The Inside Economics team is joined by CPI guru and colleague Matt Colyar to discuss the bevy of inflation-related data released this week. First the team dissects the Federal Reserve’s CCAR stress test scenarios and laments the perpetually inconvenient timing of their release. Talk turns to the root causes for the inflation of the past few years and why shelter inflation is so stubborn. The team imagines themselves on the FOMC for a day and what they would do with interest rates going forward.
The Inside Economics team is joined by CPI guru and colleague Matt Colyar to discuss the bevy of inflation-related data released this week. First the team dissects the Federal Reserve’s CCAR stress test scenarios and laments the perpetually inconvenient timing of their release. Talk turns to the root causes for the inflation of the past few years and why shelter inflation is so stubborn. The team imagines themselves on the FOMC for a day and what they would do with interest rates going forward.
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 I'm joined by a few of my colleagues. Of course, we've got Marisa DiNatale, and Cris deRitis. Hi guys.
Marisa DiNatale: Hey, Mark.
Cris deRitis: Hey Mark. You'll never guess who I ran into yesterday.
Mark Zandi: The Dalai Lama?
Cris deRitis: No, no. A close second.
Marisa DiNatale: Mario Draghi.
Cris deRitis: A close second. Ryan Sweet.
Marisa DiNatale: Oh yeah.
Cris deRitis: Former co-host of Inside Economics.
Mark Zandi: Yeah. How's Ryan doing? Where'd you run into him?
Cris deRitis: At the NABE Conference.
Mark Zandi: Oh, that's right.
Cris deRitis: National Association of Business Economists. So he's actually moderating a panel on monetary policy today as we record this.
Mark Zandi: Oh, very cool.
Cris deRitis: But the most exciting piece of news I wanted to relay is that I asked him to come on the podcast and he agreed.
Mark Zandi: No. Really?
Cris deRitis: He did. He did. And we were thinking maybe a little bit of a battle of the champions when it comes to the stats game, given Marisa's prowess and his prowess. Maybe we can do something around that.
Mark Zandi: Has he finally given up on the whole recession call? He was like the largest supporter of, oh, we're going to have a recession in 2023.
Cris deRitis: He admits that we did not have a recession in 2023.
Mark Zandi: So he's still holding to it then, still recession?
Cris deRitis: No, no, I don't think so. Well, that's why we need to have him on.
Mark Zandi: Yeah. Yeah, that would be really good to have him back on. Yeah, that's very good. Good. And so you were at NABE and what were you speaking on?
Cris deRitis: I spoke on commercial real estate and this question of whether or not there's going to be a doom loop.
Mark Zandi: Yeah. Did you learn anything in the conversation? I'm sure they learned from you, but did you learn anything?
Cris deRitis: Yeah, absolutely. So there were some interesting remarks, there were some practitioners there, folks that are in the industry. So just kind of interesting ways that they look at the market and how they subsegment it so finely. Class A office properties, not just Class A office property. It's got a lot of different nuances and subsegments top and bottom end. It was just interesting.
Mark Zandi: I mean, my sense of it is that this has become, it's obviously a risk and still a weight on the economy, but the threat is abating, at least in terms of this idea that we're going to go into a doom loop. Did you come away with that view or something different?
Cris deRitis: Yeah, yeah. That was the view going in. That was the view coming out.
Mark Zandi: Coming out.
Cris deRitis: Certainly some cities are going to have a tougher time adjusting to the loss of office properties, for example, top property tax revenue, but not at a national level. It's very unlikely. And even the financial system itself, there may be a few banks here or there that get caught up with larger losses, but we don't see a systemic problem arising here unless you couple it with something else, right?
Mark Zandi: Yeah. This may be too much of a tangent because there's a lot to talk about here today. A lot of data. It's consumer price index, PPI. There's a data dump, industrial production, retail sales, housing starts, so a lot of economic data. And the Fed came out with the, so-called CCAR stress test, and I want to come back to that in just a second.
So there's a lot to talk about. But the one quick tangent, well now that we're on CRE, commercial real estate, we construct our own estimate of commercial real estate prices by property type. And you look at that data, at least based on the way we're constructing it at the moment, and you come away thinking the worst is already behind us. You want to describe that? Because we just got that data. We got this data point yesterday for the fourth quarter of 2023. You want to describe that data and interpretation of it?
Cris deRitis: Sure. So very quickly, it's a commercial real estate price index. It's a repeat sales index, which is similar to many of the house price indices that listeners may know about, the Case-Shiller or our own would you say, analytics house price. So we're looking at the same properties transacted multiple times and inferring price changes from those changes.
This is a way to try to control for the quality of the properties or the mix or distribution of properties that are transacting. Bottom line is in our latest update, which is an equal weighted series, so we give all the properties equal weight in this version of the index, we actually see that things are actually picking up.
We're seeing a little bit of an increase in property prices really across the board, even office showing a little bit of strength. So maybe worst is over, seems reasonable. I'd be a little cautious to read too much in the index because we also know that transaction volumes are still very, very low.
So we may only be observing the best properties or the properties that are in healthy markets that are transacting. So there might be some of that bias creeping in here, but taken at first blush, it looks as though things may be not zooming back to solid growth, but at least not declining as rapidly as they had been.
Mark Zandi: Now on a value weighted basis, so you said this is equal weighted, so if it's a small office building versus a tower sitting in New York, we don't make ... in that index, there's no distinction, but if you weight things based on the value there you see some-
Cris deRitis: That's right. Then yeah, so we have another version of the index that we're working on that show more significant price declines once you account for, because it is those larger central city properties that are seeing some of the largest declines in that version of the index, you do see much more severe type of declines. But even there, it looks as though things may be stabilizing at the end of the series. Again, given all the ... the same caveats apply.
Mark Zandi: I wonder if we made the same forecast error with CRE prices as we did with house prices. House prices initially declined back in '22, then they kind of came back in '23 and now we think they're going to be flat. But previously we thought they'd continue to decline. We're now still thinking CRE prices are going to decline more, but maybe not. Maybe given with declining interest rates and the economy doing reasonably well, and maybe the adjustment here is prices go flat for a while as opposed to go down.
Cris deRitis: Could be. I guess another takeaway from those practitioners I talked about is just how creative the CRE investing property managers are. They're going to figure out a way to use these properties with high vacancy rates or repurpose them. It may take some time, but I think it'd be premature to count them out, say, oh, these properties are dead forever. I think they're a pretty creative bunch.
Mark Zandi: Yeah, interesting. Okay. All right, well I failed to introduce ... Now I've got to say his name right.
Marisa DiNatale: Oh, boy.
Mark Zandi: Matt.
Cris deRitis: Matt [inaudible 00:07:44].
Mark Zandi: Matt is here.
Marisa DiNatale: Patsy.
Mark Zandi: Oh no, I think I know. I think got a clue. Collier County is Naples, so I'm going to say Matt Colyar.
Matt Colyar: Perfect.
Mark Zandi: Oh my gosh. Way to go.
Matt Colyar: I was ready to give up too. That's great.
Mark Zandi: No, that really helped out a lot. Collier County.
Cris deRitis: Yeah, that makes a lot of sense. That's Naples, Florida. Yeah, absolutely.
Mark Zandi: Well, it's good to have you, Matt.
Matt Colyar: Yeah, great to be here.
Mark Zandi: Yeah, and of course when we get the CPI or inflation data, you're the first person we think of, so we're going to dive into that. Before we get into the CPI though and the PPI and all that stuff, the other big thing that happened this week was the Federal Reserve Board finally, finally released the so-called CCAR stress test.
This is the bank stress test that were established in the wake of the financial crisis back in 2009. And each year about this time, we're waiting, waiting, waiting for the Fed to release those scenarios so that we can run them through our models and the banks can use them in their capital planning and everything else.
And this year the Fed took it right down to the legislative wire. I didn't realize this, but written into law, I guess Dodd-Frank, the big reform legislation that was passed in the wake of the financial crisis, the Fed has to release by law these stress tests by February 15th. And yesterday was February 15th. What the heck? What do you think? What was going on there, Cris? I mean, what was the delay do you think?
Cris deRitis: Well, they added two scenarios this year, two exploratory scenarios and they claim, or they stated that they used data through the 13th of February. So, perhaps that's why they wanted to wait until the last possible moment to incorporate the latest information into this release. I don't know. I don't know. I'm making it up.
Mark Zandi: I mean, pick up Q4, 2023 Q4 data more fully maybe, is that what you're saying?
Cris deRitis: Well, no, it's actually some of the market data because there's some market data in there. I think it's some of the, they were trying to capture maybe the more recent data.
Mark Zandi: So typically in recent years, the Fed releases two scenarios. One is just the baseline, which is basically, I don't know, blue chip consensus or something similar.
Cris deRitis: Something like that. Yeah.
Mark Zandi: And then they release a, so-called severe adverse scenario, which is a pretty dark scenario kind of on the tail of the distribution possible outcomes. That's what the banks, the big ... I guess this year there's 32 banks that are taking the test, I think.
Cris deRitis: That's right.
Mark Zandi: And they used that to determine how much capital they need to hold against the losses in a very severe scenario stress scenario. But this year they added what they call two exploratory scenarios, scenario A and scenario B. You want to describe what those are?
Cris deRitis: Yeah, so these are new. They are scenarios that are really designed to focus on some of the key stresses to the financial system, to the banks themselves. I assume they're born out of last year's mini banking crisis, what happened with SVB and other institutions. So these scenarios really focus on funding stress primarily, right?
So what if a bank undergoes a severe period of funding stress in addition to an economic recession? So the two scenarios are, include funding stress plus either a mild economic recession or a more severe recession. So the combination of these factors plus inflation, plus rising interest rates. So that's kind of a layering, if you will, of multiple risks. At least that's how I interpreted it.
Mark Zandi: So it feels like a reaction to last year's banking crisis. SVB, the banks kind of choked on the losses on their security holdings. They got kind of wrong-footed in terms of their funding, their funding costs above their lending rate, their net interest margins coming under pressure, that kind of thing.
And this was a way to say, hey guys, let's go stress your balance sheet income statement and let's make sure you're okay under a severe in one of the exploratory scenarios, very severe kind of stress environment, both in terms of the economic environment, but also in terms of the funding environment.
Cris deRitis: That's right.
Mark Zandi: Good. Marisa, have you had a chance to look at the scenarios at all?
Marisa DiNatale: A bit, yeah.
Mark Zandi: What do you think?
Marisa DiNatale: The baseline and severely adverse look typical as they normally do, right? The Fed is mandated to, in the adverse scenario, kind of move it with the current data so that for example, if the unemployment rate is higher, the peak will be proportionally lower than it was in the prior year. It's higher today than it was a year ago when we did these. I mean the Fed has, so they're adding two new exploratory scenarios.
There have been years where they've had multiple regular scenarios. They used to have a baseline and adverse and a severely adverse. So it's a little bit more work for them than they've done in the past couple of years. But they have previously done multiple scenarios in the regular CCAR test. And I guess we should note Cris too, that these exploratory scenarios aren't going to be used in capital planning for the banks. They're not exactly optional.
I think the Fed, certainly our banking clients are not treating them as optional, but they're not going to be used in capital planning. They're for their information to help gauge the risks going forward, but they're not going to be graded on these scenarios like they are on the regular CCAR scenarios.
Cris deRitis: I think the results will also be reported in aggregate for those two scenarios. You won't get them by bank.
Marisa DiNatale: Not by bank. Right. Yeah. The Fed actually scores each individual bank and publishes each individual bank's results whether they pass or fail these CCAR scenarios every year. So they're not going to do that individually for these exploratory scenarios.
Mark Zandi: Did you happen to notice, and I'm probably pressing too hard though, too hard there, but what was the peak trough decline in CRE commercial real estate prices in the severe adverse scenario? I think last year it was about 40%. Is it the same?
Marisa DiNatale: I think it's the same.
Cris deRitis: It's the same.
Mark Zandi: Okay. All right. That's so interesting. Just if anyone from the Fed's listening, you're ruining our weekend. I mean you're ruining everybody's more than a weekend. This is like crazy. You've got to take it right up to the wire February 15th, and then you add another two scenarios, hair on fire, everyone's scrambling here to get this thing done. I mean, I'm not sure why.
Marisa DiNatale: Like it's a secret of when it's going to be released.
Mark Zandi: Yeah, why can't you just, it's going to be this date and it's this date and-
Cris deRitis: And there are four scenarios.
Mark Zandi: And there's four scenarios and be ready. Why? I mean, I guess you could say, and I'm just guessing, operational resilience. I mean, they're just putting pressure on the banking system and everyone involved to see if you actually can do this.
Marisa DiNatale: It's part of the stress test.
Mark Zandi: It's called a stress test, guys, come on. You've got to be under your stress.
Marisa DiNatale: Well, they usually ruin Super Bowl weekend. At least they didn't do that this year.
Mark Zandi: That's true.
Marisa DiNatale: It's almost always Super Bowl weekend.
Mark Zandi: Oh, maybe that's why they delayed it to the 15th.
Marisa DiNatale: So now it's President's Day weekend. So long weekend.
Mark Zandi: Now it's President's Day weekend.
Cris deRitis: If you go all the way back in the stress testing, it was 2009. It was Thanksgiving got ruined. They pushed it and then Cristmas was getting ruined. New Years. So I think they're just going through the holidays, right?
Mark Zandi: Yeah. I just find it so weird.
Cris deRitis: It is odd.
Mark Zandi: Am I missing something? It is odd. It's really odd.
Marisa DiNatale: They're probably just trying to provide cover for themselves in case they make a mistake and they've got to go back and redo something or they rethink something or it's not 100% ready. They're probably just trying to take the pressure off themselves to have it done by a specific date.
Mark Zandi: Oh, I see. They don't have a deadline. They don't have a deadline. You guys have a deadline. We don't have a deadline. All right.
Cris deRitis: Well there's definitely information, they could tell us a week before, a couple of days before, hey, it's going to be a little later, whatever. There is just silence and then all of a sudden it appears.
Marisa DiNatale: Well, it takes the fun out of guessing.
Cris deRitis: Okay, fair enough.
Mark Zandi: All right. Okay. Enough of the venting I guess.
Cris deRitis: Yes.
Mark Zandi: Yeah, enough of the venting, at least for the time being. There better not be a mistake in the data. And there has been in the past, not in recent years, but that would be, I think we would've heard about that already if there was some problem there.
Marisa DiNatale: The exploratory scenarios are a little weird.
Mark Zandi: But they're always a little weird. When they were doing the adverse scenarios, you pointed out it was always weird. Immaculate conception inflation is raging. No explanation as to why, but there it is. So anyway, okay, let's move on. Let's talk about the economic news of the week and inflation was the headliner.
We got both the consumer price index, I believe that was on last Tuesday, was it not? This past Tuesday, and then the producer price index, that's prices kind of at the wholesale level and that was released this morning. Both on the hot side and hot meaning stronger than expected. And of course markets have reacted to that, the bond market and stock market.
Matt, do you want to give us a top line sense of the numbers and then I think we're going to dig a little deeper into some of this, particularly owner's equivalent rent, cost of housing services because that's a big chunk of the miss here in terms of the high inflation. And we might risk going too deep into the bowels of these numbers, but I think it's worthwhile. Anyway. Matt, do you want to give us kind of high level of the data, say?
Matt Colyar: Sure. It was definitely more than everybody wanted to start the year, the CPI report, that came out on Tuesday for January. So the headline number from December to January, the CPI rose 0.3%, we were closer to 0.1. Consensus was 0.2. So nominally looking at it, that's not a disaster, but it's hotter than expected.
So you're on Twitter, so I know you may remember this silly conversation a year or so ago that was a couple of months of 0.1, even 0% monthly growth was held out as success that hey inflation, we're winning, this inflation battle is going as we want it to. And then there was a pushback of like, oh, what are you talking about? It's still 7%, it's the annual rate, which both parties were right. This struck me immediately as like, oh, that's the opposite because the headline number dropped from 3.4 to 3.1 on an annual basis.
Mark Zandi: Year over year.
Matt Colyar: Year over year
Mark Zandi: December through January.
Matt Colyar: Right. And it's like, okay, that would be great. We'd be out of the woods pretty quickly if we got that every month. But the monthly rate is what's causing all the concern, certainly what financial markets were reacting to as you mentioned.
Mark Zandi: I thought you were going to say, and I may have this wrong, but my recollection is last January we also got a hot number that was higher than expectations. No?
Matt Colyar: Yeah. I think the period I'm referencing is maybe mid-2022. It was very early to start to get over the peak.
Mark Zandi: The reason I bring that up is because it feels like, and we'll come back to it, but seasonality here is maybe playing a big role. I mean it's noise versus signal. And I'm going to ask you how much is noise, how much is signal? But go on. What else do you want to tell us about these numbers?
Matt Colyar: So, just breaking down components, and I know we'll spend more time on shelter, but the big ones, energy was a negative contributor this month that was expected. There's been a real decline in late 2023 and into January for gas prices. So gasoline contributed, or I'm sorry, gasoline fell 3%, 3.3% from December to January. Electricity prices which come from natural gas go into the utility, CPI was positive, but not so much. So the 0.9% decline in the energy CPI in January is the third month in a row of declines of a decline.
Mark Zandi: Let me stop you for a second on the electricity. And that has been increasing, but we know that natural gas prices, I don't know if you've looked recently, but they have collapsed. I mean we're now below $2 per million BTU, $2 in my mind is this kind of threshold. Anything below that is very, very low because we have all this inventory of natural gas everywhere and natural gas is the key feed stock into the production of electricity in the country. So that would argue if this continues and it feels like it will, that we're going to start seeing some negative signs on electricity prices here going forward. Would you concur with that?
Matt Colyar: That's right. And our model, it's a lag of about a month or two when you see those natural gas prices drop when that actually shows up in electricity bills. But moving the other way is gasoline prices since bottoming out in January have drifted up. WTI closer to 70 throughout January is now a lot closer to 80.
So there is the kind of counterbalancing effect there. So the increase that's coming, I would not expect as we are today, we're still only halfway through the month, to be a dramatic increase. But I would say the increases in gasoline and in oil are going to offset the decline in natural gas prices.
Mark Zandi: So that's energy. So energy is basically flat to down, and down this month, flat next month or something in that order of magnitude.
Matt Colyar: I think that's fair.
Mark Zandi: Okay.
Matt Colyar: Food prices, which were pretty stable even though they get lumped in with the volatile food and energy category. When we look at core CPI, accelerated in January, so a 0.4% increase. A lot of that still is coming from food away from home, which is your dining out, which is a more labor-intensive way to get food than going to the grocery store and you're dealing with manufacturing prices and shipping and logistics.
But when you go out to eat, dining out has been much more expensive, less affordable than grocery store prices. So food away from home rose 0.3% in December and then 0.5% in January and is up over 5% relative to a year ago. So that remains an inflationary source in the US in a way that groceries aren't. So food at home rose-
Mark Zandi: You're going to sense a theme here by the next thing I say, and that is it feels like food away from home price growth is also going to slow because you listen to some of these large retail restaurant chains like a McDonald's or a Yum brands, they are saying demand has come way off particularly by their lower income customers and they sense some real sensitivity to the price increases and that consumers are starting to pull back. If that's the case, that would argue that the companies as restaurateurs are going to have to become a little bit more circumspect in their price increases. Does that resonate with you?
Matt Colyar: It certainly makes a lot of sense and would be a good disinflationary force moving forward.
Mark Zandi: Cris, Marisa, do you see what I'm doing here?
Marisa DiNatale: I see the setup.
Mark Zandi: You see the setup.
Marisa DiNatale: See right through it.
Mark Zandi: See right through it. Okay, now we're at food at home and you may say, well, it's kind of flat-ish and really hasn't ... the good news is it hasn't really increased that much in the past year. Obviously it rose a lot in '21 and 2022 into 2023. And it feels like that's the thing that has people really upset.
It's the food that's got them going crazy because we buy food, people buy food every single day and they're very focused on that. And when people think about inflation, they think about the cost of a gallon of regular unleaded, no doubt that's a big deal, but they're also thinking about some food item as well. So what's going on with food at home? Do you think we're going to see continued moderation there as well?
Matt Colyar: I think so. I mean, I think you're at the same type of price sensitivity point. If it's slowing economy or moderating the way that we expect it to, I think those are all reasonable intuitions.
Mark Zandi: I guess the other thing is if diesel prices stay down, obviously a big chunk of the cost of food at home is getting food from the farm to the store shelf. That goes to cost of transportation, which goes to trucks, which goes to diesel. Diesel prices are, I don't think they're falling anymore to your point about oil prices. But they're down quite a bit as well. And that should help, I would think in the next, at least few months.
Matt Colyar: That sounds right. I haven't thought about our diesel forecast, but would be interesting to look at looking energy.
Mark Zandi: All right, any particular food items that you noticed that were up significantly? Is there any stories behind them? Someone mentioned to me meat prices, but were meat prices up a lot during the month? Do you know?
Marisa DiNatale: They fell, I think.
Mark Zandi: They fell? Okay. Oh, really? Okay.
Cris deRitis: But I'm surprised you didn't bring up hot dogs, Mark.
Mark Zandi: Oh really?
Cris deRitis: I know you're a lover of hot dogs.
Mark Zandi: I love hot dogs.
Marisa DiNatale: Up 2% over the month, Mark.
Matt Colyar: Oh wow.
Mark Zandi: Maybe that's what the person was saying about meat.
Marisa DiNatale: Egg prices are down almost 30% over the year. Remember that great egg debate?
Mark Zandi: Yeah, I'm not a big egg fan, but I'm a hotdog fan for sure.
Matt Colyar: That's good. I was scanning for something for the numbers game, like an obscure food that moved oddly, and I think tomatoes rose like 5% or four and a half percent, which is ketchup, which is hot dog adjacent. But I didn't-
Mark Zandi: I was trying to figure out how to connect the dots, but okay.
Matt Colyar: Yeah, I'm not sure hot dog is meat, but that's a connection, ketchup.
Mark Zandi: Okay. Where do you want to go next, Matt in the report?
Matt Colyar: I can dig further into components, but after talking food and energy, I think core CPI is a good transition. So core also came in a little bit stronger than we expect-
Mark Zandi: Core being ex-energy and food. So yeah.
Matt Colyar: Right. So 0.4% growth on the month and that kept core CPI at 3.9%, which again, we expected a 0.3%. So we're talking a 10th of percentage point difference. You've highlighted the points and we'll have a few more that we think, okay, tough month but still the larger picture is a positive one. I think within core CPI, a good place to go would be to talk about vehicles which-
Mark Zandi: Wait, wait, wait, so hold on. So the big thing in core CPI was the cost of housing services, right?
Matt Colyar: Right.
Mark Zandi: The housing services, that's rent of shelter and homeowners equivalent, right? I'm a homeowner and what is the implicit rent that I charge myself to live in that home, that's how the Bureau of Labor Statistics measures the cost of home ownership. That's, I believe, correct me if I'm wrong, a third of the CPI and maybe what, 45% of-
Matt Colyar: Close to half.
Mark Zandi: Close to half of the core CPI. So that's really the ball game right there. And in fact, again, correct me if I'm wrong, but if you look at the consumer price index, the whole thing, less shelter, that one third that year over year, that is now I think one point, through January 1.6%. That's the rate of growth in CPIX shelters. The only reason why CPI, top line CPI is 3.1, the number you mentioned earlier is because of the very continued strong growth in the cost of housing services.
So the key here to getting inflation back to something we all feel comfortable with, back to the Federal Reserve's inflation target of 2% on the core consumer expenditure inflator is getting the growth and the cost of housing services down. And it has been the view, not just our view, the universal view that that's going to happen because ultimately the way the Bureau of Labor Statistics measures the cost of housing services is through measuring rents for rental property, what's going on in the marketplace.
And we know that rents nationwide have been flat to down over the past year and everything indicates that that's going to continue to be the case going forward here, at least for the next year or so because there's just so much multifamily supply coming into the market and vacancy rates which are already off bottom are going to rise meaningfully more.
The surprise here has been that this slowing in, the expected slowing in the growth in the cost of housing services has not happened nearly as quickly. And in fact, last month in January, instead of showing any sign of slowing, it re-accelerated, right? I think in December, owner's equivalent rent rose four tenths, in January, it rose six tenths, something like that.
Matt Colyar: That's right.
Mark Zandi: Did I characterize all of that correctly?
Matt Colyar: Yeah, absolutely.
Mark Zandi: Okay, so let me turn to you, Cris, what is going on? And that's a very deep question because when you get down to owner's ... measuring anything is difficult, but it feels like measuring owner's equivalent rent is really difficult. Am I right?
Cris deRitis: Yeah. It's so difficult that most countries don't actually do it in [inaudible 00:30:15]. I heard they just look at observed rents, market rents, even that has some nuance, how you control for different rent, but at least there are market prices you can see in it, observe over time. Then there's this owner's equivalent rent, which is just a very squishy concept.
What exactly are we're trying to measure here? There are lots of ways we can think about it. If you want to have a deep philosophical discussion, there are lots of alternative approaches, but the way that the BLS does it is through this idea of taking observed market rents and using that data to impute values for all the owner's properties, right?
Because we don't observe the housing service cost of someone who owns their property, we're going to impute it from this other data. In theory that sounds reasonable, but throughout, there's some big measurement issues, right? In a lot of markets, the owned market and the rented market are very distinct or disjoint.
So you might not have data that really allows you to accurately assess what the owner's properties values really are, or rental values really are. And so that could introduce some potential error and I think that that might be part of the reason why we see these movements here. It's just that imputation process is imperfect. But over time, I think I still think it'll correct. I think there's just some sources of noise here.
Mark Zandi: Yeah, I got a little distracted there. You might hear the dogs in the background. I don't know, but you may have said this, but just to reiterate, one thing we learned since the release on Tuesday, because every month we dig deeper and deeper into the bowels of the data to try and understand what's going on that to impute owner's equivalent rent, the Bureau of Labor Statistics looks at rental properties at a block group level and says, okay, the homes that are owned for ownership, we tie those back to those rental properties and the rents being paid and use that as a basis for constructing owner's equivalent rent.
The issue is, or there's many issues, but one of the most obvious issues is that in some parts of the country there aren't a whole lot of rental properties and there's no good way to tie the rental market back to the home ownership market. But the Bureau of Labor Statistics has to do that anyway. And this isn't really an issue in most times because the housing market is more homogeneous in terms of the dynamics and what's going on with rents and everything else.
But in the current market, there's this large distinction between what's going on kind of at the lower end of the housing market because the affordable part of the market, because affordability is so tough, vacancy rates are excruciatingly low, record low, there's no supply. So rents have held up better.
And if I go towards the higher end of the market, which are more correlated with the home ownership market, that's where we've seen more weakness. If we take what's going on at the more affordable part of the market and apply that to homes at the high end of the market, we're going to get this result we're observing where we're getting relatively strong increases in owner's equivalent rent that just doesn't seem to conform with what we're observing. I said a whole lot there. Did I make sense? And do you agree with that?
Cris deRitis: I do agree with that. It does make sense. I think it may not be the only reason. I mentioned there are some other measurement challenges. We always go back to seasonal adjustment, whatnot. So there could be some other reasons why this particular month, the disconnect between owner's equivalent rent and rent, primary rent was so large. But I would agree that that imputation process is imperfect and it can lead to a situation like this given the current dynamics.
Here's a statistic for you, 16% of census block groups have less than 10% rentals. So just to give you a sense of the problem, right? It's not insignificant. It's a pretty substantial part of the market.
Marisa DiNatale: How do they know what's for rent, especially in a single family home market?
Cris deRitis: How do they know what's for rent?
Mark Zandi: How do they know, if you're talking about a block group, and let's say on my street it's all single family homes, some of these are owned but rented out, how do they know what's for rent? What's being rented versus what's being owner occupied? Do you know?
Cris deRitis: I thought they were just sampling, right?
Mark Zandi: Yeah.
Cris deRitis: Calling people up and seeing.
Mark Zandi: Saying, do you rent? Do you own it, right? Yeah. I think that's the way they do it. They just ask, are you a renter or are you a homeowner? Right? All right, but your sense is still despite it all, the growth and the cost of housing services should continue to moderate going forward just because the rental market in aggregate is soft.
Cris deRitis: Yeah, the market rents exactly, are showing, all the other private data sources show weakness in the rental market. So that has to bleed in overtime. But again, it could take a while given this methodology.
Mark Zandi: So just to summarize, energy basically flat, maybe down feels like unless oil prices go up here, that's definitely a risk. But barring that, significantly. Food prices, kind of flattish maybe down for food away from home because the price competition and the resistance consumers are now showing with regard to price increases.
Growth in the cost of housing services, that we feel is going to continue to slow. Now let's turn to vehicle prices. And you may say, well, how big a part of the index could that possibly be? Well, it's not inconsequential, particularly if you consider the cost of ensuring a vehicle and the cost of maintaining and repairing a vehicle.
Those are also in the basket of goods and services in the consumer price index. And they're all tied back to, at the end of the day, new vehicle prices. And new vehicle prices went skyward during the pandemic because of the supply chain disruptions and the collapse in inventory. But now we're starting to see more inventory and more discounting is starting to come into the market and we expect that to continue. Matt, do you want to provide any more detail there on the new vehicle prices and maybe used if there's any insight there as well?
Matt Colyar: Yeah, I certainly agree with the story, but to throw some numbers on it, new vehicle prices were flat in January, so it didn't change from the month before and were very little change from a year ago, about 0.7% relative to January, 2023. It speaks to your suggestion that lots are building up, there's not the supply.
We're moving further and further from the supply issues of a couple of years ago. Used vehicles fell 3.4%, which is massive, which is the biggest monthly decline in about late '60s. So what's that, 60 years, 55 and are about the same as they were a year ago. That decline is a little misleading. There's a methodological change to the BLS that updates mileage depreciation on a vehicle monthly instead of annually.
So it's not something that we're going to expect to see again and again and again. It was kind of a down level shift. So both of those, we have flat for new used vehicles, big decline for used vehicles, and then as you alluded to, motor vehicle insurance jumps again, and it's risen over 1% each month for at least through 2023 now into 2024.
And that's a response to the increases in prices we've seen before in both vehicles and now in vehicle repairs, which are intuitively very correlated. So relative to a year ago, motor vehicle is 20.6% higher. It's another one of those kinds of essentials that you mentioned that has people, yes, inflation's moderating, but look at these essentials.
You'll see motor vehicle insurance, like food be held out as a pain point. And if you look back to 2019, motor vehicle and car insurance is about 40% higher than before the pandemic, but that's still less than car repairs. So you could suggest that there's still more room to go for insurance premiums in a way, even if we're starting to see moderation in new and used vehicles.
Mark Zandi: But bottom line, it feels like as we look forward here over the next six, nine, 12 months, we should see vehicle prices here really throttle back and actually maybe see some negative numbers in aggregate as we move forward.
Matt Colyar: Yeah, I think that's fair. And just mathematically, the vehicles cost more and are given more weight than insurance and repairs are.
Mark Zandi: Okay, so what in the inflation measures, what component could be a surprise to the upside that's going to add to inflation here? Because so far everything seems to feel like the direction here is for slowing inflation or outright price declines. But what could add to inflation here of consequence?
Matt Colyar: I don't want to overstate how much of an add, but moving in that direction is medical care, and I think we saw it in January. And this is medical care has not been part of the story of the post pandemic bout of inflation in a way that cars have had their moment, housing we're still talking about. But medical care is a big part of the CPI basket, and it's only up 1.1% relative to a year ago, but the past three months has been 0.5%, 0.4%, and now again in January a 0.5% increase.
So that's a 5.4% annualized rate over that period. And there's a few things going on here. Some of it is the well-known staffing shortages that hospitals have had, that's increased in labor costs. Those eventually get passed through in prices, which in healthcare are slow to change and they're often, those costs are set far in advance. So these price increases take a bit. There's also some idiosyncratic stuff, the way that the CPI goes about calculating based off of insurance retained earnings, which we can delve into or not. But I think the more interesting point is ... Go ahead.
Mark Zandi: No, no, go ahead. I was just going to say we dug so deep into the other one, maybe we'll wait until next month to dig into the other one, into the medical care. I think we're exhausted.
Matt Colyar: Yeah. So my main interest, and not to lead the way too much, is, okay, what does this mean for the PCE deflator? Because they're in that measure which the Fed cares more about, their healthcare is a bigger weight. And if we're seeing this surprise in January, is it just noise? Is it a sign of things that come?
I think there's a lot of reasons that it isn't just noise. And if anything, the CPI has perhaps been underselling or understating medical care inflation or healthcare inflation in a way that the PPI or the PCE deflator. So I think we could see another stretch for a few more months where healthcare, medical care is providing upward pressure on the CPI and it's tough to disaggregate in the PCE deflator, but the kind of thing that after this report this week for the CPI and the PPI, I think both make me think that a downside surprise for the core PCE deflator is less likely.
Mark Zandi: Or said in another way, we're going to get a strong PPI increase is what you're saying. I mean a strong PCE increase, consumer expenditure deflator increase.
Matt Colyar: Correct.
Mark Zandi: Yeah. Okay. Do you have an estimate yet of what it's going to be for the month of January?
Matt Colyar: I know our model-
Mark Zandi: CPI and PPI.
Matt Colyar: I know our model is 0.3% month-over-month growth-
Mark Zandi: Which is hot because annualize that, that's what, 3.6, 3.7 and target is two, but of course that comes after six months of at target kind of growth, right? But okay. Anyway, so you take this mélange of stuff and extrapolate forward, forecast forward, we continue, at least my expectation is that by the end of the year, we're going to be pretty consistently at Fed's target, 2% on the core consumer expenditure deflator, PCE deflator.
CPI will have come in more, PPI will maintain. Anyone take umbrage with that forecast? Is everyone still on board with that forecast despite January's number? I mean barring January's inflation numbers. I mean, nothing changed for me given the numbers. Data zig and it zags and January's a tough month, seasonal noise signals, so forth and so on, everything we just said about the trajectory here for all different components, it feels like we're headed towards target by the end of the year. That's our forecast. Anyone disagree? Marisa, do you disagree with that forecast?
Marisa DiNatale: No.
Mark Zandi: You're good with that. Okay. Cris?
Cris deRitis: No. I might even go so far as to say there's risk in the other direction. Lower.
Mark Zandi: Oh, is that right? I'm all ears. Yeah. Why would that be?
Cris deRitis: Oh, just that we do see some softening of demand that you mentioned. You see some of these things coming in, they could think about food or some of these other commodities here, they could certainly move in the other direction as well. It could get some upside risk, if you will.
Mark Zandi: Okay. And you, Matt, any [inaudible 00:44:53]?
Matt Colyar: Well, Cris surprised me. I thought I was going to piggyback on Cris being less optimistic about inflation, maybe staying elevated was my guess. But I think if you have another month or so of reports that are okay above consensus, again, above expectations, the last mile conversation that, hey, maybe we've leveled off wage growth isn't going to continue moderating, I think those will get louder and louder and justifiably so.
Mark Zandi: Well, that comes back to Fed policy. And what I'd like to do is talk before we get to Fed policy, we'll end on Fed policy and of course between now and then we'll do the statistics game, but the one thing I want to do here before we move on to the game is take a big step back and look at inflation more broadly and inflation dynamics.
And I want to finally put a stake in the heart of the argument that the high inflation that we suffered, particularly in 2021 and 2022 coming into '23, was demand driven. Mostly demand driven. There's this broader debate, is it supply related or demand? It's both supply and demand, obviously, but which is more important. And it's been my strong contention that it's been mostly supply. It was the pandemic, its impact on supply chains and labor markets. We talked about that in the context of the multifamily construction and the cost of housing services.
We talked about it in the context of the vehicle industry and of course the Russian War in Ukraine and the impact that had on energy prices, agricultural prices, and the fact that those two shocks kind of conflated together and infected inflation expectations, which got into the wage and price dynamics. And that's when the Federal Reserve obviously went on high alert. And of course, everything I'm describing here is the dynamic that's played out globally.
It's not just the US. It is the same kind of thing that's happened everywhere. But good news, the pandemic, the economic fallout from the pandemic and Russian war are now in the rear view mirror. They're fading away. And as that has happened, that's allowed inflation to come back in reasonably gracefully without any significant slowing in demand. Unemployment remains below 4%.
The economy has not skipped a beat as a result of Fed rate hikes and inflation has still come in. To me, all of that is evidence of this is mostly supply, not completely. Demand was playing a role probably more significantly back in 2021 when we had the American rescue plan and all the fiscal support and stimulus. But that's long faded. And at this point in time, it's really not about a demand to any significant degree. It's been mostly about supply. Okay. That's a soliloquy. I'll stop. Anyone want to tackle that, take umbrage with that, disagree with that? Cris, would you argue back? Would you take a different perspective on that view?
Cris deRitis: No, no. In general, I'd be on board. But certainly you could point to some specific products or services if you want to go underneath the reports here. But if you're talking general inflation, I think that's probably consistent with my view that yeah, demand was a pretty significant component back in '21. I don't think you're disputing that, but that it's really been the supply side throughout and continuing to have some impact on inflation today.
Mark Zandi: Marisa?
Marisa DiNatale: No. Yeah, I think demand was a factor back in 2021, but only to the extent that supply couldn't meet that demand because supply chains were so gummed up. I mean, we did not have a normally functioning supply chain throughout the world in 2021 yet, right? So had they been functioning normally, maybe it would've been enough to meet demand at that time and that wouldn't have spiked prices as much as it did starting in the middle of the year.
I think the other sort of argument when people talk about demand being a major driver in inflation is if you look around the world, people a lot of times point to the fiscal stimulus and say, well, how could that not have been a major factor in juicing up demand? But that was not unique to the United States. Most developed economies did a significant amount of fiscal stimulus during the pandemic.
And there too, we haven't seen lingering ... Europe was behind the curve, but that was mostly due to Russia's invasion of Ukraine and what it did to energy and natural gas supplies coming into Europe. I think if you look around the world, I think it's hard to argue that fiscal stimulus in the US had a major role in juicing inflation and that it's still pervasive because it was not, that stimulus was not unique to the United States.
And you see similar patterns around the world. The other thing I would say is that I think inflation has been helped out by weakness in other economies, other developed economies elsewhere. We've talked about China a lot and the very weak economy, relatively speaking in China and how that's probably tamped down inflation globally. Now we see Japan maybe in a recession. Much of Europe is sort of hanging on edge, has been sort of teetering on the brink of very, very slow to no growth. So I think the fact that the ex-US global economies have been weak has also helped out the inflation picture at home.
Mark Zandi: All good points. I guess you were saying someone had asked a question that was, one of our listeners had asked a question that was relevant to this discussion. Did you want to bring that up?
Marisa DiNatale: Yeah, I mean, I think you just answered it. I mean, the question was really, so Fed governor Waller had given an interview with the New York Times and he was asked about the causes of inflation in the past couple of years. And he said that if it had been all on the supply side, in other words, if inflation was caused only by supply, then we might expect price levels to drop down to where they were prior to the pandemic once the supply side issues were resolved.
And because we didn't see price levels come back down, that suggests that there was a demand component to inflation as well. He wasn't arguing that it was mostly demand, but he was arguing that it was a mix of the two. And so the listener wanted to know what our take on that statement was.
Mark Zandi: Yeah, I think there's some validity to that. I'll be more affirmative. I think that makes sense. Although I will say the old adage, prices go up like a rocket, they come down like a feather, in a supply constrained economy prices took off and it's going to take time, and you can see it in profit margins for companies, the margins economy wide are very wide because businesses were able to jack up prices very aggressively during that period and outstrip the growth and the cost of their inputs, labor and everything else.
But prices only come in slowly over time as competitive pressures intensify. We talked about it in the context of the food away from home, the McDonald's and the Yum brands, it takes time for competitive pressures and for price sensitivity to kick in to a place where businesses say, oh, okay, I have to become more circumspect in my pricing.
Even then, I think there will be some products and services where you see price declines as that feather continues to fall. But I suspect in many industries it's more about pricing just going more flat-ish here. Businesses are very, very reluctant to cut price, but they are much more willing to be more cautious in raising their prices.
So I wouldn't be surprised if we have an extended period of inflation that is very low or maybe even below the Fed's target, given the competitive pressures as they begin to kick in. But I mean, I'm sympathetic to the Waller view that if it was all supply, then you'd see prices come in. But I don't know that I would take a ... I don't think that's a really strong argument because this just goes to the typical pricing dynamics that exist in the actual economy among businesses.
The other point I wanted to make, and this goes to a podcast I was listening to this weekend, I don't listen to many podcasts. I listen to our podcast, but I don't listen to many podcasts. But I was listening to one and a very good one, an economist was arguing that, he was basically arguing it was mostly demand and fiscal support, fiscal stimulus.
And he was doing this kind of the back of the envelope calculation. If you add up all of the fiscal stimulus between the CARES Act, which was the first pandemic related support program passed in March of 2020 all the way through the American Rescue Plan, which was March of 2021, and there was a few other fiscal stimulus packages provided in between, it comes to, I don't think these were his numbers, but they're my numbers, $5 trillion. That's 25% of GDP. And then he argued well apply a multiplier to that of one and a half or two.
That's a lot of GDP and how can that not be driving the inflation that occurred. I think the point though is that that five trillion, and that's the right number, 25% of GDP that was spent out over a long period of time, it's still being spent out in fact, if you look at state and local governments. They've got a big check from the federal government, and they don't need to spend that out, I think completely until the end of 2026.
They have to commit it by the end of this year, but not until the end of 2026. And there's other aspects of the funding that hasn't even been spent. For example, if you look at the way Congress wants to pay for this piece of tax legislation that's snaking its way through Congress right now, this goes to RD tax credits and Litech and child tax credit, it's paid for by the employee retention tax credit, which was funding that was appropriated part of that five trillion during fiscal stimulus.
And it's still sitting out there and they're going to use it now for these other tax support. And the other thing I'd point out is there's still, by our estimate, a lot of excess saving, savings that were built up during the pandemic that's just sitting in people's checking accounts. And so the multiplier wasn't one and a half or two. The multiplier was probably 0.2 or 0.3.
It was not that large. And so it did help support demand, but it didn't support it to the degree that it would be the primary cause of underlying inflation. Anyway, I was out there doing my old man weightlifting listening to this podcast and getting a little annoyed by it, getting a little annoyed by it. But anyway, that's why we have this podcast so we can express our views. Matt, anything on that before we move to the stats game?
Matt Colyar: No, all sounded great.
Mark Zandi: Okay. Sounds good. Okay, let's go to the stats game. We each put forward a statistic. The rest of the group tries to figure that out through questions, deductive reasoning, clues. The best stat is one that's not so easy. We get it immediately, which is hard to do with Marisa playing the game and one that's not so hard, we never get it. And if it's apropos to the topics at hand, all the better. Marisa, you're up.
Marisa DiNatale: All right. My statistic is positive 0.8% in January.
Mark Zandi: Positive 8%. The government statistic-
Marisa DiNatale: 0.8. 0.8.
Mark Zandi: 0.8 or 0.8% positive. Government statistic?
Marisa DiNatale: Yep.
Cris deRitis: Retail sales?
Marisa DiNatale: No.
Cris deRitis: No.
Mark Zandi: They were down by-
Cris deRitis: No, I think it was [inaudible 00:57:43].
Mark Zandi: ... minus 0.8. Minus 0.8.
Cris deRitis: There was a 0.8 in that report.
Mark Zandi: There was a 0.8, yeah, with a negative sign. Inflation related?
Marisa DiNatale: Yes.
Mark Zandi: In the CPI report?
Marisa DiNatale: No.
Mark Zandi: In the PPI report?
Marisa DiNatale: No.
Mark Zandi: Ah, a statistic that came out this week?
Marisa DiNatale: Yep.
Cris deRitis: Expectation.
Marisa DiNatale: No.
Mark Zandi: Expectations. A government statistic though. 0.8.
Cris deRitis: What do you think, Matt?
Matt Colyar: I don't know.
Mark Zandi: Ideas?
Matt Colyar: I'm looking at the releases, but not specific data.
Mark Zandi: Ah, just to remind you the releases.
Matt Colyar: The calendar. Yeah.
Mark Zandi: Is it, this might be unfair, one of the releases we cover on economic view?
Marisa DiNatale: It is.
Mark Zandi: Oh, Matt, how embarrassing.
Marisa DiNatale: How embarrassing for you, Matt.
Mark Zandi: How embarrassing for you, Matt.
Matt Colyar: Well, not if I get it right now. Is it import prices?
Marisa DiNatale: It is, yes.
Mark Zandi: Oh. Okay.
Cris deRitis: Nice.
Mark Zandi: Very good.
Cris deRitis: Nice recovery.
Mark Zandi: Nice recovery. Yeah. I knew I needed to put a stick in your eye to ... Explain Marisa, 0.8.
Marisa DiNatale: Yeah, so the prices of imported goods rose 0.8% over the month in January. They are down about 1% over the year, but they've risen for actually the increase in January followed three monthly declines. The increase in import prices is important because imports are part of the basket of goods that we consume and are therefore reflected in the CPI report as well.
The price of imported fuel and energy rose pretty sharply over the month in January, but so did the prices of things like capital goods, consumer goods, vehicles. So a lot of across the board imported goods prices rose over the month contributing to at least likely some of the gain that we saw in CPI.
Exported goods were also up by 0.8%. So the cost of goods that we export to other countries was up 0.8% over the year. And exported good prices are down over 2% over the year. So I just thought it was another way of thinking about the basket of goods, right? When we focus on CPI, we're talking about domestic prices, but many of these goods that are being counted in CPI come from abroad.
Mark Zandi: So that's 0.8% year over year through January?
Marisa DiNatale: No, it was 0.8% over the month, the increase in import.
Mark Zandi: Really?
Marisa DiNatale: Yeah. It was 0.8% over the month. Year over year import prices are down a little over 1%.
Mark Zandi: Okay, that makes sense. Okay, so this state is volatile month to month. I mean the trajectory here is for lower import prices, right? Strong dollar.
Marisa DiNatale: That's right.
Mark Zandi: To your point about China and the global economy. I mean, that's been a restraint on inflation. So that number in January feels weird.
Marisa DiNatale: Yeah, it was an outlier, which is why brought it up.
Mark Zandi: Which is why you brought it up, okay, fair enough. And export prices year over year, what were they?
Marisa DiNatale: Year over year, they're down 2.4%.
Mark Zandi: Okay. All right, very good.
Marisa DiNatale: So more than import prices.
Mark Zandi: Okay. Matt, you want to go?
Matt Colyar: Sure. 0.53%.
Mark Zandi: Okay. Government statistic?
Matt Colyar: Pseudo government.
Mark Zandi: Like a Federal Reserve statistic?
Matt Colyar: Yes.
Mark Zandi: Industrial production?
Matt Colyar: No.
Mark Zandi: It's not in the industrial production report?
Matt Colyar: No.
Mark Zandi: 0.53. It came out this week?
Matt Colyar: Yes.
Mark Zandi: Did anything on consumer credit come out this week from the Fed? That's not consumer credit related, no. Is it financial related, financial system related?
Matt Colyar: Inflation related.
Mark Zandi: Oh, inflation related from the Federal Reserve Board. What could that be? Inflation.
Matt Colyar: Maybe not the board, but Federal Reserve.
Mark Zandi: Oh, like the New York Fed or one of the Fed district banks?
Matt Colyar: Yeah.
Mark Zandi: Okay. And it's inflation related, like a Cleveland Fed median?
Matt Colyar: That's it. Nice.
Mark Zandi: Oh geez. Okay.
Matt Colyar: I knew it was obscure, but I thought we'd get there. That's good.
Mark Zandi: I thought that was pretty good.
Marisa DiNatale: What is it?
Cris deRitis: Pretty good.
Matt Colyar: That is good. The Cleveland Fed's median CPI estimate where they look at the item right in the middle. So 0.53-
Cris deRitis: Of the distribution.
Matt Colyar: So the 0.53% increase is from December to January. It's the fastest pace for the Cleveland Fed median CPI in almost a year, which I don't think, I mean January has its own weirdness and I don't think that we're experiencing any kind of re-acceleration. I mean shelter is rising. It's very strong, but there is a little bit of broadening out in inflationary pressures that push that up. So year over year it's 5.7%, which is up about 5.3% year over year. So I don't think the last mile conversation is really heating up, but it could heat up.
Mark Zandi: Was it 0.5 last January or?
Matt Colyar: No, in February. So it wasn't total and it was 0.6, was-
Mark Zandi: 0.6.
Matt Colyar: Yeah. So not entirely a seasonal thing.
Mark Zandi: It's funny, when inflation was raging a year or two ago, I looked at that number religiously from the Cleveland Fed. I haven't looked recently. I probably should. That's probably a mistake. I should probably keep looking at it. Okay. All right. The other Feds put out all kinds of, so-called trim, mean, other different measures, try to get a kind of core sticky price inflation, that kind of stuff. Did you look at those? Are they-
Matt Colyar: Nothing top of mind.
Mark Zandi: Nothing top of mind.
Matt Colyar: But certainly can.
Mark Zandi: Yeah, no worries. Cris, you're up.
Cris deRitis: Sure. 35.7% and minus 26.6%
Mark Zandi: Positive 35.7?
Cris deRitis: Positive. Yep.
Marisa DiNatale: Are these inflation related?
Cris deRitis: Nope.
Marisa DiNatale: No.
Matt Colyar: What was the second one? Negative 20?
Cris deRitis: 26.6.
Mark Zandi: You can't ChatGPT it Matt, that would be unfair. Can't do that. Because then they'll probably tell you the temperature in Anchorage, Alaska or something. Is it a government statistic?
Cris deRitis: Yes.
Marisa DiNatale: Is it housing related?
Cris deRitis: Yes.
Mark Zandi: It's related to housing starts?
Marisa DiNatale: Oh, is it housing? Yeah.
Cris deRitis: Not starts.
Mark Zandi: Permits.
Marisa DiNatale: Permits.
Cris deRitis: Yes.
Mark Zandi: Oh, I know what it is. Single family was up, multifamily was down.
Cris deRitis: You got it. You got it.
Mark Zandi: Oh, that's a good one.
Cris deRitis: Yeah. Overall was up 8.6% because single family is larger, right?
Mark Zandi: What's going on?
Cris deRitis: I chose it because housing usually is, or housing construction, usually is an early warning indicator of some weakness. And although there's some weakness there, builders still seem pretty optimistic they're applying for these permits. But you do see that shift, multifamily pullback, much more emphasis on the single family side here. That's all [inaudible 01:05:31].
Mark Zandi: Yeah, so multifamily has been kind of surprising, right? Because we've all been waiting for it to slow down given the banking crisis a year ago and the handing over commercial real estate and actually in our CRE, going back to the beginning of the podcast, our CRE price indices show that multifamily prices are down from the peak more than any other property type, at least so far, based on an equal weighted basis. So we're can kind of sort waiting for the Florida to fall out, so to speak, in the multifamily construction. And I guess the sense is that what's going on here?
Cris deRitis: Yeah. Although a little perspective needed here, we're down a lot on multifamily permits this year, but we're kind of right back where we were in end of 2019, start of the pandemic. So we're not collapsing here. There's still new multifamily projects being projected and put up, but you do still have this fairly sizable inventory of projects still under construction and you have those financing issues that are reducing some of the activity, but I don't see them. It's not a collapse, right? Still going back to where it was.
Mark Zandi: Okay. That was a good one. I'll give you mine. This is a bit obscure, but-
Marisa DiNatale: Again?
Mark Zandi: Yeah, it's a little obscure, but I'll give it to you. I'll give you some big hints. 2.2% and that is the monthly percentage increase in January, 2.2%. And here I'm going to give you the year-over-year increase.
Cris deRitis: This is CPI related?
Mark Zandi: It is not. It is not. It's a statistic that came out this week and the year over year through January, up 20.6%. It's a stat that came out this week. It is from the Federal Reserve Board. Yep. Federal Reserve Board. Yep.
Matt Colyar: Is it semiconductor production? Have we talked about that.
Cris deRitis: Oh my gosh.
Marisa DiNatale: How did he know that?
Mark Zandi: How did he know that?
Matt Colyar: I would love to be congratulated, but Mark, you asked about this earlier in the week, so this was fresh in mind.
Mark Zandi: Oh, that's right. That's right. I asked Matt this question.
Matt Colyar: I deserve credit for this integrity.
Mark Zandi: You should not have said anything, it was highly impressive.
Matt Colyar: Although I think 20.6% is exactly what motor vehicle insurance is up to over a year. But that's-
Mark Zandi: Oh, really? Oh, wow. Okay. Yeah. So this is industrial production in the chip industry, semiconductor industry. And it's booming. It's booming over the past year and it probably has nothing to do, you'd think at first blush, CHIPS Act. Remember the CHIPS Act? That's the legislation that was passed a couple of years ago, provides a lot of tax subsidy to build semiconductor fab plants here in the United States.
The thing is, those plants are still under construction. They're not going to be finished until this year or next year in 2026. So this increase is all about, largely about AI. I think it's artificial intelligence that just gives you a sense of how powerful that has been. And also demand to some degree. I think chip inventories got overladen back a year or so ago coming out of the pandemic and the supply chain disruption.
Companies rebuilt inventory and then some because they were fearful that they'd get disrupted again, but now inventories, and they had to work some of that off, but now inventories are back to something more normal and that's allowing production to kick back into gear. But we're going to see some pretty sizable increases I think in industrial production in the chip industry over the course of the next couple three years given the CHIPS Act. So I thought that was interesting. Oh, Matt, yeah, I forgot complete. I asked you what was going on.
Matt Colyar: I thought you were teeing me up to look smart, which I appreciate.
Mark Zandi: Yeah, that's so funny. That is so funny. Well, let's end this way. Given all the discussion about inflation, and we were railing on the Fed at the beginning of the podcast regarding the stress test, let's come back to the Fed. And I want to ask the question. Let's assume that you were sitting on the Federal Reserve Board, you were part of the FOMC policymaking committee and you need to make a decision about future interest rates.
So the question is, what would be the next move on rates and when do you think you would move it and why? Okay. And just as context, I believe, correct me if I'm wrong, Cris, if you look at market expectations, the next move is for a cut, and the most likely date for a cut is the June meeting. So it's not the March meeting, it's not the May meeting, it's the June meeting. And that happened this week, given the strong inflation statistics, the market now thinks the Fed's going to be delayed. So okay, Matt, you're on the FOMC. What do you think? What should the Fed do here? Not what will it do, but you can say that too if you want, but what should it do?
Matt Colyar: I think May is a fine time to make the first cut. That's our baseline forecast. That's probably what I would pine for. I think if you wait for the economy to show signs clearly that it's slowing and in trouble, then it's too late. So I think getting ahead of it and the trends that we're confident in, shelter, even if it's a little delayed, those prices are going to come down and the risk of waiting too long is a lot more dangerous. So I would start cutting in May. And I'm a little surprised at the futures markets that now put June as the likely probability
Mark Zandi: Of course we get another inflation reporter or two here. And if they came in on the hot side, would that change your mind or?
Matt Colyar: I think so.
Mark Zandi: I guess it depends.
Matt Colyar: So the February report comes out before the March meeting, which is the door is closed on that. But if you see another report and it's the same broadening of inflation in the way that isn't just stuff you can point to and kind of wave away, then I think then yeah, maybe we're looking at the second half of 2024, at least June.
Mark Zandi: Okay. All right. Marisa?
Marisa DiNatale: I think I would wait for another inflation report and I think I would do a small rate cut 25 basis points in May.
Mark Zandi: And when you say you'd wait for the inflation report, what-
Marisa DiNatale: Make sure that nothing looks to be concerning in that report following on this one and the PPI report and the strong jobs report that we got with wages accelerating. I think I feel pretty confident that all of these things that we've recently gotten that have run hot are sort of one-offs. And I wouldn't be too worried about it. So I'd be inclined to move sooner rather than later.
Mark Zandi: Right. Okay. Cris, what's your inclination?
Cris deRitis: I'm going to go with a 25 basis point cut in June.
Mark Zandi: June.
Cris deRitis: So, wait, be a little bit more patient here. Kind of building on Marisa's theme, just wanting to be sure. I think the downside risks are greater than the upside of cutting earlier. Yeah. But May, June, it's not a dramatic difference. That's my sense.
Marisa DiNatale: I also don't think cutting 25 basis points is that dramatic either, in either of those months. So even if you jump the gun a little bit, you cut 25 basis points and then you wait and see again, I don't think you're going to do a lot of damage with that small rate cut.
Cris deRitis: I don't know. I think that first cut is psychologically important, right?
Marisa DiNatale: That's true.
Cris deRitis: It's declaring the end of the cycle, right? It's that mission accomplished banner. So that's what I would worry about more than the size.
Mark Zandi: Presumably markets would take the one cut and say, oh, more coming, financial conditions would ease. So be very careful about that. You know what? I think I'm going to make the case they should cut now. I'm confused as to why we should wait. Here's the logic. The Fed is very close to achieving its mandate. It has two goals. One is full employment, the second is low and stable inflation.
And they define that as 2% on the core consumer expenditure deflator. On full employment, check, we're there, the 3.67% unemployment rate, that feels like full employment. It doesn't feel like we're beyond full employment that I don't think the full employment unemployment rate's four to four and a half. I think it's three and a half to four. That's consistent with everything we're observing with regard to wage growth and labor market dynamics. And the other thing is, I'd say it feels like the labor market is getting squishy to me.
You can see it in hours work, they've declined. You can see it in hiring rates, they've declined. You can see it in temp help, that's declined. You can see it in quit rates, that's declined back to pre-pandemic. Wage growth has moderated. The only thing that's kind of hung in there in the labor market, thank goodness, otherwise we would have recession is layoffs. They're low.
But everything else in the labor market feels soft-ish to me and suggests that we've got to be careful that we don't start seeing layoffs. So on full employment, we're there. On inflation, I keep going back to CPI inflation ex-shelter, 1.6% year over year. We're there and we all feel confident in our forecast. And this is more accounting than a econometric forecast that the cost of housing is going to slow. And we're going to get back to the Fed's target here in a reasonably graceful way over the next, certainly by the end of the year we'll be there.
And by the way, on a six month annualized basis, look at the core consumer expenditure deflator, it's 1.9% annualized. Maybe it'll be a little high in January. And I chalk that up to seasonals and noise more than signal. But nonetheless, I mean, on a six-month basis, we're already there. So inflation, it feels like all the trend lines are moving in the right direction and we're going to get there in a reasonably graceful way.
Inflation expectations, well anchored, no sign of either in terms of bond market expectations or expectations of consumers, we're there. Financial conditions, it feels not too hot, not too cold. The stock market's high, but bond yields are up. The 30-year fix is sitting at 7% plus, that's pretty high. That's still high on the high side. Financial credit banking lending has tightened up in the wake of their banking problems of a year ago.
The dollar is very strong. We're at 1.50 yen to the dollar. The yuan is low relative to the value of the dollar. So financial conditions kind of a wash. So you add this all up and you go, okay, I've achieved my goal. I'm there. In that context, why a five and a half percent funds rate target? Does that make sense to anybody? I mean, the Fed is saying the equilibrium rate, R star, the rate that's consistent with monetary policy and either supporting or restraining growth is two and a half.
But okay, maybe it's three, maybe it's three and a half, but still, five and a half? I mean, why? Why are we doing that? So I don't know. I think I just did make a pretty strong case for let's get going here. Come on already. And I agree with you. March, May, June, that's a couple, three months. I don't know that that makes a big difference in the context of the resilience of our economy.
But I'm increasingly nervous that these guys are going to make another mistake, the Fed. The Fed made a mistake on the other side of this. And I don't want to cast aspersion because this is a tough job. To get this right is not easy, but they got it wrong. They waited too long to raise rates back in early 2022. So they have a pension for waiting too long.
And I'm worried that they're going to do that again here. I know I'm feeding Cris's downside scenario, but that's why I was surprised you said June. They should go sooner rather than later. Not wait for something to go wrong, for something to break somewhere as a result of all this. Okay, I just said a lot. Anyone want to push back on that? Did I change anybody's mind?
Marisa DiNatale: Well, what about, I mean, the economy seems to be doing just fine at the Fed funds rate that we're at.
Mark Zandi: I'm not so sure.
Marisa DiNatale: It doesn't seem to be as sensitive to interest rates as we would've thought prior to the beginning of this cycle. So what's the hurry? And I'm actually not disagreeing with you. I'm just sort of maybe playing devil's advocate.
Mark Zandi: No, no, that's very fair. Well, I'd say I agree with you. That's why I think the equilibrium radar star is not two and a half. I think it's higher than that. I think it's three, could be three and a half. Not forever, but in the current next year, two or three, it's elevated for the reason you just expressed. But I sense some underlying weakness in the economy.
I just expressed it in the context of the labor market. I mean, we're one round of layoffs away from the economy really flipping here. And the other thing is you go look at, then you say GDP, but I'd say GDI, gross domestic product, gross domestic income. You've got to average those two things. And if you average those two things, it shows a more pedestrian economy, it doesn't show this economy is really strong.
And then I keep going back to if you have interest rates very high like this and short rates above long rates and the yield curve inverted, and it's still inverted, something in the financial system could break somewhere because you're putting a lot of pressure on the system and in the rest of the operating environment for the banks and financial institutions isn't all that great anyway.
I mean, slower loan growth, rising credit problems, higher regulatory costs. I don't know what that could be, but I didn't anticipate SVB a year ago either. And maybe the next thing that breaks isn't in the banking system where the Fed can get to it very quickly, it's in the non-bank part of the system, which is like, oh my gosh, how do I help that part of the system out in a reasonably graceful way?
So I'm saying, and why take that risk in the context of everything we know about what's going on in the economy? I have achieved my goals. Let's declare victory. Come on. And I'm not saying cut rates quick. I say cut rates quarter point, maybe once every quarter, start taking them down. And even if you do that, we don't get back to the equilibrium rate until the end of 2025 or early 2026, right? So anyway, Cris?
Cris deRitis: No, it requires a fair amount of nuance on the data though, right? To make that argument, right? You're going to say all the things we've been talking about in terms of the inflation report today, right? You've got to look through it. There's nuance here. There's a lot of technical detail. I guess strip it out. That may be a lot to argue here in terms of convincing market participants that inflation really is under control here, right?
You're making a case that the underlying inflation, I agree with you on this point, but still it's not showing up in the data quite yet. And what if-
Mark Zandi: Hold on.
Cris deRitis: What if owner's equivalent rent goes up seven tenths of a percent next time.
Mark Zandi: That's not going to happen. I mean, in all likely it's not going to happen.
Cris deRitis: Well, we could say it's coming down, it's coming down-
Mark Zandi: Actually, now this is to the Fed, what do you want? I mean, the core PCE over the last six months is 1.9% annualized. What do you want? What is it that you want exactly? Do you want it to be 2% year over year for three years before you cut interest rates? I mean, what's the bar? I mean, yes, every month to month thing goes up and down and all around.
And yes, you're going to have ... we know the seasonals are playing havoc with the data, especially in the month of January to the economic data. We know this, we know this. So what do you want exactly? What's your bar? And I'm just saying my bar, I'm over it. I'm over it. Let's go, baby. And I'm not saying slash interest rates, I'm saying cut them a quarter point and indicate that we're going to cut a quarter point every quarter, unless the data really does, inflation expectations to rise or growth starts to re-accelerate or whatever it is.
But what is it that you need to convince you that we're there? We've done what we need to do. Anyway. As you can see, I'm gearing myself up here for ... I'm writing a piece. This is the argument. This is the argument.
Cris deRitis: That's what you think they should do. What will they do?
Mark Zandi: Oh, they won't do what I just said. Yeah. I mean, our forecast is May, the market is putting some, what, a third probability on May, maybe two thirds, I'm making this up, two thirds on June. That's probably a pretty good forecast of what the Fed's going to do at this point. But as we can see, that thing can move rapidly with one release. So the next release, if it's down or up, we could change the dynamics here very quickly.
All right. Thank you for giving me the opportunity to vent like that. I've been venting this whole podcast, but I really appreciate that opportunity. But anything else, guys, before we call it a podcast? Matt, good job on the rundown. Cris, Marisa, anything? And we'll get Ryan Sweet on. It's your job, Cris. Got to get him on.
Cris deRitis: Will do. Will do.
Mark Zandi: All right. Very good. All right. With that, we're going to call it a podcast. Thank you for paying attention to us, dear listener. Talk to you next week. Take care now.