The disappointing March report on consumer price inflation is the fodder for this week’s Inside Economics podcast. The team considers just how big of a disappointment it was, and conclude it turns on second and third significant digits. Yes, that’s what it has come to when assessing just when Fed officials will feel sufficiently confident that inflation is headed back to their target and begin to cut rates. Of course, there are threats to the inflation outlook, most immediate being higher oil prices, which the group takes up.
The disappointing March report on consumer price inflation is the fodder for this week’s Inside Economics podcast. The team considers just how big of a disappointment it was, and conclude it turns on second and third significant digits. Yes, that’s what it has come to when assessing just when Fed officials will feel sufficiently confident that inflation is headed back to their target and begin to cut rates. Of course, there are threats to the inflation outlook, most immediate being higher oil prices, which the group takes up.
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 group of my colleagues. My two co-hosts, trusty co-hosts Cris deRitis and Marisa DiNatale. Hi guys.
Cris deRitis: Hey, Mark.
Marisa DiNatale: Mark. Happy Thursday.
Mark Zandi: How are you guys doing? Happy Thursday. This is a rare Thursday taping of the podcast. We normally do this Friday. Why'd we do this on today?
Marisa DiNatale: To accommodate my travel schedule.
Mark Zandi: Oh, where are you headed?
Marisa DiNatale: To Philadelphia for the All-Hands Day, but I'm going tomorrow.
Mark Zandi: Yeah, we have our All-Hands Day next week. So you're coming early.
Marisa DiNatale: Yeah, I'm coming early to see friends over the weekend. And then I'll see everybody-
Mark Zandi: All of us.
Marisa DiNatale: ... on Monday. For the first time in four years.
Mark Zandi: Everyone going to be there? I should say we also have Chris Lafakis and Matt Colyar. You see how well I did that, Matt?
Matt Colyar: Nailed it.
Mark Zandi: I nailed it.
Matt Colyar: I'll be there.
Mark Zandi: You'll be there. Chris, Mr. Lafakis, you'll be there as well?
Chris Lafakis: Oh, yeah.
Mark Zandi: Okay.
Chris Lafakis: Wouldn't miss it.
Mark Zandi: Good. Should be good. This is our second All-Hands Day since we went fully remote. Or we've been fully remote since the pandemic, but officially fully remote. I think this is number two, right? Isn't it the second one?
Cris deRitis: Yes.
Mark Zandi: Yeah. Okay. And I was just talking to Carl, my brother, and he was saying who runs the joint? And he was saying, you guys have big parts, don't you? Chris and Marisa, you have big parts in this thing. He's got a big question.
Marisa DiNatale: Yeah.
Chris Lafakis: Oh, yes.
Marisa DiNatale: He's going to put us on the spot. Right?
Mark Zandi: Right. What's the world going to look like in 20 years? Not next year, not 10 years. I go, "Carl, why 20 years? Why not not 10?" He goes, "Well, 10's too soon." I go, "Really? Okay." Okay. Very good. Well, safe travels.
Marisa DiNatale: Thank you.
Mark Zandi: Yeah, I just flew today.
Marisa DiNatale: I guess I'm the only one here traveling.
Mark Zandi: I flew today from San Francisco. I was on a plane.
Marisa DiNatale: Oh. Okay.
Mark Zandi: With no internet, which is-
Cris deRitis: Beautiful.
Marisa DiNatale: Is there ever reliable internet on... I have yet to actually purchase internet on an airplane and have it work.
Mark Zandi: No, no, no.
Marisa DiNatale: To the point where I can work.
Mark Zandi: Really? You should [inaudible 00:02:26] up.
Marisa DiNatale: Never. Ever. Ever.
Mark Zandi: No, no, that's not true.
Cris deRitis: No. Usually it works very well.
Mark Zandi: Yeah, it works very well.
Marisa DiNatale: It's like you can get onto VPN and you can-
Mark Zandi: Yes.
Cris deRitis: Yeah.
Marisa DiNatale: I've never had that successfully happen on American Airlines.
Mark Zandi: I can simulate the macro model. No, I've never had a problem. Maybe it's those planes that fly out of LAX. I don't know.
Marisa DiNatale: I don't know. Okay.
Mark Zandi: Anyway. Well this is a big week, right? We got the Consumer Price Index for the month of March. CPI a really important statistic in the context of well, everything. And it was a bit disappointing, wasn't it, Matt?
Matt Colyar: Yeah, it was. That's however [inaudible 00:03:02].
Mark Zandi: Especially for you. It was really disappointing.
Marisa DiNatale: Especially for you.
Mark Zandi: For you in particular personally, it was very disappointing.
Matt Colyar: Yeah. I've come to terms with it. I think. [inaudible 00:03:10]
Mark Zandi: I haven't.
Cris deRitis: I haven't.
Matt Colyar: Okay.
Mark Zandi: I tweeted it out. I was so confident in your 0.2, you're going to have to explain what I mean by 0.2. But anyway, tell us about the report. Why was it so disappointing?
Matt Colyar: And I'll say too, I made the mistake of reading the comments to that Twitter post of yours, which was not wise.
Mark Zandi: Never do that.
Matt Colyar: Yeah, I wouldn't do it again. Yeah, but jumping into it, the headline CPI in March rose 0.4%. Our forecast, consensus forecast, was for a 0.3% increase. So hotter than expect it again, which is a familiar story. In 2024, the annual rate, the 12-month rate for headline CPI rose from 3.2 to 3.5%. I would say that that's maybe a little overstated. There are some base effects.
Even if CPI came in as we expected, it still would've lifted the annual rate. But nevertheless, disappointing report prices were moderating gracefully in 2023. That seems to have stalled at the start of 2024. Moving into some of the big components, energy price.
Mark Zandi: Did you say Core, what was Core?
Matt Colyar: Core rose 0.4% as well.
Mark Zandi: That's Core meaning X food and energy, which is we look at that because it's, we think, sort of the underlying trend in inflation.
Matt Colyar: And that's one because it's the underlying trend. And it's also the more painful spot here, because that was the 0.2% you're referencing, that was the forecast that we put out that was a little bit lower than consensus. Consensus was at 0.3. A lot of rounding up. So very close to 0.2, but 0.3, and we'll get into-
Mark Zandi: 0.2 just for the listener. The difference between 0.2 and 0.3 is like night and day. I'm giving you a hard time, but you'll thank me for it 10 years from now.
Matt Colyar: Yeah, I appreciate that. So, if-
Mark Zandi: Let me ask you this, Matt. So Core came in at 0.3 and to the second significant, was it no points?
Marisa DiNatale: It was 0.4.
Mark Zandi: 0.4, I'm sorry, 0.4. Consensus was 0.3 and we were at 0.2. And can I also ask on the 0.4, was that rounded up to 0.4? Do you know?
Matt Colyar: Yeah.
Mark Zandi: It was rounded up I think. Okay.
Matt Colyar: .36 was the actual-
Mark Zandi: Or something like that.
Matt Colyar: Was it to the second digit.
Mark Zandi: You see what we've come to? We're focused on the second and third significant digit here. But anyway, this is really instructive. Why did we think it was going to be 0.2, and it came in at 0.4? Explain the difference, what was the error?
Matt Colyar: So there's the big components that go into Core CPI, shelter, famously has been slow to moderate. So we expect rent prices to come down, and they are-
Mark Zandi: But hold on, hold on. That wasn't the cause of the error.
Matt Colyar: No, we're nailing that. So is the question why did I come in at 0.2 or what-
Mark Zandi: Yeah, why did we say 0.2, and the actual was 0.4? What was the reason for the difference?
Matt Colyar: The biggest is auto insurance.
Mark Zandi: Let me put it another way. You screwed up.
Matt Colyar: Sure.
Mark Zandi: Screwed up.
Matt Colyar: Right.
Mark Zandi: And I want to know why.
Matt Colyar: Well, I'm doing gymnastics to minimize the mistake. But the biggest is auto insurance. Auto insurance is-
Mark Zandi: There we go. Okay.
Matt Colyar: ... jumped by 2.6%, which is bigger than any monthly increase during supply chain crunch in 2021, 2022. Insurance premiums, if you look back to 2019, are 40%-ish higher than late 2019. Car prices are about 20, 25% higher for new and used vehicles. So there's this expectation, especially after some moderation in February, that auto insurance, and this goes to auto repairs too, makes sense why they tracked for a while, but there's this expectation it should start to roll over now that they've... Premiums represent what insurance companies have to pay out now that cars cost more.
So that 2.6% increase, even if you don't hear a lot about the CPI for motor vehicle insurance, mouthful as it is. But it is a big part of household budgets. It gets a big weight. We thought there would be an increase, but a much more modest one. We were about two percentage points low. And that's the bulk of our forecast miss, which is I think like a lot of people. But that's about half of our miss on Core CPI.
Mark Zandi: Oh, go ahead Marisa.
Marisa DiNatale: Do you know how important it is to Core?
Matt Colyar: To Core, it's-
Marisa DiNatale: Like it's that big of a weight that-
Matt Colyar: A little over 3.5% would be my guess. It's 2.5 I think for headline.
Mark Zandi: Yeah, I think it's 2.5 in the total. So the Core would be-
Matt Colyar: So maybe a little [inaudible 00:08:17]
Mark Zandi: 3.5, maybe?
Matt Colyar: Yeah, I guess 3.5, but I would say between 3.0 and 3.5.
Mark Zandi: When I say 3 and 3, so the listener, 3.5% of the Core CPI Index, and we're making that up, but roughly right. 3.5% Of the Core CPI Index is the cost of-
Marisa DiNatale: Auto insurance.
Mark Zandi: ... vehicle insurance. And then if you throw in vehicle repair, which is also I think part of the error, I think you're now closer to almost 6% of the, 5.5% of the Index, or Core CPI Index, something like that. So it's small, but it's not inconsequential. When you get a big number, big increase and you do the multiplication, it adds, it's not tenths of percentage point, but it's enough of a basis point difference that explains 0.2 rounded down versus 0.4 rounded up. You see what I'm saying?
Matt Colyar: Right.
Mark Zandi: But actually this conversation is quite interesting in the sense that it shows you how we're parsing the data here. Parsing the data very finely to understand what's going on.
Cris deRitis: You know the old joke about economists and sense of humor, right?
Mark Zandi: Yeah. What's the joke?
Cris deRitis: How do you know an economist has a sense of humor?
Mark Zandi: How do you know?
Cris deRitis: They use a decimal point. So imprecise. "We're going out to the second [inaudible 00:09:42]."
Mark Zandi: I forgot that joke. That's a good joke. Yeah, it's a very good joke.
Cris deRitis: And true, very true.
Mark Zandi: I was going to say, what was I going to ask? Oh, but my proclivity is to think that inflation is coming in. And I look at that data and I think to myself, well, and I think you mentioned this, the cost of vehicle insurance and maintenance is very closely tied to vehicle prices. So vehicle prices are higher and they surged during the pandemic.
And for new vehicle prices up until this past couple months they've been surging. Then the high vehicle insurance and maintenance costs reflect those higher vehicle prices. So if vehicle prices start falling, that would suggest obviously with a lag that it will take steam out of the cost of insurance and maintenance. Is that roughly right?
Matt Colyar: Yeah, I think so. And it makes the acceleration that much more surprising. The catch-up has happened, and it is a lag, but it starts to show signs for auto insurance, the signs of moderation. And now there's this big strong pick up in March, which was definitely a surprise.
Mark Zandi: And vehicle prices both new and used fell in the month of March, right?
Matt Colyar: Right. So used vehicles fell about a percent, 1.1%. From February to March, they're down almost 2%, relative to a year earlier. New vehicles fell again. And that's five of the past six months, monthly declines in new vehicle prices. And they're about flat when you compare them to a year ago. So hard to argue, unless insurance premiums were really under-counting some kind of risk in their payouts for claims, that this divergence between a 40% increase in insurance premiums and a 20% increase in cars, reasonable to expect that gap won't continue to widen. So the increase in March, it stinks and it explains a big forecast miss, but I don't think representative of more cyclical consumer spending type of inflation that really concerns Federal Reserve and predict is a lot more persistent.
Mark Zandi: Okay. So people are listening to this and we're really into the weeds, and I may not be exactly following along with everything we're saying. But the bottom line here is the difference between the 0.2 and the 0.4, 0.4 of a hair on fire. Markets are selling off, people are changing their forecast for the Fed. If it came in at 0.2, it would be the exact opposite. The market would be taken off, lots of green, bond yields would be falling.
And you're saying to me, and this is how am I hearing it, that the difference between the 0.4 and the 0.2 is vehicle insurance and maintenance costs and those things probably should be declining, and probably will be declining in the not too distant future, because they're tied ultimately to vehicle prices and they are now falling. And they're falling more fundamentally. So right? Do I have it wrong?
Matt Colyar: I agree with the explanation of bad, but it's not a three-alarm fire.
Mark Zandi: What about a two-alarm fire?
Matt Colyar: There's one fire alarm going off, I would say.
Mark Zandi: Okay. I wouldn't even turn on the alarm, but okay, you're saying one. Okay, well that's instructive. Okay. So there's one other point about this you have made to me in email conversations, is the difference between the way vehicle insurance is calculated in the CPI, the Consumer Price Index, and the way it's calculated in the consumer expenditure deflator.
And just for the listener, it's the consumer expenditure deflator, another measure of inflation, that's what the Fed ultimately is looking at when setting policy. Their target is 2% inflation on the Core, excluding food, energy, consumer expenditure. So what's the difference there and what are the numbers like?
Matt Colyar: So the direct mapping for what goes into the PC deflator, the inflation measure that the Fed target, actually comes from the Producer Price Index that has as granular detail as the Consumer Price Index, but for businesses. So we see intermediate products, final and demand products, the stuff that businesses pay to each other to make their goods and services.
And the PPI for auto insurance is what gets mapped and goes into the PC deflator. And that rose just 0.1% in March. We got that data this morning. That's a significant difference from the 2.6% increase in the CPI's measure of auto insurance. And there's already been this widening between CPI, or more specifically Core CPI and Core PCE, in a way that's made the Fed a little bit more calm about these hot CPI prints because it's not what they're focusing on.
And I think the, not just shelter, but now what we see with auto insurance, are two factors that juice the CPI report but don't necessarily translate into a PCE deflator, and could potentially or are likely to widen this gap that we see between the two. And make it not so simple to say inflation has stalled entirely, or is re-accelerating, because the other measure is not subject to the same type of jumps like we've seen in the CPIs.
Mark Zandi: Do you know offhand Matt, you said the PPI is being used for the consumer expenditure deflator. What is the Bureau of Labor Statistics using for the CPI when they measure vehicle insurance? Do you know?
Matt Colyar: That's a good question. I don't, offhand.
Mark Zandi: Can you find that out for next time? Because that's a big difference. 0.1 versus 2.6, the CPI measure is 2.6% increase. The PPI measure is 0.1. That's a big difference.
Marisa DiNatale: And I wonder if that kind of suffers from the same thing we've seen with shelter inflation, right? Is this long lag to kind of incorporate more current changing conditions into the CPI? When you buy a vehicle or you get auto insurance, usually you're doing that once a year or once every six months that your rate might change. So I wonder if there's a similar timing component with that as well.
Matt Colyar: Interesting.
Mark Zandi: Yeah, Matt, maybe you can investigate that too. I don't know the answer to that. We now have the Consumer Expenditure deflator coming up that's going to be released. Is that next week? Next Friday? Two weeks.
Matt Colyar: Two weeks. Two weeks later than usual in the month.
Mark Zandi: Okay. And now we have CPI for the month of March. We now have PPI for the month of March. What are those two things imply for the Consumer Expenditure deflator for March that's going to be released in two weeks. Do you have an estimate for that?
Matt Colyar: Early estimate is 0.3%, if we're just rounding to one decimal point, 0.3% growth for both the PCE deflator and the Core PCE deflator. We have a good amount of input data and understand how the PCE weighs certain things. So that'll be the expectation now. And again, we're talking tenths of percentage points, and that's more encouraging.
Mark Zandi: Okay. If you go to the second digit, what is it?
Matt Colyar: On the low side. I want to say we're rounding up from 0.27. We would round up to 0.3 for the Core PCE. So there's a bias towards the lower end. So maybe I'll talk myself into rounding down again and stick my neck out there.
Mark Zandi: Don't do it, Matt. Don't do it.
Matt Colyar: For all the nice people on Twitter.
Mark Zandi: You did notice on my Twitter feed, by the way, at Mark Zandi, just saying, I did call you out. I said, "My crack team of economists." That's you.
Matt Colyar: Sure. I like it.
Mark Zandi: You and Justin and the team. But I jest, of course. Forecasting this stuff month to month is crazy hard. There's so many variables and moving parts and the differences we pointed out between 0.2 and 0.4 boils down to who knows what. So very difficult to do. Any other component of the CPI release that surprised you both, let's say on the upside or the downside? Let's begin with the upside. Any other component surprise you?
Matt Colyar: On the upside, I think, surprising or not, I think it's a good story. And that's when you kind of lump in grocery prices, new and used vehicles, which we touched on. Airfares, hotels, they're cyclical. When consumers are lining up to buy these things, prices get bid up and consumers line up to buy those things when they're taking home stronger wages. So they are a proxy for the kind of demand that's really hard to bring out of the economy.
And in those elements and across those categories, prices were either flat or declined as we saw with new and used vehicles. I think that's a positive story. On the negative side, which has its own implications for the PC deflator, but medical services, we have a 0.6% increase in March, which was a little bit above our expectations. Not a huge miss, but it's given a lot of weight.
It's more the trend and then kind of the underlying dynamics in healthcare that I think make it one of the few components that we're forecasting stronger growth in 2024 than we did in 2023 marginally. But most things are moving the other way. Kind of structural stuff. Healthcare prices are set far in advance. It's very labor-intensive. Hospitals, nurses.
Hospitals have a really hard time staffing their operations famously. And those increased labor costs are starting to flow more and more into prices. So I think you're going to see pretty sturdy medical care or healthcare inflation over the next year, and it's getting significant weight. So I think it's going to come under a lot more scrutiny and I think we see that in March with a 0.6% rise. So those are two things that I would touch on.
Mark Zandi: And just as a point of interest, the weight of medical care in the CPI is lower, much lower than it is in the consumer expenditure deflator, the PCE. Because the CPI is out of pocket and we tend to use insurance and other things. And so it has a smaller rate in the CPI. Okay. Marisa, anything in the CPI report that you want to call out that Matt didn't focus on?
Marisa DiNatale: We mentioned shelter, it's good that it didn't accelerate, I guess. It's just hanging in there. It's not coming down, it's not accelerating.
Mark Zandi: It's coming down. It's coming down, no? I think it's coming down.
Cris deRitis: The rate of growth, then. The rate of growth for revenue.
Mark Zandi: The rate of growth, yeah.
Cris deRitis: 0.5 to 0.4. So yeah.
Mark Zandi: It's moving. Okay. Right? No? Yeah. Okay.
Marisa DiNatale: Yeah.
Mark Zandi: I'll take it.
Marisa DiNatale: 0.4 is lower than 0.5.
Mark Zandi: Yeah. Right, right. Okay.
Marisa DiNatale: Yeah. But it's still too strong.
Mark Zandi: Too strong.
Marisa DiNatale: And we still are not seeing this real definitive slow down that we're hoping to see. And it's still 60% of the change in CPI every month.
Mark Zandi: It is a big part of the story why it's still-
Marisa DiNatale: It's the biggest part of the story still. Right? So that's where we really need to see the movement.
Mark Zandi: Right. Cris, can you just, we've done this ad nauseum, but it's so complicated. I keep forgetting, exactly. How do you explain, what's your favorite explanation for why it's taken the cost of housing services to slow down? It's slowing, it's moderating continues to moderate. But very, very slowly. More slowly than one would expect based on historical leads and lags. What's your pet explanation for what's going on there?
Cris deRitis: Pet explanation? Well, I guess we're talking about rent of primary residence specifically versus the owner's equivalent rent?
Mark Zandi: Both. I think both. Both.
Cris deRitis: Both, okay.
Mark Zandi: Yeah, right.
Cris deRitis: But just on the rent, straight-up rent, should be easy to measure. I think it is, but I think we have some compositional issue. A lot of rental is on the lower end perhaps, and that is a segment of the market that continues to have some significant demand. So it's possible that that's preventing that rental growth from receding as fast as we might see when we look at market rents. I don't know. It comes down to how the sampling would be done. The rents only change once a year typically. So there's some lags here in terms of how those rental effects are incorporated in the CPI.
The owner's equivalent rent, and we've already talked about this in the past, I think that has more methodological issues just in terms of how you estimate a rent for someone who's owning their own home based on rental properties in their similar market. You can try to control for other factors, but it's still, at the end of the day, a pretty complicated process. And I don't think we have sufficient data in a lot of markets to really nail that down properly.
Mark Zandi: So the way I articulate it, and let me do it and tell me I've got this right, is we've got an affordable housing shortage. We've got a very severe shortage of homes at lower price points for lower rent. High end of the market, much less so. Particularly in the rental market. We've got a lot of units coming on. Vacancy rates are rising, rents are a lot weaker. But we have a lot of strength at the low end because of the shortage.
But when the BLS tries to calculate in many markets, all they have is there isn't enough variety in the housing stock in the areas that they're looking at that. They're using the rental measures for the affordable part of the market for the rest of the market. And therefore it is making it look like rents across the market are stronger than they really are. Did I get that roughly right?
Cris deRitis: That's right. For the owner's equivalent rent.
Mark Zandi: For the owner's equivalent rent. Yeah.
Cris deRitis: I think that's right. I think that's a reason to explain why that's been stickier than we might've expected. The rent of primary residence though is a bit different, right? There we don't have that issue. We're just counting. So it could be the compositional effect again, that there just is more demand at that lower end of the market and that's skewing the overall picture.
I guess the mystery is why is that so persistent relative to what we're seeing on new leases? If you look at all the other market data, leases are flat, even down in certain markets. Apartments, even single-family homes are much weaker than what the CPI would suggest.
Mark Zandi: All right. Well, the way I frame this conversation around the cost of housing and what it means for overall inflation, is we've been talking about the so-called harmonized CPI. The harmonized CPI excludes owner's equivalent OER. In fact, in many other parts of the world, particularly in Europe, the statistical agencies there don't include OER because they throw up their hands and say, we can't measure this.
It doesn't provide any real information. It's not useful as a guide towards inflation. And the Bureau of Labor Statistics has been publishing a harmonized CPI now for some time on an so-called experimental basis. They're not out there. I don't think it's in the press release, but you can Google it. You can say BLS harmonized CPI.
If you look at the harmonized CPI, this was going to be my statistic for the game. But I'm going to give it up right now. If you look-
Cris deRitis: I would've gotten it.
Mark Zandi: Oh, well, let me ask the group in another way. What do you think Core meaning X food and energy harmonized, excluding OER, CPI growth year over year through March was? What do you think that was? Anyone?
Marisa DiNatale: 1.9%.
Mark Zandi: Yeah. 1.9. 1.9.
Marisa DiNatale: Is that right?
Mark Zandi: Exactly right.
Marisa DiNatale: That was a guess.
Mark Zandi: Was it a guess? You said it was.
Marisa DiNatale: It was. I didn't know that.
Mark Zandi: Oh yeah, 1.9.
Marisa DiNatale: It was an educated guess.
Mark Zandi: Yeah. Yeah. And it's been 2-ish or below for more than a year. For more than a year. And this is on the CPI, not on the consumer expenditure deflator. Right? So that is below Fed target. Below Fed target. So the only thing keeping inflation, Core inflation, underlying inflation from the Fed's target, or below the Fed's target, is the growth and the cost of housing services. Which we all, in one way or another, saying we can't measure it.
We can't measure it. Anyone want to disagree with that comment? No? You agree?
Cris deRitis: We can't measure it well.
Mark Zandi: You can't measure it well enough, so it provides any information that's useful. Particularly in terms of understanding what's going on with inflation and how monetary policies should be set. Let's put it that way. Disagree with that?
Cris deRitis: No.
Matt Colyar: What about super Cores rise of late?
Mark Zandi: Who cares? Everything else is this washes out. Things go up, go down all around. But we want to get to... The question is, the question, the fundamental question, is what is underlying inflation? What is abstracting from the vagaries of the data, the volatility in the data, methodological issues? What is underlying rate of inflation? And I would posit the best measure of that is the harmonized Core CPI. That feels like to me the best benchmark of underlying inflation.
Chris Lafakis: So Mark, if someone gets a new loan and it's 6% or 7% and their cost, their monthly mortgage payment is elevated relative to the other guys that got in at 3 or 4%, we have to include that in the overall inflation estimate, right? It's a cost.
Mark Zandi: I'd say, Chris, this is what I'd say, Chris. If you could do that, well, I'm all in. If you can't do that well, you're just screwing things up. You're just messing with things. You're obfuscating what's going on underneath. So I'd say we want to get a measure that we feel confident in is giving us a sense of underlying inflation. And that to me is saying we're there. We're there. I don't hear any strong objections to that. No? Okay. All right. You're not convinced. And of course, that view I'm expressing is certainly not the consensus view, I don't think. I don't think.
Chris Lafakis: Yeah, I don't think so. I think the Fed is looking more at super Core and Core.
Mark Zandi: Well, this is what I get irritated about this whole... People say, and I won't call out names, but other economists, they get mad. They get annoyed when you start saying, don't include this, don't include that. They say you're just cherry-picking. And then they go, "Well, what about super Core?" I go, "Come on. What are you talking about?" It's like, come on. I find that really annoying, highly annoying. Anyway, I'm just trying to find the truth here, guys. Right? Trying to find the truth.
Marisa DiNatale: Speaker of truth.
Mark Zandi: The speaker of truth. Okay.
Marisa DiNatale: Speaker of truth.
Mark Zandi: Okay, well you heard Chris Lefakis's voice and we brought Chris on because something we haven't talked about yet. But the thing that worries me the most about inflation and the economy going forward is energy prices. Oil prices more specifically. And they have moved up quite a bit and they contributed to top line inflation, and it has lots of implications for Americans. You pay more at the gasoline pump.
In fact, I think, Chris, correct me if I'm wrong, but you go back a year ago or so, we were kind of in the, for a barrel of oil in the $70s, firmly in the $70s, probably the low $70s. Now we're in the high $80s, somewhere around there. So the question is, Chris, what's behind this run-up in oil prices, and should we be fearful that we're going to see further increases in oil prices going forward here? So what do you think?
Chris Lafakis: Yeah, so I do think that we will get an increase in consumer energy prices, regardless of what happens to oil prices, just because of seasonality. We are entering a period of high demand in the Northern Hemisphere. And if you look at so-called crack spreads, these are the difference between wholesale petroleum product prices, like diesel, jet fuel, kerosene, motor gasoline, and oil prices. These typically expand in the summer driving season.
And the effect is significant. It could add as much as 20 or 30 cents per gallon to the price at the pump. So even if oil prices stay where they are right now, on a national basis, we are at $3.63 cents for a gallon of gasoline. That's as of today. We're recording this on April 11th. And if you add that 20 to 30 cent seasonal increase in the crack spread, just those two factors alone, if oil prices stay where they are, we're going to get awfully close to $4 per gallon nationally.
And there's some states that will absolutely breach that threshold. And that's a very important psychological threshold. So we are going to flirt with that. I think in the summer month, you'll absolutely see some states will go above $4 per gallon. The hope is that it is temporary. We do believe that it will not be a persistent increase on a national basis because we expect oil prices to come in, not by a lot, but maybe $2 to $3 from where they're currently at. And I'd be happy to talk about why oil prices have increased and what our outlook is going towards.
Mark Zandi: Before you do that, because you brought it up. So what you're saying is oil prices today are $85 to $90 a barrel. WTI, West Texas intermediate, it's $85. I'm waving my hands here. $90 on Brent. And at that $85 to $90, right now we're at $3.63 for a gallon of regular unleaded. Even if oil prices stay where they are, which is what we're expecting, but even if they stay there, you're saying gasoline prices, cost a gallon of regular unleaded, is going almost to $4 over the next couple three months. That's what you're saying?
Chris Lafakis: Yes. In some states definitely will reach that threshold. And nationally we're going to get awfully close. And perhaps there's going to be a day or two where we do get over $4, just because of the day-to-day fluctuations in oil prices, retail and crack spreads. So we're going to get awfully close to that $4 threshold nationally, and certainly will reach it in some states.
Mark Zandi: Yeah. Okay. And going back to oil, why were prices so... I think the surprise last year, and this was I think one of the reasons why the economy did as well as it did surprisingly, was oil prices were low. They actually fell for much of the year. I think, as I said, we were firmly in the $70s on WTI and Brent. And now we're in the high $80s. What happened? What's going on?
Chris Lafakis: Well, I think we can thank US shale producers. They had a banner year. Prices are still above their breakeven cost of extraction. Interestingly enough, we just got a data point from the Dallas Fed. Every year they conduct their energy survey, and in March they ask a special question to all the producers in the state, is at what price can you profitably drill? At what price at WTI can you profitably drill a new well?
We were expecting that cost to increase. It was $66 in the Permian Basin in last year's survey, and now it's gone up to $70. So that is an increase. And it's just like we're talking about, well, it costs more to make a house. It costs Americans more to make a car. You have to pay workers more, and it costs more for equipment, and to lease rigs in order to establish new sources of production as well.
And that's where the $4 increase in the Permian Basin comes from. And the Permian, by the way, it is the marquee place to drill and provider of the marginal barrel of oil on the global market. So that is increased. But still, if you compare $70 to where we're at right now, $85 for WTI, it's still profitable for US drillers to establish new sources of production.
And I think I've gotten a little bit more optimistic over the last month or two on the US capacity to bring new barrels online, because prices have risen. And part of that is because OPEC, what OPEC has signaled. But that should help us to put a cap almost on oil prices, or at least prevent them from going over $100, barring some kind of geopolitical catastrophe.
Mark Zandi: So you're saying, really, the swing producer here is the North American shale producers, the frackers. Last year in 2023, they ramped up production dramatically. As I recall, they increased production by about a million barrels per day to over 13 million barrels a day. And just for context, the globe produces and consumes a little over 100 million barrels a day. 13 million. That's a record high. And that's higher than anyone else on the planet. I think the Saudis are now, because of their cuts, down to what, 8, 9 million barrels a day? Something like that.
Chris Lafakis: Nine, yeah.
Mark Zandi: And they were able to do that last year because they took out of mothballs a number of wells that they had started but never completed. But they completed them and produced a lot of oil. All that oil came onto the market, more than offset the production cuts by the Saudis, and the effects of the sanctions on Russian oil. We had a surfeit of oil and that kept prices down. But here we are today, the North American producers are still ramping up production, but not nearly to the same degree. And we're still getting more global... Global demand continues to improve for oil. Is that roughly right?
Chris Lafakis: Precisely. And all of that growth in global oil demand is coming from emerging markets. So if you look at OECD countries, oil demand in those countries is relatively flat.
Mark Zandi: Or here in the US it is been down. Is it even rising here in the US now?
Chris Lafakis: Yeah. You cherry-pick beginning and ending points, but yeah, you could say that. And that's just industrialization of emerging market economies. India, China, Southeast Asia, and that train has left the station. So every year we need to come up with an additional 1 to 1.5 million barrels of supply.
And the US carried the bulk of the load in 2023. But they did that by drawing down on their inventory of uncompleted wells. These were wells that were started maybe during the pandemic, but were not completed. And what I mean by that is you can drill a hole, but it's not going to produce oil until you frack it. And fracking it is actually two thirds of the cost of establishing production.
So if you just drill the well and then you don't do anything with it, you can keep that as kind of inventory. But you have to pay Baker Hughes or Halliburton or companies like this in order to frack it. That's two thirds of the cost. So they've been reducing their inventory of drilled, but uncompleted wells substantially in 2023.
And actually right now we're at the lowest levels of inventory on record. And that series goes back to 2014 for drilled but uncompleted wells. So the theory is that US production will slow because now all of a sudden you have to come up with an extra third of the cost in order to establish new production.
Mark Zandi: Did I hear you right? The so-called DUCs are at a record high? I thought we broke those down.
Chris Lafakis: Record low.
Mark Zandi: Oh, record low. Okay, fine. Okay. Record low.
Chris Lafakis: Yeah, they're lower than they have been at any point in the series going back to 2014. And so now what that means is you have to actually rent the rigs and drill the holes in addition to fracking. And that extra cost of establishing production is something that we expect to weigh on production growth in the US in 2024.
Now, it certainly helps when oil is at $85 than when it is at $70 or $75 like it was a year ago. And I think that that's gotten me a little bit more optimistic about the US. And our forecast actually calls for prices to fall by $3 or $4, even while OPEC production remains at its current levels. Because OPEC has decided over the past two years to bring in quite substantially their oil production. They have in effect seeded market share to non-OPEC producers, especially the US where most of that production is going.
The levels of excess capacity, meaning how much oil production Saudi Arabia could bring online. And really, I mean it is OPEC's spare capacity, but Saudi Arabia, it counts for the lion's share of that. That excess capacity stands at above 5 million barrels per day. That is historically very high. It has been very difficult historically for the cartel to maintain this level of discipline for such a long period of time.
But they have signaled to the market that they don't intend to unwind production cuts, at least in the foreseeable future. That has caused oil prices to rise. That's been the main contributor to the rise in oil prices. Also, we've gotten past a period of weak seasonal demand. Also, there's geopolitical concerns with the war between Israel and Hamas and how that might conflagrate and spread to Iran-Israel conflict as well. So there's really a number of factors that have contributed to the rise in oil prices.
But an old adage, the cure for high prices is high prices. So it has given producers the opportunity to establish new sources of production. And I feel good about the US adding maybe 300,000 barrels per day to a half million barrels per day in 2024. And I would say if you asked me the same question a couple of months ago, I would've said 250,000 to 350,000 barrels would be my estimate. So there is kind of a silver lining to the increase in oil prices that we've experienced in recent months.
Mark Zandi: Okay, so what you're saying is last year production increased dramatically in the shale fields because they had all these DUCs sitting out there. What does that stand for? Drilled but uncompleted?
Chris Lafakis: Drilled but uncompleted well [inaudible 00:42:57]
Mark Zandi: Yeah, and they just took them out of mothballs. They fired them up and produced a million barrels more of oil a day. That's done. Inventories of DUCs are at a record low. They can't really go there anymore. But prices are up. We're in the high $80s, and according to Dallas Fed breakeven is $70. So you can make real money at that, at the current price. And therefore they're going to start drilling more wells, putting more rigs in the ground and start investing more because they can make money at doing it. And they feel reasonably confident because OPEC is not going to start pumping a lot of oil. In all likelihood, the Saudis are going to keep production where it is. And there's no confidence in this at all, but they're reasonably confident that they're going to get that price.
Chris Lafakis: Yeah, absolutely. I think what becomes more imperative is the Baker Hughes rig counts, and they were kind of less important in 2023. They were actually, just to go into the weeds a little bit more, they're actually an input into the EIA's model to forecast real time oil production on a weekly basis. There's a weekly petroleum status report that comes out every Wednesday at 10:30, and they estimate US production.
And part of an input into that model is Baker Hughes rig counts. And so the EIA was estimating low levels of production because no one was drilling in 2023. But in fact, production from the actual hard data was substantially higher because they were using DUCs to establish new source of production. They weren't drilling as much.
I think now with the inventory of DUCs depleted, the rig counts become a little bit more important than they have been over the past nine months or so. That's not to say that DUCs can't continue to fall, it's just that it becomes much harder to rely on that as a source of production when inventory levels are so low.
Mark Zandi: Have you noticed any pickup in rig counts yet?
Chris Lafakis: Not substantially. So just a little bit, but it's something that I'm keeping a close eye on.
Mark Zandi: And you expect it to happen?
Chris Lafakis: I think it will happen. I think especially with what's happened over the past month, month and a half or so, and it does take some time for it to show up in rig count. So basically the sequencing is that prices have to rise. A CEO has to decide we're going to drill more. Two months later after they make that decision, you would see it in rig counts.
And then in additional two to three months, you would see it in actual hard production data. So there's a bit of like a sequencing that we have to go through. We haven't really felt the full effects of the recent rise in oil prices on rigs and subsequently drilling, but it's going to play out over the spring and into the summer.
Mark Zandi: Chris, the other fact, and you mentioned this, but just to put a finer point on it, the unrest in the Middle East, you can notice day-to-day movements and oil prices are closely related to events in the Middle East. Right now they feel a little bit juiced because of the concern that Iran is going to retaliate for the Israeli bombing that occurred a week or two ago. And everyone's kind of on edge and wondering what that means. What kind of premium is built into the price for that kind of, let's call it geopolitical risk, do you think?
Chris Lafakis: Yeah, I think it is substantial. I think it's around $4 to $5 per barrel. Just because Iran is a major oil producer and we're moving into this conflict situation. And then there's also the impending invasion of Rafah, which could cause geopolitical issues for Israel as well. So I think the market participants are viewing this, and they're viewing the attacks on oil containers that are moving through the Red Sea, and they're assigning a risk premium on that.
And it is not just the premium, but it also affects dollars and cents. Because many shippers have chosen to go around the Cape of Good Hope instead of travel through the Red Sea. And that adds not a huge amount of time and money to shipping routes, but it has a marginal effect, maybe of $1 or $2 per barrel because the transportation has gotten more expensive.
Mark Zandi: Okay. All right. Okay. So the bad news is that gas prices are going up. That's baked in. It's going to happen. Because as you get into the summer months, the crack spreads, the margins that refiners get will rise. And it reflects the mix of gas that has to be produced. The good news is that you think we're at the peak in terms of oil prices because we will get more production, particularly coming out of the shale fields, that will be sufficient to meet the demand. And even more fundamentally, there's still a lot of excess capacity out there. So prices start to rise to any significant, if we get into the $90s, then the pressure, the economic pressure for OPEC to start cheating on its quotas will be such that we'll get more oil. That's in a nutshell what you're saying.
Chris Lafakis: Yeah, absolutely. And people like Iraq are more likely to cheat in that scenario. I do think the range for Brent is between $75 and $95. And I would agree that we are at the higher end of that range currently.
Mark Zandi: Yeah, we forecast lots of stuff. Some I feel pretty confident in. Inflation is going back to the Fed's target. Some not so much. Like oil prices, which a lot of intrepidation there. Okay, anything else on oil? We didn't even go into natural gas, but we're getting long in the tooth here. Any other burning points you want to make, Chris, before we move on and play the stats game?
Chris Lafakis: No, I think there's uncertainty with the forecast, but we are forecasting for prices to kind of tread water and fall down. And that's it in a nutshell. And I'm happy to play the game.
Mark Zandi: Okay, let's play the game. 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 is not so easy, we get it quickly. One that's not so hard, we never get it. One that is apropos to the topic at hand is really, really good. And Marisa, you're up. You always lead on the stats game. So here's your chance, what's your stat?
Marisa DiNatale: Okay, my stat is 7.37%.
Mark Zandi: The second significant digit. Is that important? The second significant digit? It is. Oh, okay.
Marisa DiNatale: I think so.
Mark Zandi: Okay. Inflation-related?
Marisa DiNatale: Not directly. Indirectly.
Matt Colyar: Year over year?
Marisa DiNatale: No.
Mark Zandi: Is it a growth rate?
Marisa DiNatale: No.
Cris deRitis: Is it a share?
Marisa DiNatale: No.
Mark Zandi: Oh, my gosh. It's not a share. It's not a growth rate. It's not a percent of any type.
Matt Colyar: Is it mortgage rates?
Marisa DiNatale: Yes, it's the prevailing mortgage rate at the end of the day today.
Mark Zandi: But you see how she does that? It's just not fair what she's doing. I object, strenuously.
Marisa DiNatale: What do you object to?
Mark Zandi: I say, is it a percent and you delay.
Marisa DiNatale: I didn't say no.
Mark Zandi: Well, that's my point. You didn't say yes.
Marisa DiNatale: So the number I put forward was 7.37%.
Mark Zandi: Oh, you did?
Marisa DiNatale: So yes, it's a percent. I thought that went without saying.
Mark Zandi: Oh, okay. Sorry, I apologize.
Cris deRitis: Answer the question.
Mark Zandi: I fell down. I didn't hear the percent. It was a percent. Okay.
Marisa DiNatale: Oh, okay.
Mark Zandi: I missed it. Sorry. Anyway.
Marisa DiNatale: I did say it.
Mark Zandi: You did. I'm sure you did. Yeah. Did she say it, guys? Did she say it? Did she actually say it?
Cris deRitis: Yes.
Mark Zandi: Roll the tape. Roll the tape. Okay. Well, that's a good one. The fixed mortgage rate. Why'd you pick that?
Marisa DiNatale: Yeah, it's back up above 7%. It jumped on the CPI report, along with bond yields in general, when the CPI report came out. So we didn't really talk about this, what our expectations are for what the Fed is going to do. But the expectation now in the market is that there won't be a rate cut soon, right? There won't be a rate cut in the next couple of months given the hotter inflation data. So the 10-year treasury yield higher, it sent mortgage-backed security yields higher, it sent mortgage rate higher. All up the curve. Not good.
Mark Zandi: Yeah, not good. What do you think, Chris? 7.37, what kind of damage is that going to do to the housing market?
Cris deRitis: You are still out of the money, right? You were out of the money before, so I don't know that that doesn't help, certainly, but I don't know that it changes a lot of the supply dynamics. But more on the affordability side, right?
Marisa DiNatale: It's just like if there's a psychological break going, jumping above seven. When it went above, people have these whole numbers in their mind.
Mark Zandi: That was my thought. I think anything over seven, the market goes into a deep freeze. Anything south of six that feels like life comes back to the market. But yeah, that's a good one. Good one. Good one, Matt. Good, good, good get. Why don't you go next, Matt? You're up next.
Matt Colyar: 4.7%
Marisa DiNatale: CPI-related?
Matt Colyar: No.
Marisa DiNatale: PPI?
Matt Colyar: No.
Mark Zandi: Inflation-related?
Matt Colyar: [inaudible 00:53:12]
Mark Zandi: Labor market related?
Matt Colyar: Yes.
Mark Zandi: Okay.
Marisa DiNatale: Wages for something?
Mark Zandi: No. Atlanta Fed Wage Tracker.
Matt Colyar: That's right. Yeah. So the three-month moving average of annual wage growth as measured by the Federal Reserve Bank of Atlanta.
Mark Zandi: Okay. How well do you know that data?
Matt Colyar: The composition of it?
Mark Zandi: Just how it's constructed. Do you have a good sense of the data?
Matt Colyar: I know that it's timely. And I often reference it for that reason. But it's down from 5% in February to 4.7% in March. It's the lowest rate since late 2021. So I think that's a positive story. Very hard to continue having these above target inflation if wage growth continues to lower and lower. So I think it's a good story there. It's still too high, but it's trending in the right direction. And in a week of not the most encouraging data, I think that was a positive spot.
Mark Zandi: Doesn't the Atlanta Fed track individual workers? And I think from the CPS data. The CPS data?
Marisa DiNatale: They use the CPS.
Matt Colyar: That sounds right. [inaudible 00:54:25]
Mark Zandi: They calculate a median. So they look at the entire distribution and then they look at the median in that distribution. And also they do three month moving average, and they do 12 month moving average, something like that. To smooth out the volatility. Because I'm sure there's a fair amount of volatility. Which is the control for mix issues because following the same worker. So it makes it valuable.
And they also have all these demographic breaks, parts of the wage distribution, male, female, age, switchers versus people who are staying on the job, all those kinds. And then by region, they do it by region as well. So it's pretty cool data. The thing though is does the level of the growth rate matter? Because 4.7% is higher, meaningfully higher than the 4%-ish we were getting on the average hourly earnings.
And I think the ECI, the Employment Cost Index, which we all look at as well, and that's generally taken as the gold standard for wages, for measuring wage growth. That's closer to 4 by some of the measures. The difference between 4 and 4.7. Again, the theme of this whole podcast is we're parsing everything down to decimal points here.
But that could be material, right? In terms of is that consistent with the 2%? What's consistent with the 2% inflation target? 4.7% probably isn't, right? Because 4.7, 2% inflation, let's even say 2% productivity growth, that's more consistent with 3% inflation than 2%. You see what I'm saying? You see what I'm saying? So does the level matter here or not?
Matt Colyar: That's tough to say, but I would say the trend is-
Mark Zandi: Trend is good.
Matt Colyar: And to me that's the encouraging part of it. But 4.7% is not what the Fed estimates to be compatible with their targets. So there's that issue. But it's not the primary wage measure they're looking at. But I think it declines, and a pretty consistent decline in the first quarter is encouraging, levels aside.
Cris deRitis: Is the Atlanta Fed tracker consistent? Historically, has it always been higher? If you go back?
Mark Zandi: I don't think so.
Cris deRitis: Okay.
Mark Zandi: Not to my mind's eye.
Cris deRitis: All right.
Marisa DiNatale: The construction of that has its biases in it too.
Mark Zandi: [inaudible 00:56:56] Marisa?
Marisa DiNatale: Well, in order to be counted in there, as you said, they're looking at the same worker, right, in this month. And then they're going eight months out and looking at that worker again. You have to have a job in both. They're using the CPS, so you have to be employed in both places, which inherently there's a bias there because it's not going to pick up on people that are new entrants into the labor force, or people that may have been out of the labor force and come back in and are going to get these big wage gains. It tends to over-sample older workers, they think. For that reason, people that steadily have the same job over and over. So that can bias the estimates of wages on that one.
Mark Zandi: Is your sense is it would, in the current context that it would be biased higher relative to actual?
Marisa DiNatale: Well, I don't know. I think there's an argument, I'm not sure, because I haven't dug into this. But you could argue it would actually bias it lower. Because if you're a more experienced worker and you have the same job, you're not getting big increases in your pay year after year. Right? You're much more likely to get a big bump in pay if you go from nothing to something. Or you switch industries presumably, or you... So I don't know. I think it could depend on the time period we're in, but I could see an argument for it actually biasing it down too.
Mark Zandi: Okay. Yeah, this wage checker has been bothering me a little bit because it's on the high side of, it's not consistent with the 2% inflation [inaudible 00:58:44]. It's more consistent with the 3% inflation, which is kind of sort of where things are stuck. So if you buy into the Atlanta Wage tracker, you're saying, oh, inflation is not going to get back to 2. At least not unless the labor market eases up, and we get further deceleration of wage growth here. All the trend lines look good as you point out. They're decelerating, which is good. There's no reason to expect that that's going to stop. But nonetheless, it's been bothering me a little bit. Well, that's a good one. That was a good one. Okay. Chris L, you're up.
Chris Lafakis: Okay. My number is 24.
Mark Zandi: 24.
Cris deRitis: Inflation related?
Chris Lafakis: No, it's energy and a little bit politics.
Cris deRitis: Oh.
Marisa DiNatale: 24. Are there any units on that?
Cris deRitis: No.
Chris Lafakis: Yeah, it is a [inaudible 00:59:42]
Marisa DiNatale: That's what the guess is.
Mark Zandi: There's 24 of them?
Marisa DiNatale: Right. And we have-
Chris Lafakis: Yes.
Mark Zandi: There's 24 of something, is that right? 24 of something?
Chris Lafakis: Yes.
Mark Zandi: Energy related political. There's 24 states?
Chris Lafakis: Yes.
Mark Zandi: Okay.
Chris Lafakis: Yes, that's right.
Mark Zandi: 24 states where gas prices are above $4?
Chris Lafakis: Were above $4. But that's incredible. Mark. Yes.
Mark Zandi: I love being described as incredible. I love that.
Marisa DiNatale: I should get the cowbell out for that one. That was [inaudible 01:00:21]
Cris deRitis: I think you mispronounced, that's incredulous, right?
Mark Zandi: Yeah, exactly. Incredulous. Yeah.
Chris Lafakis: There were 24 states in which gas prices were $4 or more two months before the last midterm election in which the Democrats did well. I'm trying to give you a little bit of solace Mark, because gas prices I know are a key factor in our presidential election model. And they could swing the election one way or the other. And so I went back at the last midterm election to determine how many states were gas prices above $4 a gallon, and it was 24.
And still, I think by all intents and purposes, the midterm election was either a draw or a win for the Democrats based on basically what the polls were indicating. So I think that it is certainly something for us to pay very close attention to in terms of the elections that are coming up in November. But regardless of the energy climate, I think that there's still some substantive issues that will decide the outcome of the election.
Mark Zandi: So what's your gas price forecast for November for the election?
Matt Colyar: $3.70. No, $3.62.
Mark Zandi: Oh, really? Okay.
Marisa DiNatale: There was a tipping point in the election model, Mark, where if it-
Mark Zandi: Yes, Brendan, our colleague who has been working on this with Justin Begley, Brendan Lacerda, calculated it's $4.09. So if oil prices average $4.09 for three months, not for a day or a week. So that means it's going to be well into the $4s, I would think for some period of time. All else being equal, that flips the election results. We are currently given Chris's forecast of $3.62 forecasting Biden wins with 308 electoral votes. But if it goes to $4.09 on average in the second quarter of the year, then all else equal, it goes to Trump. Trump will win. So that's how close it is.
Matt Colyar: That $4.09 was January, February, approval ratings and consumer sentiment type of inputs too. Do we think that has changed?
Mark Zandi: No, it's all else equal. For consumer sentiment and approval, we're just taking the current value as the forecast. No change there. But the approval rating doesn't matter in the model. And consumer sentiment doesn't matter all that much either.
Matt Colyar: Conference Board?
Mark Zandi: That's in, yeah, but you have to go read the paper. I don't want to go down the rabbit hole. Those aren't particularly useful in trying to understand how this things. The other thing that will swing it though is mortgage rates. Anything over 8.00, that'll swing it, all else equal. So if you go to, let's say you go to 7.75 and a gas goes to $3.90, well then I'm making that up, but the model probably would, it could flip at that point. So it's very close. It's very close. All right. Let's do one more. Cris deRitis, what's your statistic?
Cris deRitis: 88.5.
Chris Lafakis: Is it an participation rate of some sort?
Marisa DiNatale: Is it a diffusion index?
Cris deRitis: No.
Mark Zandi: Inflation-related?
Cris deRitis: What did you ask for, Chris? It's not inflation-related.
Chris Lafakis: Is it a rate?
Cris deRitis: It's not a rate.
Mark Zandi: You said a participation rate. That's what Chris said. Chris L. said that.
Chris Lafakis: It's not a rate.
Mark Zandi: It's an index?
Cris deRitis: It is an index. Came out this week.
Mark Zandi: ISM didn't come out this week. Oh, NFIB?
Chris Lafakis: NFIB?
Cris deRitis: NFIB. Small-
Mark Zandi: I'm just saying I've been pretty hot.
Marisa DiNatale: You're killing it.
Mark Zandi: I'm killing it.
Marisa DiNatale: You're on fire.
Cris deRitis: Yeah, Marisa, what's going on? It's an off week, Marisa?
Marisa DiNatale: I'm letting my boss win because I'm going to see him next week.
Mark Zandi: Please do. Anytime you want to do that, feel free. Feel free. I have no problem with that. I'm just saying. Yeah. Lefakis would never do that to me. But you'd ground me into the dirt if you could.
Chris Lafakis: We'll play the game.
Mark Zandi: Yeah, yeah.
Chris Lafakis: Best man wins.
Mark Zandi: All right, Chris D, why'd you pick that one?
Cris deRitis: It is very low. It's lowest level since-
Mark Zandi: Yeah, what the heck?
Cris deRitis: ... December of 2012. Small business owners are nervous. At least according to the survey, they're saying they're not particularly thrilled about the economic prospects. They're feeling pressure on their sales. They still have problem hiring or finding high quality workers. So something to bear in mind. At least the small business community is signaling that things are not so-
Mark Zandi: Do you read much into that though? Really? It's like the University of Michigan Consumer Sentiment survey.
Marisa DiNatale: I think it's got a political bent to it as well.
Mark Zandi: Yeah, very political.
Matt Colyar: Pretty empirically. It's dramatic swings by who's in the White House.
Mark Zandi: Really?
Matt Colyar: Yeah. Yeah. More than the University of Michigan, which they've all become a little bit more partisan, but NFIB, for sure.
Mark Zandi: Yeah. I don't know. That's interesting though. I did notice, I was looking at one of your decks that you put together, that business formation, which has been very elevated since the pandemic hit. That is starting to come off the boil a little bit.
Cris deRitis: Yes. It's not a whole lot, but it's down every year.
Mark Zandi: It's still high. It's still high, but it's coming down a bit. It's coming in. Do you think, well, I was going to ask another question, but we're already pretty long. I thought we'd end the... And I already gave you my stat, the 1.9, so I played out. So let's go to the last part of the conversation what this all means for the Federal Reserve in markets.
And as we were discussing earlier, the hot 0.4% increase in CPI, a hair on fire. I think the stock market sold off over 500 points on the Dow. Did you see the 10-year treasury yield? I think it increased like, I don't know, 20 basis points or something. Some crazy increase.
Marisa DiNatale: It's almost at 5%.
Mark Zandi: No, it's a 4.50. 4.5% on the 10-year.
Cris deRitis: 4.56.
Mark Zandi: Is it 4.56?
Cris deRitis: 4.56.
Mark Zandi: Let me turn to you, Cris. What did the CPI do to expectations for the Fed? If I go look at the futures markets, what are they saying?
Cris deRitis: Yeah, I pushed them out. So June had been the, I guess the mode or the median up until the CPI came out, and now that's off the table and they're pushing out the expectation to September for the first cut. It looks like two cuts this year, September and December.
Mark Zandi: Yeah. Do you have probabilities? Any sense of probabilities? If not, no worries. If you don't remember. Is it now basically the markets don't think there's any chance for a June rate cut?
Cris deRitis: One in five.
Mark Zandi: Oh, one in five. Okay.
Cris deRitis: Yeah, and that's the shift from... It was only about 55% before yesterday's data. And they're starting to be a shift a little bit away to begin with, but it dropped from majority to 20%.
Mark Zandi: Is the preponderance of the probability now in September as opposed to, because there's a meeting in July too, right?
Cris deRitis: Yeah, July is a slight majority is expect another pause. And then in September is when you start to see it tip to the majority of participants. It gets a little convoluted over time where people are going to be, but the majority of the investors expect at least one cut in September.
Mark Zandi: Okay. So it gets over 50% probability at the September meeting.
Cris deRitis: Right.
Mark Zandi: Okay. I think we'll have to sit down and discuss this, but I think we're definitely going to push out when we have our first rate cut. I would argue September, right?
Cris deRitis: Yeah.
Chris Lafakis: In terms of the OER component, does the 7.37% level on the fixed mortgage rate boost that and to what extent?
Mark Zandi: No. No. It is not the mortgage payment, Chris. It's the equivalent rent. So not directly. Maybe over a long period of time it has some impact, but not directly. Then if you go to Canada, if you go to the Canadians, and the way we used to calculate it here was a mortgage payment. So if the mortgage rate increased, the mortgage payment would increase and that would show up in the CPI. But that changed here when Chris? Back in the '80s or something.
Cris deRitis: '84, '83?
Mark Zandi: Yeah, something like that. But the Canadians still do it that way. So you have to be careful when you look at the Canadian data. And the Europeans throw it out altogether, remember they harmonized, so they don't pay any attention to it.
Cris deRitis: UK too.
Chris Lafakis: In terms of financial markets, it looks like the financial, they'll handle it reasonably well, maybe sell off a little bit, but as long as they're convinced that the next move is down instead of up, they'll handle it gracefully. But if for whatever reason they think that more hikes would be necessary, then that would be like a DEFCOM scenario for future markets.
Mark Zandi: Yeah, it's a whole different ballgame. Let me to that end, turn it back to Cris deRitis, what would it take for the Fed to actually begin cutting rates? It feels like, to me, they're focused on the inflation statistics at this point. They're not really focused on the job numbers anymore. They feel like the job market has cooled off. We are getting very strong job growth, but it's okay because we've got all this labor supply.
Unemployment is actually notched a little bit higher here, and wage growth is normalizing. So they're not worried about that. But they're really worried about the inflation numbers. Are they coming in or not? Are we stuck at 3% or are we going to two? And what is it do you think they would need to see to convince them that yeah, we are going to two, sufficiently so that they start cutting interest rates, which we're saying by September this is going to happen. Do you have any sense of that?
Cris deRitis: My sense is they need to see three, four months of consecutive trend down in the inflation rate that we are clearly on the path towards that 2% target. Right? No stalling out, just very, it doesn't have to be immediate, but need to see those 0.2, 0.1% prints. You got to get that direction in there.
Mark Zandi: Yep. That's my thought. It feels like they need three months that average out to 0.18%, so that's what they need. Something like that. You can get a 0.2, but you need a 0.1 thrown in there and you need it three months in a row, and that's how you get to September, right?
Because you get an April, May, June, you're going to get one bum month in there, July, that takes you to September. Maybe July. Maybe, but you got to have pretty good luck here to get 0.2s and 0.1s for the next three months.
Cris deRitis: And I think it has to be definitive to really make the case for July. It has to be even more of a downward slope.
Mark Zandi: I guess that could change if something breaks in the economy or we start to slump, which is possible. I don't know if you noticed, but our tracking estimate for GEP now is in the low ones. I don't know if you noticed that. So it feels like things cooled off here pretty significantly coming into-
Cris deRitis: Yeah, well, policy misstep is our number one risk, right?
Mark Zandi: Yeah. Yeah, exactly. Right. Okay. All right. Marisa, anything you want to add on that on the Fed front? Say that three times fast.
Marisa DiNatale: No, it's becoming increasingly more difficult for them, I think, to navigate this. And now we're looking at potentially a first move that's right before the election too.
Mark Zandi: Oh, that's a great point. That's a great point. Let's say they get the three consecutive months of 0.2, 0.1, and now you're looking at September. Maybe decide to wait until... The November meeting is right after the election. Right?
Cris deRitis: Right. Yeah.
Mark Zandi: Do you really want to-
Marisa DiNatale: It's like the day after or something.
Mark Zandi: Yeah. Do you really want to get caught up in the politics of that? That's a really interesting point.
Matt Colyar: But isn't pausing a political consideration for the independent central bank?
Mark Zandi: Yes. Great point. Great point.
Cris deRitis: You're damned if you do.
Mark Zandi: But it's easier to not, if you move, that's different than if you don't move. Right? I guess it depends on how definitive the data is. If the data's screaming at you, "You morons, we're a target and you're taking a chance here." Then they got to go. You're right. But if it's not screaming at them, you're a moron, then maybe they wait.
Marisa DiNatale: Yeah. But I think that the odds that you get that this very smooth, consistent month after month deceleration and inflation are low, given what we saw. You could have made the, well, you did make the argument that they could have moved on the data at the end of 2023 [inaudible 01:14:27] board rates and they didn't.
Mark Zandi: They didn't.
Marisa DiNatale: And then they'd be in this situation where they would've moved and then they would've had hot inflation readings. Right?
Cris deRitis: Are you arguing for November, December, Marisa, for first cut?
Marisa DiNatale: No, I'm not arguing that they what they should or shouldn't do. I think what I'm arguing is that I think it's unlikely that they're going to have from here on out inflation readings that are 0.3, 0.2, 0.1. I think that's unlikely. And so then they're going to be in this position where, well, it depends how you read it. If you take this out, if you do a three-month moving average, if you take a six-month moving average.
Mark Zandi: You go to the second decimal point.
Marisa DiNatale: You go to the second decimal point and you round up or you round down, I don't think it's going to be as clear cut as what they would like it to be.
Mark Zandi: I tell you what though, I suspect it's also not going to be clear sailing on the economy either. Something's going to happen somewhere. We're going to get a really slope significant. I think the probability that we slow down is much greater than we re-accelerate here, or something breaks in the financial system because you've got this inverted curve. The Feds got its foot on the brake. It just feels like, and then you're going to say, okay, do I really need a 0.18? Maybe I can live with a 0.23, something like that, and I can cut.
I don't know. It's going to be interesting though. Okay, very good. Anything else, guys? Before we call it a podcast? I think that was very informative. And Matt, I was just pulling your, I think there's a phrase called pulling your chain, right? Isn't that?
Marisa DiNatale: I think so. That there is, yes.
Mark Zandi: It's funny, when I say these sayings and I start thinking about them, I go, is that really a saying? That ever happened to you? Pulling your chain? No?
Chris Lafakis: I think so.
Mark Zandi: This is the same thing as your password. Once you start thinking about your password, you go, oh, what's my password? I can't think of my password. You go into a panic mode, right, because you just type it. You don't even think about it. And then once you started thinking about it, you go, oh my gosh, what is it? Is that just me or is that everybody?
Marisa DiNatale: I do that with my home address.
Mark Zandi: Oh, do you really?
Marisa DiNatale: Yeah, the starting numbers, I start questioning-
Mark Zandi: Well, that's weird. Marisa, I'm just standing there for you [inaudible 01:17:01]
Marisa DiNatale: When I say it out loud, I'm like, that doesn't sound right. Is it a four or a three?
Mark Zandi: Something's wrong, Marisa, something's wrong.
Marisa DiNatale: It could be.
Mark Zandi: Could be.
Marisa DiNatale: I'm [inaudible 01:17:10] Out.
Chris Lafakis: I do it with my age.
Mark Zandi: That too. Yeah, that too. Yeah. Isn't it like the Heisenberg principle or something? Whatever you focus on, you mess with it.
Marisa DiNatale: Makes sense.
Mark Zandi: I don't think that's the Heisenberg principle.
Marisa DiNatale: I don't know. Is that something you just made up?
Mark Zandi: See, I could have. I could have. Exactly. That's exactly it. All right. Anyway, we're going to call this a podcast. Take care, everyone.