the ECI, the Atlanta Feds wage tracker, even average hourly earnings, which we always have some caveats about, but nevertheless, the trends are kind of all going in the same way, which looks like wage growth is cooling.

Cris deRitis:                       Okay. So our forecast calls for a cooling labor market. We actually have some increase in unemployment, cooling wages. Last question for you. Is this going to impact or how will it impact the upper income versus lower income earners out there? Where would you expect to see more of the job losses or more of the weakness in wages, let's say?

Marisa DiNatale:              Well, so the wages that got really, really juiced during, let's say, the summer of 2021, 2022 was sort of peak wage growth time and wages peaked, I believe, in July of '22. The industries that saw the fastest wage growth were among the lower earning industries. So it was industries like leisure, hospitality and retail and to a lesser degree healthcare where we saw the fastest wage growth, and that's because these were the industries that were hurting the most for workers initially. They lost the most jobs and laid off the most workers during the pandemic and then trying to very quickly rehire all those people and finding out that not all these people were around anymore and available for work. And so wage growth, the poster child would be leisure, hospitality, this is bars and restaurants and hotels, wage growth peaked at about 12% year over year during the summer and that has come way down. I mean, now it's just a little bit above average. I think the last time I looked it was like 6 or 7%.

                                             So in terms of growth in wages, I think it is going to be sort of the lower end of the income spectrum that's going to see the most marked kind of drop off in growth in wages. I think if we look at the coming year and what industries are likely to slow the most or even lose jobs, those are going to be really the interest rate sensitive segments of the economy. So we haven't seen it yet. We haven't seen construction job losses but we expect at some point this will happen as the housing market continues to slow or bottom out. There's a lot of, and maybe you disagree, there's a lot of strength on the multifamily side that could offset what's happening on the residential side. But nevertheless, I think we'd agree we would see a slowdown at least in jobs there.

                                             And then we already are seeing, we've heard about a lot of high profile layoff announcements in tech and financial services, and you do see that in the job numbers already. So if you look at information services, that broad industry lost jobs in both January and December, and those tend to be higher paid industries. And again, those are the more interest rate sensitive segments, so I think those higher paid industries are going to probably face a lot of maybe near term pain with rising rates. Longer term, if we were to fall into a broad-based recession and consumer spending pulls back, then it's going to be pretty ubiquitous throughout all of these categories. But the most marked slowing in wages should be leisure, hospitality, retail, these industries that saw really fast wage growth.

Cris deRitis:                       Oh, great. I'll then pass the baton to you, Marisa, for the next one.

Marisa DiNatale:              Okay.

Mark Zandi:                      She's going to pepper me, I understand, right?

Marisa DiNatale:              I am going to pepper you with questions, a variety. So let's start with some questions around federal fiscal policy and the debt and what's going on with the debt limits. So you talked about this and we highlighted it as maybe the major risk for 2023. Can you talk about that a little more? What two things, what's the drop dead date for the debt ceiling, and two, where do you place the probability of the US government actually defaulting on its debt?

Mark Zandi:                      So to the first question, we don't know for sure because that depends on the x date, the date at when the treasury won't have enough cash on hand to pay all its bills in a timely way, someone's not going to get paid on time. The x date is unknown because it depends on revenues and expenditures over time that are very uncertain. Particularly the April tax payments, the treasury has an idea about how much they're going to receive in tax payments but they don't know exactly how much and exactly when they're going to receive those payments. So it's uncertain.

                                             CBO, the Congressional Budget Office, the nonpartisan agency that does the budgeting for the federal government came out with a report yesterday. It was actually a pretty good report. Yesterday would be the 15th of February, and they said it would be sometime between July and I think October. We are doing our own work. In fact, to be more specific, Bernard Yaros, our colleague, good colleague who follows us very carefully, looks at spending day by day, revenues day by day, goes back, looks at this period last year to see what is happening to determine what's going to happen going forward is coalescing around August 8th as the exact day at which the treasury will breach the limit. He's going to update-

Marisa DiNatale:              That's my birthday.

Mark Zandi:                      Oh, is it really? There you go. Yeah.

Marisa DiNatale:              Yeah. What a gift.

Mark Zandi:                      What a gift. You'll go down an infamy for sure. But that can change and we'll see. Bernard will continually update that x date as we go forward here. One thing that might happen is if it is August 8th, congress and administration might agree to a temporary suspension of the debt limit to make it coincide with the next fiscal year budget. Because that's the other thing that has to happen by the end of September is a passing of the budget to keep the government funded to keep it open. So they might kick the can a little bit down the road to the end of September and say we are going to solve both these problems at the same time, do something about the debt limit, but also pass a budget to keep the government open. And that would be my guess as to what they do. So the x date would actually get kicked down to September 30th. That would be my guess.

                                             If they don't suspend or increase the debt limit by that point in time and treasury doesn't pay someone on time, whether that be social security recipient, the military bond holder or treasury bond holder, or just the electric bill, that, in my view, is a default. The government has defaulted and I think that would be the fodder for what I would call a tarp moment when stock prices fall, chaos in the fixed income markets, the bond market, it would be a mess and would in all likelihood undermine our baseline forecast of no recession. We would almost certainly go into recession at that point.

                                             In terms of the probabilities of that actually happening, for the government to actually breach the limit and not pay someone on time, it's low but I'd say it feels higher than it has at any point in time in the 30 years that I've been following debt limit battles. Even the 2011, if folks recall, in 2011 we had a pretty very ugly debt limit battle that ended in a downgraded US government debt by S&P, Standard and Poors, and US lost its AAA rating according to S&P. Not Moody's. Moody's still has the AAA but according to S&P. And that was pretty messy but this feels like it could be messier just given the very vexed politics and the fact that the House is controlled by Republicans, but by a very thin majority, five seats, and of course the speaker of the House, McCarthy is there, seems to have, his support is very tenuous and the change in the rules make it such that it's going to make it very difficult for them to come to some kind of consensus on what to do and actually execute on it in a timely way.

                                             So having said all of that, our baseline is that they will get it together by the x date, sign on the dotted line, pass a piece of legislation and life goes on. But I would say there's a nonzero probability probably in the single digits that they breach it either because it was intentional or more likely it was just a mistake. They couldn't get it together in time to pass that legislation. So single digit kind of probability at that point. And if you look at our risk matrix, which Chris went through in detail in the webinar, you can see that it is a low probability event, but if it happened, it's a big deal. It's a big problem for the economy.

Marisa DiNatale:              Yeah, yeah. On a related note, and this is a question we get a lot, what are the longer run macroeconomic consequences of continuing to rack up debt, which is now, what, the statutory limits, what, 31 trillion, something like this, so longer run, is this a problem for the US economy?

Mark Zandi:                      Yeah, I think it is. I don't think it's a problem for the here and now. I mean, it's not an issue for next quarter or next year, but if policy doesn't change, and again, you can go back to that CBO paper that was released yesterday on the 15th, they do a long-term forecast for the economy and the budget. You can see that the government's debt load rises from just under 100% currently to, I think it's 110 percentage points by 10 years from now. It rises about a percentage point per annum. I might not have that exactly right but that gives you orders of magnitude. The thing that really is pernicious though is the increase in interest expense on the debt, and if you look at that as a share of GDP, right now it's low. It's about 2.5% of GDP, maybe even a little bit lower than that. But that's going to rise about a percentage point in the coming decade. So we'll go from 2.5 to 3.5 and then the next decade, 3.5 to 4.5, and at some point we're going to be spending more on interest expense than we are on, let's say, the military. And that doesn't make a whole lot of sense, I don't think. People wouldn't be very comfortable with that.

                                             So I do think we need to address our long-term fiscal issues, and the first thing we need to make sure that we do, I think, is if there's any legislation that would cut taxes or increase spending and needs to be paid for by tax increases or other spending cuts so that it's deficit. Any legislation is deficit neutral, at least deficit neutral going forward. And to some degree, the Inflation Reduction Act, that was the last piece of legislation passed in the last Congress in the Biden Administration, that satisfied that rule. In fact, it will lower the budget deficit in subsequent decades. In the first decade, first 10 years of that after that legislation, it's budget neutral, might reduce the deficit a little bit, 10 year cumulative deficit a little bit. But if you go out the second 10 years and the third 10 years, it lowers the deficit. So if we can do something like that with new pieces of legislation, then I think we'll be okay.

                                             One other point. If the borrowing costs of the government, the interest rate they pay, the average interest rate across all the debt is less than the nominal growth rate in the economy, then you can run deficits. It's that sustainable because your debt to GDP ratio won't rise. It's a product of budget math. Since the financial crisis up till now, that's been the case, so-called R, the interest rate on the debt, has been less than G, the nominal growth rate of the economy, so that gave us a lot of so-called fiscal space. We could borrow aggressively and help us navigate through the pandemic and get to the other side of that and not be in a dire situation. But now interest rates are higher, R is higher. The 10-year treasury yield is now close to 4% and G is probably about 4%. That's nominal potential growth rate of the economy. So we're getting pretty close to R equals G and if R rises above G, then we can't run deficits. I mean, then debt will become unsustainable. So we're getting to a place where we really do need to think about our long run fiscal situation.

                                             I'll say one last thing about all this and tie it all together. I don't think though we'll generate the political will to do anything substantive about this until interest expenses' share of GDP is measurably higher, until a lawmaker can tell the population, the electorate, look, if we don't do something, we're going to be paying more to Chinese bond holders, Japanese bond holders, Saudi bond holders, British bond holders than we're paying to defend ourselves around the world in our military budget. So once that happens, once the interest expense is high enough that someone can connect those dots for people, I think that's when we will make a change.

                                             In fact, that's what we did back in the '90s. If you go back to the 1990s, the last time we really addressed our long-term fiscal situation, that's when interest expense was 6/7% of GDP. And that was Clinton and Bob Rubin, who was the treasury secretary at the time, could generate the political will to pass the kind of legislation they needed to address that, and we ended up by the end of the 1990s with a surplus. You may remember, I think the last year we had an actual surplus was 2000, Y2K, something like that. A lot of other factors contributed to that, but the fiscal discipline was very important. So my point is I don't think we're going to really do, I'm not counting on lawmakers doing anything of substance here, maybe not doing any more damage, but nothing of substance to address this problem until they can connect the dots for the electorate and that's going to require interest expense being a lot higher as a share of GDP.

Marisa DiNatale:              Okay. Okay, those-

Mark Zandi:                      That was a good [inaudible 00:36:01]. Yeah.

Marisa DiNatale:              No, that was great and I think that answered all the questions sort of on the fiscal side.

Mark Zandi:                      Oh, good. Good, good. Do you want me to take the baton?

Marisa DiNatale:              Yeah, why don't you take the baton and then I'll come back to you later.

Mark Zandi:                      Okay, very good. So Chris, you're up again and I think we're going to talk about inflation and we've got a bevy of questions around inflation, and I'll start you off with an easy one. What's behind this high inflation? What is the cause of the high inflation that we're suffering right now?

Cris deRitis:                       Well, let's see. You have demand exceeding supply foundationally. We still have the high oil prices, high gas prices, still certainly relative to where they were a year ago. So that's still a factor here in terms of the overall inflation that we're feeling as well as that then feeding into food prices. But then as the Fed has highlighted, we are certainly focused more on the service side of the price spectrum as well and we are getting those housing costs that we referred to earlier, still continuing to put upward pressure on prices overall. And that's just going to take time to work its way through given the lags between rents and home prices. And beyond that, we have concerns about the service sector ex-housing. So some of those high wages that Marisa referred to continue to put some upward pressure. We have at the core, it's been the supply chain issues that have kept prices high over the last few months. Those are continuing to fade but they're not gone entirely yet and so that's certainly part of the equation as well.

Mark Zandi:                      Well, can I just... The way I frame it and just tell me what you think is.

Cris deRitis:                       Sure. It's clearly not the way I frame it.

Mark Zandi:                      No, no, no. Just to make it, there's a lot of moving parts here, right?

Cris deRitis:                       Yep.

Mark Zandi:                      The way you answered it, you talked about each of the moving parts a little bit, but most fundamentally in my mind, it's the pandemic and the Russian invasion, that the pandemic scrambled supply chains, scrambled labor markets. Still to this day, we're suffering from that. I mean, new vehicle prices, they're still going up because of supply chain issues limiting production globally in great shortages. And the Russian invasion caused oil prices to jump, ag prices to jump, and that's still filtering through. And it was the combination of those two things, those two shocks to the supply side of the economy that kind of came to the conflated and then drove up inflation expectations and that's when inflation kind of metastasized, got into wage demands and wage growth and that then broadened out the inflationary pressures to the service side of the economy where there's a lot of labor-intensive activities, healthcare, hospitality, that kind of thing.

                                             So at core, if we had just had the pandemic, I suspect we would not have been talking about inflation in 2022, but we had the pandemic and then we had the Russian invasion and then that's all we talking about is inflation because of those two shocks. Now there's the idea that demand has been all juiced up by fiscal support and at this point we're talking about the American rescue plan which was passed in March of 2021, which is now 18 months plus in the rearview mirror. And I would argue that yes, that certainly helped to lift demand in inflation back in the spring, summer of 2021, but that's long gone in terms of its impact on the economy in terms of lifting inflation. This is mostly about just adjusting to the continued fallout from these two massive supply shocks. So what do you think of-

Cris deRitis:                       Yeah, no, I think that's most of it. I don't want to discount demand entirely though, or even a substantial amount. Not only the fiscal supports you talked about, but there have been some behavioral shifts in demand throughout this period as well.

Mark Zandi:                      Yeah, good thought. Good thought. Yeah.

Cris deRitis:                       So early on in the pandemic, we all chase goods and that causes prices to rise, and then afterwards we all chase services and that's causing prices to rise, so the demand side of it is certainly driving inflation as well.

Mark Zandi:                      But I would say that's the pandemic. That goes back to the shock.

Cris deRitis:                       Yeah, but-

Mark Zandi:                      It affects demand and supply. You're saying... It's the pandemic. Yeah, so okay.

Cris deRitis:                       It's the pandemic but I think often many think of the pandemic from the supply side only. The supply chains got scrambled. That's why we can't get all the goods that we wanted.

Mark Zandi:                      Yeah. Right.

Cris deRitis:                       Well, but we also wanted more goods than we wanted previously, so...

Mark Zandi:                      Right. Right. Okay.

Cris deRitis:                       That was the easy one? That was the...

Mark Zandi:                      Well, I actually, that was sarcastic, that was thick with sarcasm. That was thick with sarcasm. Here's another one. This is not so easy. It goes to the Inflation Reduction Act. That's the the last piece of legislation passed in the Biden Administration that addressed prescription drugs, health insurance premiums. But the big part of that was around climate and trying to incent through tax incentives and other means, the move from fossil fuel to clean, to green energy. And the question is, do you view that as inflationary or disinflationary? And you can answer that in any way you want, near term, long term, because the questioner didn't ask. But if you read the question that they ask, they're coming from the prism that you're just adding costs, because this is costly to move from fossil fuel to clean, and that's going to be inflationary. It's not going to be... And it's going to take a long time before you make that transition, and maybe once you make that transition, it will lower inflation, but in the interim it's going to be inflationary. How do you think about that?

Cris deRitis:                       It's a bit complicated, but yeah, I would agree with that general sense that it does add cost in the short term, and longer term everything will work out. However, as we think about inflation, we think about broad-based changes in prices, right? So clearly the IRA, it will impact EV prices. It's incenting more EV production, presumably that also is driving some of the additional demand that's out there so you could see that the prices on EVs and the materials going EVs, for example, could be impacted. But that's a pretty small sector of the broader economy. Is that affecting enough other prices that it's a general increase in price levels? I don't think so. And I think many aspects of the IRA are like that. Like heat pumps, right? Again, there can be certain aspects or certain parts of the consumer basket that do get impacted.

                                             But is it going to have such a broad-based impact? I don't know that it's all that much at the end of the day and it is spread out over time. We're still trying to figure this piece of legislation out. For example, I don't see this as being a major driver of the inflation that we're experiencing right now. I don't think the act itself has been figured out enough to really have a major impact on price, even from an anticipatory standpoint. We're still trying to figure out what these incentives mean, what's an SUV, what's a... Right? So there's a lot of answers or a lot of questions yet to be answered there. So I think it'll have some impact in the short term, but over time, I think those would be fully digested.

Mark Zandi:                      Yeah, I think it's all sense to me. I mean, the one thing that really was struck home for me during this period since the Russian invaded Ukraine and oil prices jumped is just how critical oil prices are to inflation. It's not only the direct effect on how much we pay at the pump or how much we pay for electricity. It's the indirect effects on food prices, the cost of diesel getting the food from the farm to the store shelf. And even more important than that, the very strong link to inflation expectations and wages. And I think the reason we're struggling, the most significant reason we're struggling with inflation now, and the thing that's going to be most persistent is the strong wage growth and getting that back down to something more consistent with the Fed's target. And we're having trouble with that, we've had trouble with that because of the higher oil prices and how that's affected people's thinking about future inflation.

                                             So I don't think we can underestimate how important it is for us to get off fossil fuel, just to get off. It's critical in the long run for lots of obvious reasons around CO2 emissions, temperature rise and all the costs of climate change. But in the near term, I think we're so reliant on whether OPEC is going to increase production by a half a million barrels a day, or what the Russians are going to do, or that just seems like a nutty place to be if you don't have to be there. So I think we need to get away from fossil fuel as fast as humanly possible to, and it really does matter in terms of getting inflation in. I do agree that climate mitigation, climate adaptation adds to cost and will be inflationary. But as you point out, that plays out over a long period of time. I don't think, that doesn't add a percentage point to inflation in any given year. It might add the basis points to inflation in any given year, something like that.

                                             Anyway. Okay, that's inflation. Let me pass now the baton back to you, Chris and I think you're going to ask Marisa another set of questions. I can't remember which. Oh, recession questions. We got a bunch of questions on recession.

Cris deRitis:                       Recession questions.

Mark Zandi:                      Yeah. Recession.

Marisa DiNatale:              Yeah. We got a lot of questions about our scenarios and that kind of thing. Right.

Cris deRitis:                       Yeah, that's right. That's right. I'm going to start off with this question about excess savings. We did spend quite a bit time talking about excess savings, and Mark talked about some of the demographic effects. This one's really about the timing though. So when do you think the excess savings run out, and do you think inflation can be tamed before then?

Marisa DiNatale:              I thought that they had already run out for the bottom part of the income tiers, right, so we had showed this chart that showed that excess savings peaked back in the summer and they've been drawn down pretty substantially over the past few quarters. But we're still looking at over a trillion and a half in excess savings across all income tiers. Every time we put the estimates together, there's still more savings there than I would logically think there would be given just how pernicious inflation has been, particularly for people at the lower part of the income spectrum. They spend more of their income on gas and groceries and that sort of thing. And indeed, I don't think there is much left there for lower income households, folks probably at the bottom 20% of the income tier.

                                             Are we going to get inflation under control by the time it runs out? Well, if you define under control as being back to the Fed's target, perhaps not, because that very likely isn't going to happen until either the very end of this year or early next year. And here I'm talking about the lowest tier of the income spectrum, not overall. So I think it depends how you define under control. If you define under control as it's on a clear downward trajectory, which I think we all believe that it is, there may be some month to month fluctuations like we just saw in this week's CPI release, you might have some bumps along the road, but I think we clearly believe that inflation is on a downward trajectory. So I think that the risk is that excess savings runs out for the lower income tiers perhaps this year, maybe in the middle of the year, and we're still looking at inflation that is above the Fed's target before then, or by the time that happens.

                                             The higher income tiers are likely treating the excess savings differently than lower income tiers. So it's unclear if people are just stocking this away and it's cash in the accounts, if they're thinking about it the way they're thinking about their own wealth. We know it's cash sitting there, but are they planning on reinvesting this in equities? Are they going to invest it in real estate? Are they thinking about it in retirement terms? It's very possible that they're not going to be spending it and probable that they're not going to be spending it in the same way that lower income households are spending it. So I think more of the risk there for running out before inflation is under control is at the bottom end of the spectrum.

Cris deRitis:                       Okay. Another question was around the odds of inflation. So we mentioned there were 50/50 odds of the baseline where we avoid a recession but it's a slow growth environment. 50% odds of recession. Several of the audience members asked what that recession might look like, if you can describe that. And specifically, they made references to our various scenarios, the S2 or the S7 scenarios, which are all recessionary but they're all a bit different. So maybe you can describe a little bit what you think is the most likely path of if there is a recession and what the timing might look like.

Marisa DiNatale:              Yeah, I think the S7 is called our Next Recession Scenario and we run this for the US and we recently, a few months ago, started running it for all countries that we forecast. I think that's the most likely and that's more in line with our narrative about why recession may happen, which is just that the Fed is struggling to get inflation under control, they're tightening monetary policy, this tightens financial conditions, consumers pull back on spending, and it reduces demand to the point that we enter a somewhat relatively mild recession. So in that sense, the S7 is more in line with our narrative right now.

                                             The S2, S3, S4 are probabilistic recessions that are based on historical severities and a lot of our clients like to use those for stress testing purposes or stress testing their balance sheet for CECL or IFRS 9 accounting purposes. So those are recessions where the recession happens right away in terms of the timing. What's nice about the S7 is it's in line with our narrative of a recession not beginning until late this year. We have a lot of momentum, positive momentum going in the economy right now so I think it would take something really crazy for us to go into a recession in the next couple of months. So the most likely scenario is the Fed hikes rates once, twice, couple more times perhaps, rates stay high for the remainder of the year, and then by the end of the year in this high rate environment, that causes the economy to go into a recession.

                                             The recession itself, what would it look like? Over the course of probably the next four quarters after the recession begins, you get a peak unemployment rate of, I believe, around 6% toward the end of 2024. The unemployment rate as we know right now is at 3.4%. So unemployment at 6%, you're looking at the loss of about 5 million jobs over that time period and a peak to trough decline in GDP of about 2%. So in historical standards relative to, take out the pandemic, we don't want to compare really anything to the pandemic, but if you go back to the financial crisis, if you go back to the recession of 2001, which was also mild in terms of the length that it occurred, that's a relatively mild recession when you compare it to sort of the average recessions we've seen since the '80s.

Cris deRitis:                       All right. Well, thank you. And I'll pass the baton back to you.

Mark Zandi:                      I think this is the last set of questions, is it not? I believe it is.

Cris deRitis:                       Yes.

Mark Zandi:                      And for the life of me, I can't remember what you're going to ask me, but fire away.

Marisa DiNatale:              Well, we're going to go in a couple different directions.

Mark Zandi:                      Off script. Okay. Yeah.

Marisa DiNatale:              We kind of have some random questions that we couldn't categorize.

Mark Zandi:                      Yeah. Oh yeah, sure. Yeah. Okay. Yeah.

Marisa DiNatale:              I think it's a nice add-on to what you were talking about when we were talking about the debt and that if the nominal rate of growth of the economy is below the cost of financing that debt, then we're in real trouble, right? So let's talk about the cost of financing debt. So if we look at the 10-year yield forecast, how does that compare to what markets think? How does your forecast of the 10-year yield, and let's look at the medium term in addition to the short run. How do we think about what sort of the equilibrium 10-year yield should be relative to all these other rates [inaudible 00:54:46] some that the Fed controls.

Mark Zandi:                      Yeah. Yeah, great question. I think that the equilibrium, so-called equilibrium 10-year treasury yield is 4%. That's equal to the nominal potential growth rate of the economy. So in the long run, the nominal potential growth of the economy, the return on capital should equal to the cost of capital, the 10-year treasury yield. And I get to 4%, that's 2% roughly real potential GDP growth plus the 2% inflation target. So two plus two is four. That's nominal potential GDP growth. And empirically that works out. I mean, there are long periods when the actual 10-year yield is higher or lower than that equilibrium yield, and by the way, the equilibrium yield's not static. It changes over time given the potential growth rate of the economy. So if you go back 30 years ago when the potential growth of the economy was higher than the equilibrium, 10-year yield was higher so it's come down.

                                             So, oh, I was going to say, if you go look at over a long period of time, so if you go back to 1970, look at the last 50, 60 years and take the average of the 10-year treasury yield and the growth rate in nominal GDP, they are exactly equal to each other within a basis point or two. So empirically, theoretically, it should be the nominal potential growth rate of the economy. That's the 10-year yield. That's about roughly where we are today. I was just looking, the 10-year yield is sitting at 3.87 so that's within spitting distance of where we should be in the long run. 10-year yield was well below the equilibrium yield throughout the period between the financial crisis and most recently, but I think that goes to some significant headwinds to inflation that caused the Federal Reserve constantly trying to get inflation up. So it was following a very loose monetary policy, that easy monetary policy and that kept long-term yields below its long run equilibrium intentionally in an effort to get inflation back up to target.

                                             I don't think that's the case going forward. Now I think, instead of headwinds to inflation, we're going to have tailwinds to inflation. We talked a little bit about climate. There's decoupling, de-globalization, there's labor market issues and wages. So I think the Fed's going to be fighting another battle going forward and that is trying to keep inflation down and that might keep pushing rates up a little higher than that equilibrium yield over extended periods of time. So I think the risks here have changed quite considerably. But spot 4%, just as a benchmark. I keep going back to that CBO paper that was done, released on February 15th, I highly recommend it. Their 10-year treasury yield in the long run is, wait for it, wait for it, wait for it, 3.8%. So I think 3.84%... They get 3.8 because they say real potential growth is 1.8, not two. So I think it's closer to two, but I'm not going to fight over it, one point or two point or four.

Marisa DiNatale:              One of the questions was what would account for the differences in what you or anyone who's forecasting this thinks the long-term 10-year yield would be? And is that primarily the assumption that differs? It's the long run growth rate of the economy?

Mark Zandi:                      Well, I'm coming at it like an economist. You got other people in the market, they're not thinking like I think. They got different models, different perspectives, different views, and three quarters of the time, I don't understand where they're coming from. Usually what interest rates were in the last six months to 12 months is going to determine their forecast for the next 60 years, that kind of thing. And they were looking a lot more right than I was back before the pandemic, right? Because people were saying, looking at our forecast, because it was always going to 4%, always going to 4%, saying what are you talking about? Chris would come back with a lot of folks who were questioning our long run 10-year treasury yield. They wouldn't do it to me directly. They'd go through Chris and say, well, what the hell's he smoking? Why is he so much higher than everybody else?

                                             But that's the stake in the ground. And it's like every asset price, it's like a stock price. It's like all asset prices have an equilibrium price, and the actual price can deviate from that over long periods of time. But ultimately in the long run, it comes back to that equilibrium price. It's just hard to know exactly when, because there's all these other dynamics going on, its sentiment, and it's... In the case of the 10-year treasury yield, it's not only what's happening here, it's what's happening all over the planet because it's a global market and you've got a lot of forces globally that are at work here.

                                             I will say though, I am predisposed to think going forward, the 10-year yield is going to be on the high side of four, not the low side of four. I mentioned inflation, but I also think going back to the budget deficits, that would argue, because that's a lot of debt that's going to be going into the marketplace, a lot of treasury debt and the Fed's not going to be buying it hopefully. They're not going to be QE-ing, they're QT-ing. They're allowing their balance sheet to wind down. So if that's the case, it feels like if anything, it's going to be on the high side of four, not on the south, the north side of four, not on the south side of four going forward. But our forecast is four. It's our forecast.

                                             By the way, that implies that 5.5 to 6% 30-year fixed rate mortgage, right, because the typical spread off the 10-year treasury is about 150, 175 basis points so if you told me that the 30-year fixed over the next 10 years is going to average 5.75%, I'd say that sounds about right to me. And by the way, right now it's 6 to 6.5, maybe up a little bit in the last couple of days because of what's going on in the bond market but that's roughly where it's been. So we're not that far away from where it will be in, it's a little bit on the high side, but not a lot on the high side. The market's going to have to adjust to these higher interest rates. The mortgage market, the housing market's going to have to adjust to these higher rates going forward.

Marisa DiNatale:              Okay.

Mark Zandi:                      Chris does that, I'm going to throw that back to you. What do you think of the way I just explained that? Does that make sense to you?

Cris deRitis:                       It does. Certainly the theoretical equilibrium, but as you said, a lot of things are influential in the medium to even long term, right, so it's hard to say. And I think the international aspect is something you need to consider here, that the 10-year treasury today is not just the US asset, it's global. So my bias would be that it could actually be a little bit lower because of that additional demand from overseas. But that could change very rapid. I don't think you want to make a forecast based on that trend persisting forever.

Mark Zandi:                      Right.

Marisa DiNatale:              Okay.

Mark Zandi:                      So any others who want to fire away? Maybe do another... Is there one more?

Marisa DiNatale:              Well, we had that closing question that I want to save.

Mark Zandi:                      [inaudible 01:02:14]? Yeah. Go for it. Go for another.

Marisa DiNatale:              So I don't know how much time we have. Should I do that?

Mark Zandi:                      Go ahead. Fire away. We'll do it real quick. Lightning round.

Marisa DiNatale:              All right. The closing question is what do you think the best historical analogy is to what we are experiencing now from an economic perspective?

Mark Zandi:                      Oh, right, right. Anyone want to take that?

Marisa DiNatale:              I like this question.

Mark Zandi:                      Chris, you want me to-

Marisa DiNatale:              Well, I would-

Mark Zandi:                      Go ahead.

Marisa DiNatale:              Why don't you go first?

Mark Zandi:                      No, you go first.

Marisa DiNatale:              I think it's like natural disaster, right?

Mark Zandi:                      Okay, I'll go first. No, I'm kidding. Sorry.

Marisa DiNatale:              I mean, I think that if you look at the pandemic-

Mark Zandi:                      Go ahead. Go ahead. Bad joke.

Marisa DiNatale:              If you look at the severity of the pandemic and what happened and the supply chain disruptions and not necessarily everything that followed, but just the catastrophic, very sharp, quick destruction in the economy, it's kind of like a natural disaster. When we would model natural disasters, and I did this a lot when I was very focused on regional work, you would see events like a hurricane or a fire or a tornado or an earthquake and you would just get this massive, massive supply side shock to a greater extent than demand to the economy, and you would see this sharp fall and then this extremely strong rebound as things get rebuilt and things come back online. So that's what I go to is some sort of exogenous catastrophic event like that. Now other things have happened since the pandemic that have kind of piled onto the situation, but that's sort of the way I think about it when I talk about it.

Mark Zandi:                      Yeah, I love that. I love that. I think that's a good frame for thinking about this. Yeah. And it's very kind of mind-numbing because it's hitting the supply side. People think of the economies from the prism of demand because that's typically what drives the business cycle, the ups and downs, demand is strong, demand is weak, the Fed's raising rates and demand is weak. You don't really focus on the supply side except for long run forecast. What's the economy going to do in the long run?

                                             But when you have a supply shock which, again, that pandemic and the Russian invasion are massive, massive global supply shocks one on top of the other, that makes you have to think about demand and supply and the relationship between the two, and then you're thinking about prices, which is the result of these demand and supply forces working with and against each other. Very difficult to do and that's why there's been so much confusion and so much debate and so much difficulty gauging all this, I think, for people. And for us, it's been a difficult time to do forecasting, although I think I feel pretty good about our forecasting. Throughout the pandemic period, I think we did, Chris probably wouldn't say otherwise, but it's [inaudible 01:05:35].

Marisa DiNatale:              Really off the mark.

Cris deRitis:                       It's admirable. Admirable.

Mark Zandi:                      But I think that's a beautiful answer. I think that is the answer. Yeah. Chris, anything you want to add to that or anything-

Cris deRitis:                       It's a great... The way I would've answered it is I think there is actually no historical analog. It is so different than what we're experiencing today that I don't even want to give [inaudible 01:05:59] because I don't want someone to go back and say, oh, well it's kind of like the '70s and take a look at what happened there, and fail to consider everything else that is so different, demographically and the supply chain effects that you talked about, Mark. So I hate the phrase, but I actually do think in terms of the current situation, this time is different. There are many different forces-

Mark Zandi:                      You said it. I was waiting for him to say that. Does that apply to the yield curve?

Cris deRitis:                       In terms of what the recession's going to look like, yes, it is different.

Mark Zandi:                      Does that apply to the yield curve?

Marisa DiNatale:              He still believes the yield curve is a harbinger of recession.

Mark Zandi:                      Oh, yeah.

Cris deRitis:                       Don't discount the yield curve quite yet.

Mark Zandi:                      Discount. Don't discount. Yeah, true. Yeah. Yeah. Okay. Very good.

Marisa DiNatale:              How would-

Mark Zandi:                      This was very-

Cris deRitis:                       How about you, Mark?

Marisa DiNatale:              How would you answer that, Mark?

Mark Zandi:                      I like the way you answered it. I think it is analogous to a massive global natural, two natural disasters piled on top of each other. That's what it feels like to me. And the metaphor I have in my mind is the economy is this little paper ship in the middle of the ocean or maybe better in a pond, right? You take a rock, you throw it, and this is what I would do when I was 10 years old, hit near the ship and that's the pandemic and the ship's going like this, crazy like this. And then you go, oh, let's throw another rock and that's the Russian invasion and the thing is going like this and you're afraid it's going to tip over and the only reason it didn't tip over is because of pretty deft policymaking by the Federal Reserve and the federal government. They stepped in and they righted the ship, kind of kept it going, but the ship is still doing this, still trying to navigate around.

                                             And by the way, it's the waves created by the one and then the waves created by the other and then the two of them, the waves coming together that really complicate things. So that's the kind of metaphor I have in mind, but I think that's the natural disaster. That's kind of what it does so I think that's exactly right. I think that's a great answer. Okay. We're going to call this quits. In fact, this feels like we did this as a answer to a webinar, but gee whizz, this feels like a podcast to me somehow. I don't know. What do you think? Maybe we can do both.

Marisa DiNatale:              It could be.

Mark Zandi:                      A bonus podcast, Inside Economics. Watch it, listen to it. We do that every Friday. Okay, with that, we're going to call a, I don't know what we're going to call this, whatever this is-

Marisa DiNatale:              A webinar Q&A session.

Mark Zandi:                      A webinar Q&A. We are out.

                                             And there it is. That was our Q&A session in response to all the hundreds of questions we got in our webinar a couple weeks ago. I hope you found it of some interest and value. Let us know if you did. And with that, we're going to call it a podcast. Take care, everyone.