Mark, Marisa, and Cris are joined by their colleague Matt Colyar as they delve into the resilience of the U.S. economy. Matt kicks off the conversation with a rundown of the latest Personal Consumption Expenditures (PCE) inflation data and its implications for monetary policy. Following a brief, engaging Stats Game, the team explores the reasons behind the U.S. economy's rapid and robust recovery compared to the rest of the world. The discussion concludes with answers to audience questions, focusing on the implications of quantitative easing/tightening and the predictive power of the yield curve.
Mark, Marisa, and Cris are joined by their colleague Matt Colyar as they delve into the resilience of the U.S. economy. Matt kicks off the conversation with a rundown of the latest Personal Consumption Expenditures (PCE) inflation data and its implications for monetary policy. Following a brief, engaging Stats Game, the team explores the reasons behind the U.S. economy's rapid and robust recovery compared to the rest of the world. The discussion concludes with answers to audience questions, focusing on the implications of quantitative easing/tightening and the predictive power of the yield curve.
Guests: Matt Colyar – Assistant Director, Economist - Moody's Analytics
Hosts: Mark Zandi – Chief Economist, Moody’s Analytics, Cris deRitis – Deputy Chief Economist, Moody’s Analytics, and Marisa DiNatale – Senior Director - Head of Global Forecasting, Moody’s Analytics
Follow Mark Zandi on 'X' @MarkZandi, Cris deRitis on LinkedIn, and Marisa DiNatale on LinkedIn for additional insight. For more on Jonthan Smoke Click here
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. I've got Marisa DiNatale, and Cris deRitis, my two co-hosts. Hi guys.
Cris deRitis: Hey Mark.
Marisa DiNatale: Hello.
Mark Zandi: And Matt Colyar. Matt Colyar.
Matt Colyar: There you go. That's good.
Mark Zandi: I'm sorry, Matt. I'll never get this right. Matt Colyar. Good to have you, Matt.
Matt Colyar: Great to be here, nice to see everybody.
Mark Zandi: How's everybody doing?
Cris deRitis: Good.
Marisa DiNatale: Very good.
Cris deRitis: Doing well.
Mark Zandi: We got a big conference coming up next week in DC. I know Cris, you'll be there.
Cris deRitis: I'll be there, we were preparing yesterday for it.
Mark Zandi: Yeah. And what will you be talking about at the conference?
Cris deRitis: I've got two sessions. One is on productivity, the mono a mono debate with Dante DeAntonio about the trajectory of productivity going forward. Kind of touched that on the podcast before. And then a second session on housing, we got a great housing panel so we'll be discussing some of the trends there.
Mark Zandi: Yeah, I think it's a great agenda, because I drew it up, but I thought it was pretty good. We're going to talk demographics, with Laura, Cat, Ratz, and Adam Kamens. So immigration, all the foreign immigration and internal migration flows. We got Wendy Edelberg from Brookings on, she's going to talk about fiscal policy and immigration. She's done a lot of good work there. What else? What other sessions do we have? Oh, geopolitical hotspots with Eric Gaus and Steve Cochrane, because we have some cool data that we pulled together on trade flows and see how that evolves over time, bilateral trade flows. So, that's going to be pretty interesting as well. But yeah, I think it's going to be a great conference. We'll miss you, Marisa, at this one, but-
Marisa DiNatale: Yeah, I'll see you out here in LA, Orange County.
Mark Zandi: In LA, yep. Looking forward to that.
Cris deRitis: Yeah, we'll see you.
Mark Zandi: Yeah, good. Well, it was an action-packed week on the economic front. We got another look at GDP for the first quarter, but I think the real headline was the data that came out this morning. This is Friday, May 31st, on consumer spending and of course inflation, the consumer expenditure deflator, the preferred inflation measure the Fed looks at when setting policy, that's their 2% target. And Matt, I thought you've done a lot of good work here on the harmonized deflator. Maybe you can give us a sense of those numbers.
Matt Colyar: Yeah, so starting with month-over-month growth, the headline-
Mark Zandi: Bottom line, good or bad? Quick.
Matt Colyar: Good.
Mark Zandi: Good, okay. All right, that's what I wanted to hear. Okay.
Matt Colyar: Four letters or less.
Cris deRitis: Yeah, right.
Mark Zandi: Go ahead.
Matt Colyar: So, the 0.3% growth in the headline PC deflator from March to April is market expectations, what everybody typically assumed, this data point comes out later in the month. We have a lot better read from the CPI, from the PPI, so a little easier to be accurate. Of course, surprises still occur. So, the headline PC Deflator was unchanged on an annual rate. So 2.8% year-over-year growth, which is the same as March. And then the core PCE deflator, the most important metric of any inflation metric from the Feds perspective, that rose 0.2%. So, that's the good news. If I'm characterizing this report is a good one it's because of that slowdown from 0.3% growth in March to 0.2% in April. I will say that we were a little bit lower than consensus, this came in where we expected where consensus was closer to 0.3%, although it was-
Mark Zandi: Oh, was it? Consensus
Matt Colyar: ... kind of on the razor's edge. And to be there teasing this out a couple of decimal points, April's growth was 2-4-9, so 2-5, but then rounds back down to 0.2, so about as close as it can get but-
Mark Zandi: Oh, was it that close, really?
Matt Colyar: Yeah, it was close.
Mark Zandi: Hold on, wait. So the core, excluding food and energy, personal consumption, expenditure deflator was up 0.249 in the month of April?
Matt Colyar: Yeah, so-
Mark Zandi: Oh, wow.
Matt Colyar: ... as close as it gets, which Dante says he would round that up to ... He's a teacher, so if somebody had an 89.49, he rounds that up to an A or a 90. So, this is like a philosophical debate we have, and it came to fruition with this core PC data, which is interesting. But so year over year-
Mark Zandi: So, we knew it was going to be close. And of course the consensus, as you said, was waffling between 0.2 and 0.3. So, it was going to be on the bubble, so it was dead on expectations even though it got rounded down to 0.2.
Matt Colyar: Right.
Mark Zandi: Got it.
Matt Colyar: Yeah. Relative to a year ago, it's 2.8%, and that is the same as March as well. And I misspoke, I'm sorry. Headline PC is 2.7%, core PC is 2.8% relative to a year ago. So again, if this is getting characterized as a good report, I think that's the story. I don't think it's an abundantly positive one, but after first three months of 2024, real fear that potentially inflation was accelerating, I think between April's CPI report and April's PCE deflator report, I think we could be really confident, and I think we were all along, but everybody should be pretty confident that inflation is not picking up in 2024. This is the kind of moderation that everybody was hoping to see, even if it wasn't a blowout report that is going to inspire the Fed to cut at June's meeting or anything.
Mark Zandi: Can I say, a couple other measures of inflation that I look at, one is harmonized, and we'll come back to that in just a second because you've done a lot of good work around that in constructing an estimate of that for the consumer expenditure deflator, the PCE deflator. The other is, I don't know if you look at it, market-based measures of inflation, because there's a lot of components of these inflation measures that are imputed. They're not measured by looking at actual prices out there in the marketplace. If you look at the market-based measure, which presumably is a more accurate measure, less subject to the vagaries of the data month-to-month, I saw that, that's even more benign, I think. In fact, I think that was up in the month 0.17, core market-based was up 0.17, and year over year up 2.5. Two questions. One, do you look at that measure? Do you put weight on that measure? And second, or you take as much solace as I did in that increase?
Matt Colyar: I don't focus on it a ton, not for any particular reason, but when I break down the imputed stuff, so housing, I get a sense of what that would look like so I don't spend as much time focused on those numbers, but it is encouraging. So, the 2.5 market-based PC year-over-year growth is, spitting distance that's maybe the upper bound of the Feds' target range, and the core market-based PC deflator is right there as well. So, it's definitely an encouraging story.
Mark Zandi: Marisa, do you look the market-based measures at all? You do.
Marisa DiNatale: Yeah, I actually just started looking at them recently, just given all the debate about all the imputation that goes on in these, and there's quite a lot in the PCE. They include payments that businesses and governments make on behalf of other people, for example. So, they're trying to capture the price of, let's say prescription drugs that an insurance company is footing for the consumer. They use that kind of stuff, in addition to the OER measure. So, I think it is-
Mark Zandi: The owner's equivalent rent.
Marisa DiNatale: ... instructive. Yeah, the owner's equivalent rent, which we've talked about a lot on the CPI front, but the PCE in particular does a lot of that third party imputation. So, the market-based measure takes some of that out.
Mark Zandi: Right. And then the other measure I mentioned, harmonized, do you want to explain that, Matt, and the work you've done there?
Matt Colyar: Yeah, and this mirrors what other countries do. That's the motivation too, to put this kind of measure together. So, in the European Union to standardize inflation, what they landed on was a measure inflation that excludes, doesn't consider owning a home as a cost in the way that the BLS does, which has been a really stubborn inflationary point in the U.S. and isn't actually a cost that anybody pays. So, what does inflation look like in the U.S. if we just ignore that? Because the Fed targets the PCE deflator, we went-
Mark Zandi: So you're saying, okay, take the PCE deflator and throw out the owner's equivalent rent, the implicit cost of home ownership. And that's the so-called harmonized PCE deflator. And that's being used in other parts of the world, in most other parts of the world. And so, what are those numbers?
Matt Colyar: So there, expectedly, because shelter inflation has been really slow to come down, it's a more encouraging story, and that measure is up 1.6%, which is well below where the Fed would need to see inflation before they started loosening policy. And-
Mark Zandi: Year over year-
Matt Colyar: Year over year-
Mark Zandi: ... 1.6%.
Matt Colyar: ... and 0.2% growth monthly. So, implicitly what that tells you is that shelter continues to rise faster if you're removing it and you see a slower rate. So housing services, the PCE for housing services rose 0.4% in April, harmonized metrics removes that, and you're looking at much more modest 0.2% growth. And then the core harmonized PCE deflator also rose 0.2% and was up 1.7% year over year. So, if we were to make inflation, the Fed's inflation target consistent with European measures, we'd be loosening policies. It's from the initial building of that metric was the glaring conclusion to me. But of course, which I think you guys did a great job talking about a few weeks ago, the credibility story, can't move on because of that. But it gives a good sense of the idiosyncratic stuff behind inflation's still elevated level.
Mark Zandi: In the BLS, the Bureau of Labor Statistics, they publish an experimental harmonized CPI consumer price index, harmonized core consumer price index, but they don't ... Or the BEA, the Bureau of Economic Analysis that puts the PCE deflator together does not calculate a harmonized measure. And you have done that. That's the work that you've done, and that's what you're articulating right now.
Matt Colyar: That's right.
Mark Zandi: Yeah, okay. Cris, you wrote this op-ed with ... A opinion piece with Jim Parrott, and I wrote it the other day and been trying to get it published in a paper, a newspaper, and I sent it to you for comment, and you liked it. Thank you. My interpretation of your comments back, but you said something I didn't know. You said that the European Central Bank, ECB, actually would prefer to include owner's equivalent rent in their measure, that they exclude it because not all the countries involved can measure it. But if they had their druthers, they would actually include it. Is that right?
Cris deRitis: Yes, that's what they've said in numerous policy papers, and speeches and whatnot. Yeah.
Mark Zandi: Recently though? My question is maybe was that before all this mess with regard to OER? Or is it after all this? Is it more recently they've been saying this?
Cris deRitis: Certainly post-pandemic they've continued to mention it, but they're taking their time. They're saying conceptually it makes sense, it's a part of the economy, it's a part of consumers world. Homeowners also have expenses and whatnot, so they want to capture that piece. But to your point, the real issue is how do we measure this properly consistently? So that's my interpretation, that they're taking their time to really research and figure out what is the best method here. Because the OER, there are other methods you can consider. Consider acquisition method where you ... That's more based on the house price itself and just looking that changes in house prices. The BLS doesn't adopt that, or prefers the OER because that also includes not only the cost of housing services, but also an investment component. There's an appreciation of the home, so they want to control for that. So yeah, ECB I think would want to consider OER, or the cost of homeowners housing, but they haven't figured out yet what the right measure is.
Mark Zandi: Yeah, if you'd asked me before the pandemic, or even until recently, should we include OER in an estimate of inflation as a basis we're trying to determine the appropriate interest rate monetary policy, I would've said yes. But given what we've learned over the last year, or two, or three, and given the topsy-turvy housing market, I mean, we're in a very bizarre situation, affordable housing shortage, interest rate lock, lots of things are going on that really are messing with the ability to measure what's going on here. I'm now of the mind that in the current context in trying to set monetary policy, I would not ... And by the way, this is the point of that op-ed, that opinion piece, this is the argument I was making, and therefore the Fed should ease policy, that's the bottom line. But I wonder if ECB is the same way. It'd be good to know when they last opined on the inclusion of OER in their measures.
I mean, I've changed my mind, I wonder if they've changed their mind over the last couple of years.
Cris deRitis: But you're of the same mind. Conceptually, theoretically makes sense.
Mark Zandi: Yeah. Yeah, absolutely. You have to do it-
Cris deRitis: If we could measure it properly, we should. And in most cases, it's been in there forever, since '80s. And when the housing market is stable and moving around relatively well-behaved, it doesn't really make a huge difference on the inflation calculations. It's just at this point in time that we see such a divergence.
Mark Zandi: Yeah. Yeah, okay. Okay Matt, anything else on the report? The inflation report, the PCE deflator report?
Matt Colyar: The only other item I'd point out is the services inflation, so the PCE deflator for services, the rough approximation of wage pressures, the sticky thing that the Fed's most focused on. You see a little bit of moderation there, from 0.4% growth in March to 0.3% in April. That's 2.9% year over year. So, it's still a way to go but going in the right direction.
Mark Zandi: Okay. All right. Okay. Well, we generally play the statistics game a little later in the podcast, but given where I want to take the conversation, let's do it now. And the game is we each put forward a stat, the rest of the group tries to figure that out with clues and deductive reasoning, and questions. The best stat is one that's not so easy we get it immediately, one that's not so hard we never get it. And if it's apropos to the topic at hand, all the better or the most recent data. So Marisa, we'll start with you. What's your stat?
Marisa DiNatale: Okay, two numbers related. 5.4% and 5.7%.
Mark Zandi: Okay. Related to the data that came out this week?
Marisa DiNatale: Yes.
Mark Zandi: Today's data?
Marisa DiNatale: Yes.
Mark Zandi: So, okay. Consumer spending?
Marisa DiNatale: No
Mark Zandi: Income?
Marisa DiNatale: No.
Mark Zandi: Inflation.
Matt Colyar: PCE?
Marisa DiNatale: Yeah.
Mark Zandi: Okay. So, it's related to the PCE deflator, 5.4 and 5.7. Is it a growth rate?
Marisa DiNatale: Yes.
Mark Zandi: Is it year over year?
Marisa DiNatale: Yes.
Matt Colyar: Shelter?
Mark Zandi: Is it a component? Yeah, okay.
Marisa DiNatale: Yes, it's shelter. Yeah.
Mark Zandi: It's housing.
Marisa DiNatale: Do you know what specifically they are?
Cris deRitis: Is that rent and OER?
Marisa DiNatale: You got it.
Mark Zandi: There you go. Okay, very good. That's how the game is played. You see how we whittled you down?
Marisa DiNatale: Yeah. I am very well aware that that's how the game is played at this point.
Mark Zandi: So you want to explain-
Cris deRitis: Unless you're Marisa, in which case you know the number instantly.
Marisa DiNatale: I don't know you guys, you say that but I haven't been as hot recently as I was.
Mark Zandi: Oh, you shouldn't have said that, because-
Marisa DiNatale: I don't know.
Mark Zandi: ... I thought you were just as hot. No?
Marisa DiNatale: Okay. Yeah, so 5.4% year-over-year is in the PCE rent of primary residents. And the 5.7% year-over-year growth is the PCEs, the BEA's owner's equivalent rent for homeowners inflation. And they both increased 0.4% over the month. The rent prices, it was 0.35, and that was the slowest monthly increase since August of 2021. It's the slowest year-over-year growth rate since May of 2022. On the OER front, the 0.42% month on month increase was the slowest since October, and the year-over-year increase was the slowest since June of 2022. Now, these are all very similar to what came out in the CPI report to write. So in the CPI report, both of these components increase 0.4% over the month, and if you round, there was also a slowed down there as well.
We didn't really dig into that as much I think, when we spoke about the CPI report, but it is encouraging that I think we are starting to see these shelter prices come down slowly. They were just up there and not really moving, and you'd get some months where there was actually an acceleration, and we have this consistency between the CPI and the PCE where we're starting to see them moderate a bit.
Mark Zandi: Interesting. Just a point of interest, the weight on housing, both if you add up rent and OER in the CPI is I think it's like a third-
Marisa DiNatale: Almost double-
Mark Zandi: Yeah. Oh, is it?
Marisa DiNatale: ... what it is in the PC.
Mark Zandi: It's about a third in the CPI, and it's about, as you say, half that in PC. So, it's up about the same amount both for rent and OER, but the weight in the PC is a lot lower. And that's why I think one of the big reasons why there's this large gap between inflation is measured by the CPI, and inflation is measured by the PCE. I think it's a full percentage point almost.
Marisa DiNatale: It explains most of the discrepancy right now between the PCE and the CPI, is the weight on housing.
Mark Zandi: Weight on housing, okay. Okay Cris, you're up.
Cris deRitis: All right, 72.3.
Marisa DiNatale: Sounds like an index value.
Cris deRitis: Index.
Mark Zandi: Is it consumer confidence index?
Cris deRitis: It is not. That was one of them though. I won't say it.
Mark Zandi: I know the other index that came out that you like is the pending home sales.
Cris deRitis: You got it.
Mark Zandi: Yeah. That was down it, wasn't it? It was down, I think.
Cris deRitis: It was down a lot, down 7.7% on the month.
Mark Zandi: On the month.
Cris deRitis: I think 7.5% year-over-year. It's a record low, actually. 72.3 is the record low for the pending home sales.
Marisa DiNatale: Wow.
Mark Zandi: Whoa, I didn't know that. Really?
Cris deRitis: Yeah.
Marisa DiNatale: Record breaker.
Cris deRitis: So, even lower than the depth of the pandemic.
Mark Zandi: Yeah, you going to explain pending home sales?
Cris deRitis: Yeah pending, essentially what it's measuring, these are pending home sales for April. So, these are the housing contracts that were signed in April that will close in May, June time period. So, it gives a pretty good advanced warning of what the existing home sales are going to look like. So again, it was down a lot and it was down across all regions, which is also telling here, it's not just one or two regions, it's across the country. There is some variation there, it's down more in the Midwest and the West than in the Northeast, but still down across the board. So, I chose it along the lines of Marisa's statistic here, just indicating that we do have this housing market that seems to be slowing. This is the spring summer selling season, so this is the hot time for the market typically.
So, seeing this time of slowdown is a bit discouraging. You are seeing listings growing in a number of parts of the country as well, there's some places where house listings now are above where they were in 2019. So, does indicate that this housing market is adjusting here, and I feel pretty confident in this forecast of house prices slowing here as a result of that. And that should continue to put some downward pressure on inflation.
Mark Zandi: Yeah, wow. And existing home sales are already low.
Cris deRitis: Very low, we're around four million annualized homes sold. And I mean, typical is what, five and a half million? Something like that.
Mark Zandi: So we're at four, and this is suggesting the pending home sales, which leads the existing home sales numbers, because these are contracts, not closings. Suggests even weaker numbers, below 4 million even potentially.
Cris deRitis: That's right.
Mark Zandi: Wow. We need to get those mortgage rates down, boy.
Marisa DiNatale: They're higher now than they were back in April.
Cris deRitis: They're back well over seven, good point.
Mark Zandi: Yeah. Okay, that was a good one. Hey Matt, and I know I invited Matt, you should all know about 30 minutes before the podcast. I say, "Hey Matt, can you come on?" And he jumped right on, he's done a great job. So, I wouldn't be surprised if you didn't have a stat, but do you have a stat?
Matt Colyar: I'll throw one out there, but I appreciate the caveat if it's not good. 1.3%.
Mark Zandi: GDP?
Matt Colyar: No, coincidentally.
Mark Zandi: Because wasn't GDP 1.3?
Cris deRitis: It was.
Matt Colyar: It was. That would've been [inaudible 00:24:46] that would've said that.
Mark Zandi: Yeah, for the first quarter. That wasn't what it was. Was it in the GDP report?
Matt Colyar: No.
Mark Zandi: Okay. Was it in today's numbers, the-
Cris deRitis: PCE?
Mark Zandi: PCE?
Matt Colyar: Yes.
Mark Zandi: Okay. Year-over-year growth rate.
Matt Colyar: Yes.
Mark Zandi: One component-
Marisa DiNatale: Oh, it's food prices year over year.
Matt Colyar: That's right.
Mark Zandi: There you go, Marisa, you're back on track.
Matt Colyar: Nice job.
Marisa DiNatale: I'm back.
Mark Zandi: You're back. Oh, food prices. Okay.
Matt Colyar: Yeah. Think I'm recalling a few weeks ago the podcast, Marisa mentioned she held out shelter prices moderating, as incremental as it was, as the most important thing in the CPI report. And you pushed back-
Mark Zandi: And I berated her for that.
Matt Colyar: Yeah. You thought it was food, and I think I would've sided with, I know I would've, Marisa. I think that even if it's the second or third decimal point, I think that moderation is the most important, even if it's really small. But bringing up food prices here is my way to tie back into that even. I do think it's important, but it's moderation at the grocery store. It's really important how people, consumers feel.
Mark Zandi: So Marisa, you see how he did that? I think he was defending you, I think sort of-
Marisa DiNatale: Oh, I think he was not kind of defending that.
Mark Zandi: Oh, he was defending you. Yeah. I mean, okay. You say-
Matt Colyar: I remember where I was walking with my AirPods being like, "I'm with Marisa there," as I was exactly where I was in my house.
Marisa DiNatale: Thanks, Matt.
Matt Colyar: You got it.
Mark Zandi: All right-
Marisa DiNatale: Food prices-
Mark Zandi: ... now you're in big trouble, Matt. Big trouble. I'm going to-
Matt Colyar: Sure.
Mark Zandi: Okay, go ahead.
Marisa DiNatale: Food prices fell over the month in the PC report, right? Just like they did-
Matt Colyar: Right. Yeah, 0.2%.
Marisa DiNatale: ... in the PCI report.
Matt Colyar: 0.2% decline, that's after it was flattened in March. So not just monthly movements, I think prices are moving sideways.
Mark Zandi: Yeah. Oh, yeah. Good news. Okay, very good. Okay, I got two numbers. 1.9% and 2.9%.
Marisa DiNatale: Inflation-related?
Mark Zandi: Not inflation-related, but a stat-
Cris deRitis: GDP?
Mark Zandi: Came in the GDP report.
Matt Colyar: GDI, the 1.9?
Mark Zandi: Yeah, 1.9 is GDI year over year through the first quarter, 1.9%. What was the 2.9? GDP. GDP was 2.9. 2.9 year over year.
Marisa DiNatale: Oh, should know that.
Mark Zandi: Yeah. 1.3 on the quarter annualized, that's the 1.3 for Q1 2024. But on a year-over-year basis it's 2.9. So, the suggestion is to take those two numbers, average them, and you get 2.5, right? No, yeah. 2.4, you get 2.4. 2.4. And that's so-called gross domestic output, and that is thought to be the best representation of the reality of what's going on. So, the GDP growth rate is the measure based on looking at the so-called consumption side of the consumer spending, business investment, government spending, trade, that kind of thing. The GDI, gross domestic income, is looking at all this from the income side of the economy, so personal income, corporate profits, that kind of thing.
And you take the average of those two growth rates, that's so-called GDO, gross domestic output, and that's 2.4%. That's pretty good, that's very good. And I will point out that we got consumer spending for the month of April today as well, and that was on the soft side. It declined on a real basis in the month. But for the year? Rock solid, right down the strike zone, about 2.5%. So, right where exactly where you want it to be. So the GDP numbers, the top line numbers look pretty good. They look like the economy is pretty resilient. Any commentary there, or pushback there on that one? No? Okay.
Marisa DiNatale: No.
Mark Zandi: Okay. Well, I ended with that and I used that, because I thought we could spend a few minutes talking about the resilience of the U.S. economy. The economy has remained incredibly, I think the word is resilient. Obviously we got very good growth last year in 2023. A year when most people thought we'd suffer a recession. We didn't, we actually experienced a 2.5% GDP growth. And it feels like we're coming into this year in pretty good shape, and we should have another reasonably good year, a non-recessionary year defying all expectations of a downturn. The other thing to note is that the U.S. economy has performed much better than all other developed economies around the world. It came back faster from the pandemic, returned to full employment a lot more quickly, and more significantly more recently has been leading other countries in terms of growth.
Growth has been much stronger here in terms of GDP, and jobs, and everything else. So, the U.S. has done very, very well compared to other countries. So, the question to the group is why? What's going on here? What is the the fundamental reason, reasons for the economy's resilience? Because answering that question is critical in understanding whether it will continue or not. So maybe Cris, I'll start with you. What would you put at the top of the list of reasons for the economy's resilience? And first I should ask, do you agree with my characterization of this? Is the U.S. economy, is that a good characterization of how things are going? And if so, what's going on here?
Cris deRitis: Yeah, certainly correct, and certainly much stronger than other economies across the globe. U.S. is leading the way here. If I had to put something on the top list, I would identify the consumer. Consumers just have been much more resilient in their spending, much more willing to spend, say savings that they accumulated during the pandemic than other consumers around the globe. So, through thick and thin. You have rising inflation, you have Russian invasion of Ukraine, you have debt ceiling debates, you have all sorts of things on top of the pandemic, of course, and the fallout of that. But the consumer has been hanging tough, continuing to spend right through it all, drawing down savings, taking on credit, which may or may not come to bite us later on, but certainly that's a reason why we've seen the growth we've seen today. Consumers have been bolstered by some of the wealth effects too, so the strong housing market, stock prices has also certainly made them more confident to go ahead and do some spending. But yeah, I'd say that consumer is top of the list.
Mark Zandi: Well, can you peel that onion back one more layer? Why? Why has the American consumer held up better than other parts of the world, consumers in other parts of the world?
Cris deRitis: Yeah, so lots of reasons there too. I think first of all, I think perhaps the response to the pandemic itself, the early response certainly put more money in consumer's pockets. Other countries didn't do as much, or maybe a bit more delayed in terms of providing support to their households. And so, you had consumers able to sock away a lot more in savings early on in the pandemic. That certainly gave us some confidence-
Mark Zandi: So, fiscal policy response was a lot more aggressive here in the U.S.
Cris deRitis: Correct-
Mark Zandi: A lot more support. Those stimulus checks, unemployment insurance, rental assistance, all those things, that happened everywhere across the globe but it happened here to a much larger degree.
Cris deRitis: That's right. Many parts of the U.S. economy opened up more quickly than other areas of the globe, particularly if we think about parts of Asia. And so, we kind of bounced back in terms of a labor market perspective, so I think that's certainly helped as well. And the fact that we do have a fixed rate mortgage dominating the landscape also is quite different than the rest of the world. So, for the two-thirds of households that are homeowners, they were able to lock in a very low rate that opened up some room on their balance sheets all of a sudden. So that allowed them to do, again, some more spending than they otherwise would. So I think it's a combination, and the labor market certainly is a big part of that in terms of bolstering their confidence, willingness to spend.
Mark Zandi: Yeah. Okay, good. Marisa, what would be at the top of your list? I mean, it could be the same thing, but-
Marisa DiNatale: It is. I imagine he-
Mark Zandi: ... if he did, tell us number two.
Marisa DiNatale: I think he covered it. I mean, I would've certainly said consumer spending, the wealth effect here has been stronger. So, if you look at gains in housing prices, other asset prices, equity markets, they've been bigger in the U.S. than they've been globally. So, you have the wealth effect playing out to a larger degree. The stimulus spending I think was a little differently designed here too, I think there was more direct cash to households, whereas if you look at the UK and Europe, some of their pandemic fiscal stimulus schemes were more focused on businesses retaining workers, that kind of thing, which was great but it was a little different from putting cash directly in the hands of households. So, we just have a lot of money here to spend.
Yeah, the interest rate insensitivity in the housing market compared to other countries. And then I would say if you look at Europe, I think they were much, much more directly affected by Russia's invasion of Ukraine, and rising energy prices, and disruptions in commodity markets than we were. We were removed from that. I mean, we are takers of the global oil price, but in terms if you look at natural gas markets and that sort of thing, those economies were much more rattled by what's going on in Russia-Ukraine than the U.S.
Mark Zandi: Right, right. Okay, good. By the way, I've got a bunch of, I'm just seeing if you're going to take them, I've got a bunch of reasons why I think the U.S. has done better. But Matt, do you want to-
Cris deRitis: I've got more too.
Mark Zandi: ... take a crack? Huh?
Cris deRitis: I've got more too, don't worry.
Mark Zandi: Oh, you do? Okay. Well, okay, good. We'll do once around, including me, and then we'll come back and see if there's anything. Matt, do you have-
Matt Colyar: The way households have managed debt, I think is the primary story. It's just whether it's fixed rate mortgages, if you look at the Fed's debt or the financial obligations ratio, I think it's really interesting over a time series. It's just, it's not extremely low, but it's low enough in a way that you would say, "Okay, that's not signaling that households are having a hard time making ends meet-
Mark Zandi: The financial obligation ratio is the share of income that households are devoting to servicing their debt and other financial obligations, like rent, and leases, and that kind of thing.
Matt Colyar: The bills, yeah. And I think the fact that that hasn't risen despite rising interest rates speaks to the interest rate insensitivity of 30-year fixed rate mortgages, but it's just allowed spending not to be crowded out in a way that the UK two and five-year mortgages, those agreements mean a lot more people are rolling over a lot more quickly, and they don't have that flexibility. So, I think that's the engine driving consumer spending and the U.S. economy forward.
Mark Zandi: I would agree with that. I think the number one reason for the resilience is just looking at the maturity of the debt owed by households, and to a lesser degree businesses around the world. So, Scandinavia is in recession, Norway, Sweden, Finland, and that's because their household debt has a short-term maturity at most a couple years. So, their households have felt the brunt of the increase in interest rates very, very quickly, and it sucked the energy out of consumer spending. Go to UK, Canada, somewhere in between the U.S. and Scandinavia, their debt is a little longer term, three five year. So, they're feeling it but not to the same degree. And then of course here in the U.S. we've got, as you said, 30-year, you, and Cris, and Marisa have all pointed to the 30-year fixed rate mortgage.
And it's a little harder to do that kind of comparison with regard to corporate debt, non-financial corporate debt, but similar, I think a similar dynamic there as well. You've got big businesses here who locked in before interest rates started to rise, and are able to weather the storm a little bit better than in other countries. How about this? Another reason. Foreign immigration, I think that's a big deal. I mean, we talked about that again, it was the last week or the week before, but obviously a lot of challenges created by the surge of immigrants coming across the southern border. But the benefit of that is that it's really powered a lot of growth without generating any inflationary pickup. In fact, probably working to reduce inflationary pressures because it's eased pressures in the labor market. That seems to me to be a very significant factor, particularly when you look at it from the prism of jobs. Employment growth has been so much stronger here because we just have more people that are willing to work, and that's really been very helpful.
What do you think about that, Cris? Would you put that on the list? Cris deRitis?
Cris deRitis: Yes, yes. Sorry [inaudible 00:39:14]
Mark Zandi: What happened? You went to sleep on me there.
Cris deRitis: No, no, I thought you directed that to Marisa-
Mark Zandi: I'll give it to Matt. Oh, sorry. Sorry, yeah. So, you agree with that?
Cris deRitis: Yeah, it was one of the ones on my list too.
Mark Zandi: Oh, okay. I got a couple of them, but before I do that let me turn it back to you. Go back to you Cris, what else is on your list?
Cris deRitis: Entrepreneurship and small business dynamism.
Mark Zandi: That was on my list too.
Marisa DiNatale: That could also be related to immigration, to some extent.
Cris deRitis: Certainly. Certainly that's part of it. But there are lots of native-born startups as well. Entrepreneurs. And I think that's a differentiator. It's just a lot easier to start a business in the U.S. than many other parts of the world, and the willingness I think is a big reason why the U.S. economy has rebounded as quickly as it has.
Mark Zandi: Yeah, you're referring to, I think the business formation data based on taxpayer identification numbers, the EIN numbers from the IRS, and that shows that business formation has surged since the pandemic hit. And this is pretty cool data, it's very timely, and you can look at it across industry, you can look at it across parts of the country, and it's widespread. It's across all industry. And so, what do you think is fundamentally behind that? What's going on? Again, peel that onion back one more layer, what's going on there? Why are we seeing so many businesses form?
Cris deRitis: So, a couple reasons. One reason is, again I think that cash infusion at the start of the pandemic allowed people to maybe clean up some of their debt. And also as they were looking around with double-digit inflation, or double-digit unemployment had a lot of people thinking, "Well, maybe I need a plan B here, and this is my opportunity to look into a small business, think about forming my own small business." So, I think that was certainly part of it early on, you just had more opportunity in the sense both in terms of money and time, certainly if you were laid off.
So, that's part of it. I think the immigration story is part of it too though, so you had this bounce back or the surge in immigration after the pandemic as well. And we do know that immigrants make up a disproportionate share of the startups, so that certainly would justify it as well. I also wonder if some of the early retirements we saw, so people in the late stage career also thinking, "Oh, I've got this housing wealth, I've got the stock market wealth, now maybe I can pursue a small business dream I've had in the back of my mind as well." So I think it's, to my mind it's a combination of factors. I don't think there's just one reason why people are opening up their own businesses.
Mark Zandi: Interesting. You didn't mention, or maybe I missed it, did you just mention remote work as a factor driving [inaudible 00:42:20]
Cris deRitis: I didn't mention that, it's possible that that's a ... You think that's a significant factor?
Mark Zandi: Well, it's just my intuition. It makes it easier to start a business.
Cris deRitis: Certainly, yeah.
Mark Zandi: You can do it from anywhere, you don't need to be somewhere. So, just lowers the barrier to starting a company. Just a thought.
Cris deRitis: Yeah, yeah.
Mark Zandi: I haven't seen any studies proving that, but just a thought. Yeah. Okay, good. Marisa, anything else on your list? It's a pretty good list, but I just wonder if there's ... By the way, all those things seem to have some staying power, don't they? A little bit of staying power. It's not like they're not temporary per se. Right? Okay.
Marisa DiNatale: Right, I think so. I do think the flexibility of the U.S. labor market is pretty unique globally. So, that encompasses what you're talking about in terms of starting a business, the remote work, the hybrid work that the incorporation of technology, we've seen productivity growth rise over the past few years. So, it seems like this labor force is a bit more flexible and also a little bit more quick to adopt more cutting edge technology and that sort of thing.
Mark Zandi: Yeah, I think historically that's been a strength of the U.S. economy that people are able and willing to move if their circumstances change. Although in the current environment, given the interest rate lock-in, that's less so. I guess it really, before the interest rates locked, going back to 2020 and 2021, there's a lot of movement of people. That's less so in the last couple of years, but nonetheless we're probably much more mobile than many other economies. So, we were able to adjust to shocks a lot more quickly than I think the rest of the world. And that's been age-old, that's one of the features of the American economy I think that makes it different from other economies, and perform better, and adjust to recessions and downturns more quickly. Matt, any other things on the list?
Matt Colyar: No, the energy independence, when I think of specific comparisons, oftentimes I'll kick off a presentation the same way, like the U.S. is doing better than other rich developed countries. And some of the comparisons are just because of energy independence, like with Germany say, but every comparison has its own caveats. If you take a step back, it's like, okay, it's a bunch of different good things that are all pointing in the same direction. But I think we covered it pretty well.
Mark Zandi: Yeah, I guess there's a couple of idiosyncratic things. I don't know if they're unique to the U.S., at least the same degree, but they're related to the current circumstance, like the affordable housing shortage. We have this, as we've been talking for many podcasts, this very severe shortage of housing, which means that we've not seen any meaningful decline in housing construction despite the higher interest rates. If you go back to previous recessions, rates rise and housing gets crushed, but so as part of that housing supply gets crushed. Builders stop building. You haven't seen any of that here. I mean, housing starts are now down, but housing completions remain pretty close to record highs, no decline.
Marisa DiNatale: And the construction industry, the knock-on effect of the jobs and the wages in that industry. I mean, it's remarkable actually over the past few years what you've seen there.
Mark Zandi: And that partly goes back to the fiscal policy that Cris mentioned, the infrastructure legislation, the CHIPS Act, even the IRA, the Inflation Reduction Act to some degree. The other is the vehicle industry. We talk about this too, in past recessions when rates increased, you saw a big decline in vehicle sales and production. This go around, no, you haven't seen any decline. And a significant part goes to that during the pandemic people couldn't get cars, the vehicles, they weren't being produced because of the pandemic and the shutdown of global production. So, that has created some pent-up demand for vehicles that's supported the market, despite the higher interest rates that we're seeing right now. So, those things have some staying power too, particularly the housing.
So that might be helpful going forward, but obviously that's more idiosyncratic, less structural. Okay, good. Maybe just quickly, because I want to take listener questions, because we've gotten a lot of listener questions, but before we turn there, is there anything that would result in the U.S. economy performing less well than the rest of the world? I can't think of anything that is holding the U.S. economy back relative, or undermining the economy's resilience, or weakening the economy's resilience. I guess the only thing I can point to maybe is our politics and how that's making us all feel, maybe. But I think people feel their politics stink everywhere, pretty much.
Marisa DiNatale: Yeah. We're certainly not the only country with [inaudible 00:47:55] elections-
Mark Zandi: We're not the only country. Yeah, right. In fact, it is uncanny, isn't it? How similar the political environment is in other countries. Same dynamics playing out almost everywhere, which is an interesting point. Cris, can you think of anything that's weighing on our resilience and making us perform less well than other countries? I'm having a hard-pressed time, I can't think of it, but ...
Cris deRitis: Well I would guess, as usual, I'll point to some of the consumer debt or other debt out there potentially undermined, not in the immediate term, but if the consumer debt that we've taken on, you do see delinquencies defaults rising. So, to me that could undermine some of the additional or ongoing spending that happens. I don't know if you're then asking for broader downside risks if something were to happen to housing markets or stock markets,
Mark Zandi: No, it's more like anything that is out there that-
Cris deRitis: At the moment.
Mark Zandi: ... at the moment that's held us back, been a a headwind. That is a good one, [inaudible 00:49:05]
Cris deRitis: Yeah, so I think there's some of those debt pressures-
Mark Zandi: Yeah. I don't know the situation overseas. I mean, I would think it's probably similar issues, if not more in many other parts of the world. Just because they're paying higher interest rate, their rates are rising, so their interest expense is rising to a greater degree.
Cris deRitis: True. Although I don't think they've had maybe that formation that we've experienced more recently.
Marisa DiNatale: You're talking about consumer debt.
Cris deRitis: Primarily, yes. Yeah, consumer debt.
Marisa DiNatale: Well, I think if you flash forward six months, we could be in a situation where the Fed hasn't lowered rates but other major central banks around the world have started. And so, you're looking at the Bank of England, the ECB, Bank of Canada, all poised to lower rates probably coming up very soon. These two inflation reports look good, but I mean, the Fed needs more than that. So, we may be in a situation where relative interest rates in the U.S. are higher than they are globally.
Mark Zandi: Yeah, but this is to come. It's not-
Marisa DiNatale: That's right. But I think we might at the edge of that.
Mark Zandi: We're right at the cusp, yeah. Right. Oh, someone pointed out to me a reason for why things might be playing out better here is the fact that the growth in private credit. So, there's this rapid growth in the ability of businesses to get credit outside of the banking system. The so-called private credit, and private credit, private equity, private debt, these companies own American businesses. They bought American businesses, they lend to American businesses, but they're very loath to actually push a business into bankruptcy even if the business is having trouble. So the business gets into trouble, sales weaken, interest expense rise, whatever. They can't pay on the debt they owe, they're starting to have trouble. But the private equity firm and the private credit firm don't want a bankruptcy, because that means they lose their money. So, then they have to lose their money in reality, lose their money even more perhaps on paper, which makes their returns lower and therefore more difficult to raise more money to invest.
So, what they do is they are keeping these companies going and alive trying to figure out how to keep them from going under, and hoping that they can turn things around. But by the mere fact that they're not shutting these companies down, and if you go look at the corporate bankruptcy data it shows that they're very low, especially liquidations, liquidations of companies are very low, that that's allowing the economy to perform better because you just don't see the same layouts. I thought that was pretty interesting. Now, I don't know if that's a good thing or a bad thing. Maybe it helps out in the near term, but in the long run you're not allowing the economy to adjust. You're creating potentially zombie firms that are going to be a problem in the longer run, I'm not sure, but in the near term it's helping out. I thought that was an interesting argument.
Matt Colyar: Yeah. We kind of distort valuations too if they're not ... They're private, and that makes a portfolio look a lot healthier than it is.
Mark Zandi: Yeah, exactly. Anyway, okay. I thought that was a good discussion. Let's end the podcast around some listener questions, because we've been getting a bunch of them. And Marisa, let me turn to you for those cues.
Marisa DiNatale: Do you want to tackle that question I sent to you yesterday that was a multi-part question about the Fed and quantitative easing?
Mark Zandi: Well, I didn't even read the question, so I've been traveling. I haven't had a chance to take a look.
Marisa DiNatale: I know, I know.
Mark Zandi: Yeah, but whatever. Everything is fair, you can fire away.
Marisa DiNatale: Okay. There's several questions about QE and QT, and the Fed's balance sheet in general. So, rather than read these questions word for word, which I'm sorry, if this is your question, I don't always read things word for word. I try to summarize them or combine them with other similar questions. But there are several about the Fed's usage of quantitative easing. So, first of all let's define what that is, how it's relatively new in terms of monetary policy, and what is it? What effect has it had on the economy, do you think? Can we measure its effect in terms of interest rates? So, if it was easing interest rates, say during and after the financial crisis, and if quantitative tightening has actually added to the effective interest rate. So, I know this is nebulous, but-
Mark Zandi: No, no, there's a lot to unpack there. Yeah.
Marisa DiNatale: And is it just printing money? What effect does it have? Are there negatives to it? What are the positives? Like a primer, if you will, on QE and QT.
Mark Zandi: Okay, that could be a whole podcast.
Marisa DiNatale: It could.
Mark Zandi: Yeah, let me try to be parsimonious in the response, and then I'll turn it to Cris and Matt to fill any blanks. So, quantitative easing, QE, is the Federal Reserve buying bonds, treasury bonds and mortgage-backed securities that are backed by Fannie Mae, Freddie Mac and Ginnie Mae. These are government entities. The idea is that when the Fed lowers interest rates, the federal funds rate to the zero, lower bound gets to zero, but still wants to bring rates down, that's when they QE, they start buying these bonds in an effort to bring down longer-term interest rates, intermediate term, longer term interest rates. So, there's supply and demand, you got bonds out there. So, if the Fed's out there buying the bonds, that brings interest rates down.
There's also the flip of that quantitative tightening. So, they do the QE when things are bad and they push interest rates down to zero, and they want to keep their foot on the accelerator and keep helping the economy out, that's when the QE. When the economy recovers and improving as it is now, then they do what is called quantitative tightening. There's different flavors of that, but the flavor they've been following is allowing the treasury securities and mortgage-backed securities that they own to mature, to come do, and they don't replace it. They don't go out and buy another one. Or prepay, mortgage securities can prepay if someone refinances a home. Although that's been obviously very minor in the current context. That's quantitative tightening. And that, by pulling out of the market stop buying bonds and not replacing them, again demand and supply, that would lead to higher interest rates.
There's a lot of debate as to to what degree the quantitative easing and tightening influence interest rates, and how it influences rates. But I think the general consensus is that the biggest effect is actually the announcement signaling effect. When they say, "I'm going to go buy bonds," they're signaling their intent to be aggressive and that brings down expectations for future rate hikes, and it raises expectations for future rate cuts, keep rates down for longer, that kind of thing. Or if they're in quantitative tightening, if they announce it that they're going to do it, then that announcement means that they're going to be holding rates longer, they're going to be less supportive of the economy and that brings pushes rates up.
I think a good rule of rule of thumb, and this is just on average over time, is that for every percentage point increase in the amount of treasury debt or MBS that they buy as a percentage of GDP, so if they're QE-ing and they increase their holdings of treasury and mortgage backed securities by a percentage point of GDP, that will, in terms of QE, reduce interest rates by one or two basis points of the 10-year yield, all else being equal. And conversely for QT. So, that gives you order of magnitude. It's not printing money in any more sense than lowering interest rates, lowering the federal funds rate.
It's just straight up monetary policy. The difference is that typically they only worked on lowering short-term interest rates, the federal funds rate, but when you hit the zero lower bound and you still want to help the economy out, that's when you start thinking about how do I lower interest rates for intermediate term or longer term interest rates? And that's when you start to QE. So, I view it more as just an extension of the typical way of conducting policy, and you need to do that in the context of severe downturns. One final thing I'll say and then I'll stop, is I don't think anybody likes QE or QT. They much prefer not to do QE or QT, for lots of different reasons. One is it's hard to measure exactly what the impact is. The other is do really want to buy mortgage-backed securities? Because then I'm just helping out the housing market.
Is that monetary policy or is that fiscal policy? And you really don't want to get into fiscal policy, so there's some questions about that. Other reasons, so they don't want to do QE, QT, and here's where I'm going to provide some advice, this is why they should raise the inflation target from two to something higher than that, because if they do, then it's less likely they'll hit the zero lower bound on interest rates and have to QE or QT. But with the 2% inflation target, much more likely that nominal rates will be lower and they'll hit the zero lower bound whenever we get into inflation. But that's for another day. So, how about that for a primer? Was that okay?
Marisa DiNatale: Yeah, I think that's great. Yeah.
Mark Zandi: Cris, did I miss anything? Matt, did I miss anything?
Matt Colyar: I mean, I always push back on the printing money side of it. It's not money, it's central bank reserves that banks can then use as the firepower for them to make decisions to lend that could end up as more money floating around, but it's not directly printing money, as it's often criticized to be.
Mark Zandi: Right, right. Good.
Cris deRitis: I guess the only other thing I would add is that it's important to focus on the QE, QT, but there are a lot of other things that were going on at the same time that make it complicated to understand the full impact. Like the reverse repo facilities, or the Fed started paying interest on reserve, bank reserves. So, there are a lot of moving parts here that conflate or may make it difficult to understand what is the direct impact of QT or QE? There might be some offsetting factors when we look across all the policies that the Fed adopted.
Mark Zandi: Yeah. One other downside, as I said earlier, I don't think the Fed likes doing this, is that the Fed comes into the bond market, buys bond with QE, and then they go out of the market. And so, that means they're pushing somebody out and they're letting somebody in, and that transition, that adjustment can be problematic. In the current context, they're QT-ing, they're pulling out of the market. And by the way, the commercial banks are also not playing in that market to the same degree, because they got in trouble a year ago when the banking crisis, when their securities got upside down when rates rose, increased. So, you have a lot of hedge funds that have come into the market, the treasury market to fill that void. So, I don't know that that's desirable that you got the Fed coming in and out, and other central banks coming in and out, and just scrambling who's owning the securities.
And that makes the market, I think less liquid, more prone to freezing up and other issues. So, I think they would again, prefer not to QE or QT if they could get away with it.
Cris deRitis: Yeah, I think it's part of the reason why the mortgage rate spread is still very high.
Mark Zandi: Yeah, excellent point.
Cris deRitis: That you have. Unintended consequence. I guess question for you, has the Fed now committed the original sin and now every crisis in the future, we can't extract ourselves from this pattern? They're going to QE, next time around they're going to QT, right? Is this going to be-
Marisa DiNatale: Yeah, one of the other questions we got was exactly-
Mark Zandi: Yeah. I mean, if they get to the zero lower bound, I mean, first thing they do, right now the federal funds rate's 5.5%. If we get into trouble in recession, they're not going to immediately QE, they're going bring the interest rate down. They get to the zero lower bound, they say, "Oh, the economy's still not performing well enough," that's when they QE. So, it's just another tool in the toolkit. It doesn't necessarily mean they'll go to it each time, it depends on circumstance, but that's what my point I was making about the inflation target. One reason why we're hitting the zero lower bound is nominal growth is lower historically because we have a low 2% inflation target. If you had set it at 3%, nominal growth rates would be higher, interest rates would be higher, it'd be less likely you'd hit the zero lower bound than have to QE. You'd have to QE.
So, it's a reason why you might want to, when you get to the other side of all this and inflation is back to the Fed's target of 2%, that the Fed actually changes the target, or at least does something to make the target less restrictive. It seems really weird to me that the Fed has to be so religious about a 2% target. Really? Do we have to be that religious about it? I mean, think about it for a second. I mean, why? Inflation expectations? But you could design the system in a way where if you're 2%, or 2.5%, or 3%, that's fine with everybody. So I think this hard, fast 2% target is creating problems that ... And one of those problems is this, we may end up having to QE more often than we'd like to. Anyway, do you want to take one more question or not?
Marisa DiNatale: Let's do one more.
Mark Zandi: Oh, let's do one more. Okay.
Marisa DiNatale: This is about the yield curve, which we haven't really talked about in a while, but is perhaps also related to the impact of interest rates from quantitative easing. So this listener wants to know, "Has there ever been another period in modern history where the yield curve has been inverted for this long?" Period. I think we know that it has not been inverted this long without a recession following. And what's going on there? I mean, we've talked about this, but it's been a while since we talked about this. So, is the inversion of the yield curve partially related to the Fed keeping the long end of the curve higher? Why is it still inverted and we've not seen a recession?
Mark Zandi: The long end of the curve lower.
Marisa DiNatale: I'm sorry. Yes, yes, yes.
Mark Zandi: Yeah, right. Cris, you want to take a crack at that?
Cris deRitis: I guess I can answer the easy questions. This is the longest period that the yield curve has been inverted.
Mark Zandi: By what measure? What measure of the yield curve, all measures of the yield curve?
Marisa DiNatale: I think so. Right?
Cris deRitis: I think by now probably all-
Mark Zandi: All of them?
Cris deRitis: Well, 10 year treasury versus the 2-year treasury, or the 10-year versus the 3-month treasury, or the 10-year versus the Fed funds rate.
Mark Zandi: Oh, and for the uninitiated we're talking, the yield curve is simply the difference between short and long-term interest rates, and typically long-term rates are higher than short. The yield curve is, as they say, positively slow, but every once in a while it inverts. The short rates rise above long rates, and that's the situation we've been in now for, well, what? In terms of the 10-year Fed funds, it's been 18 months now, I think. Right?
Marisa DiNatale: Two years. Yeah, almost two years.
Mark Zandi: Has it been that long?
Cris deRitis: July, right?
Marisa DiNatale: Almost.
Mark Zandi: Oh, is it really July? Okay. I thought it was November. Okay. But anyway, but you're saying it's the longest inversion ever?
Cris deRitis: Longest inversion ever.
Mark Zandi: Really?
Cris deRitis: And then by definition or by extension, it's certainly the longest inversion without a recession following.
Mark Zandi: Right. What else did the listener ...
Marisa DiNatale: So, why?
Mark Zandi: Why no recession?
Marisa DiNatale: Why? Yeah.
Mark Zandi: Yeah. Well, a bunch of potential reasons. My favorite explanation for that is, and by the way we had a podcast with the-
Cris deRitis: Cam Harvey.
Mark Zandi: Yeah, Cam Harvey, which was actually a damn good podcast back, I don't know, could have been two years ago now. So, I recommend people go back and listen to it. He's the father of using the yield curve as a predictor of future recession. He wrote his PhD thesis on that, so I recommended it, it was a very good podcast. But it goes to the financial system, that historically, when the yield curve inverted, when short-term rates rose above the long-term interest rates, that made life really difficult for financial institutions' banks, that's because they borrow money short, like deposits and other short-term money. Those rates are lower than the rates that they lend at. That difference between what they lend at and what they borrow at, their funding cost is their net interest margin.
That's a profit margin for banks or financial institutions. When that yield curve is positively sloped, they're making good money. The lending rate, which is longer-term, is higher than their funding cost, which is short-term term, and they're happy. They're making loans to households and businesses, the credit's flowing, the economy's good. And when the curve inverts historically, their net interest margin collapses and they can't make any money. And so, they become much more cautious in their lending, they pull back underwriting standards. Credit does not flow, and credit is key to growth. Too much credit's a problem, not enough credit's a problem, and the economy falters. That becomes a really big deal when in the period when they were lending, they lent too much. They felt so good, they're very giddy, everyone's feeling really happy, they're over-investing, they're taking too much risk, the banks are extending out too much credit.
And then when the curve inverts and all of a sudden they stop lending, and all these borrowers who took out loans need to refinance their loan, they can't get a credit and things start to break. Businesses go bankrupt, real estate deals go bust, there's more defaults and delinquencies, so forth and so on. Recession. In the current situation, two things are different and thus obviate the predictive ability of the inverted curve. One is banks have done a really good job of managing their net interest margin, even in the face of an inverted yield curve they've been able to maintain that margin through hedging and matching, and just good risk management. Now, they can't do that forever. It becomes too costly, and now you can feel net interest margins are starting to decline, and that means if the curve remains inverted, the longer it remains inverted the more difficult this becomes and there might be actually a recession.
That's why I keep arguing the Fed should lower interest rates, it should start to cut interest rates because the yield curve is inverted and it's a problem, it's just taking longer to manifest. The other thing, the other big difference, of course is if you go back before all this, we never really had that period when banks were extending out a lot of credit. I mean, in the wake of the financial crisis 15 years ago, banks have been much more cautious and circumspect. Now, some of that's pushed lending out to the private credit markets that we were talking about earlier, but as I said earlier, they're managing these things differently than the banks would manage them. They're not pushing businesses into bankruptcy. So we didn't have that boom period, that euphoric through the roof kind of activity and credit growth prior to all this, so the inversion of the curve, the tightening up and underwriting hasn't had the same kind of negative consequence for the economy, and therefore no recession. That's my favorite explanation for what's going on. What do you guys think, make sense?
Cris deRitis: It does. So, that's the argument for the yield curve having a real economic impact on the economy, affects the banks, the lending. There's another theory or school of thought that says the yield curve is really about signaling, it's investors placing their bets and worried about the future, and therefore that's causing the inversion of the yield. They're piling into those treasured long-dated treasuries because they're worried about recession, they just want to make sure that they can preserve their capital, willing to accept a lower rate. It sounds like you're discounting that, the current environment-
Mark Zandi: A little bit, because that doesn't explain why the yield curve didn't work this go around. I mean, what you're saying is the collective wisdom of bond investors can foresee the economy is going to go head south here, and therefore pile into long-term bonds and push down the yield relative to what the Fed's doing. And they're anticipating this because the Fed is raising interest rates, and that is a negative for the economy.
But it doesn't explain why we've avoided a recession this go around, because the curve's been inverted, and deeply inverted, and it's been inverted for a long time, and the economy's resilient as we've been talking about. So one theory could be well, just wait, it's coming. And you're right, at some point we will experience a recession, but it doesn't give a satisfactory explanation for why the curve hasn't predicted a ... Why hasn't there been a recession? I guess the other explanation could be well, the collectivism, generally it's right but this time it was wrong. But that's unsatisfactory to me. It feels unsatisfactory. Okay. Well, very good.
Marisa DiNatale: If anybody wants to go back and listen to that podcast with Campbell Harvey, it was on February 28th of last year.
Mark Zandi: Oh, okay. Okay, very good. February 28th of ... Oh, just a little over a year ago. Feels like a lot longer.
Marisa DiNatale: Yeah.
Mark Zandi: Wow, geez. Okay, I was supposed to say something about next week's podcast on Saturday.
Marisa DiNatale: Oh. Well, two things to say.
Mark Zandi: Okay, what are they?
Marisa DiNatale: One is that next Wednesday we have a webinar for people interested where, me, Mark and Cris will talk about the economic outlook-
Mark Zandi: You'll be in that, right?
Marisa DiNatale: ... and we're going to focus on inflation. Inflation in the Fed-
Mark Zandi: You're on that.
Marisa DiNatale: Yep, yep.
Mark Zandi: Okay.
Marisa DiNatale: I said me, Mark and Cris. Yep.
Mark Zandi: Oh, you did? Okay.
Marisa DiNatale: Yeah. And then the other thing is about next week's podcast. Do you want to say that, Mark?
Mark Zandi: Oh, that's right. So-
Marisa DiNatale: It's going to be late.
Mark Zandi: ... it's going to be late. It's going to be Saturday, not Friday like we typically do. I'm at the Congressional Budget Office, CBO, I'm on the panel of advisors. So, I do this twice a year. Go to Washington, sit at the CBO and listen to smart economists talk about all kinds of things. We're going to talk about immigration this go around, I think, and that that's Friday so we won't be able to record it. And this is Jobs Friday coming up, so we'll do that Saturday. And I think Dante is going to join me on that? Cris, you're not there, Marissa, you're not-
Marisa DiNatale: And Matt, are you on it too?
Matt Colyar: Yeah, I'll be there.
Mark Zandi: Oh, Matt's there? So Matt, Dante and I-
Marisa DiNatale: Yeah. Neither me nor Cris will be there.
Mark Zandi: Okay, all right. That means I'm going to berate Matt, because-
Matt Colyar: Dante's forecast.
Mark Zandi: Okay, it's Dante's forecast. Okay, very good. Well, we do anything else-
Cris deRitis: Do you have a forecast, Marisa, you want to share?
Mark Zandi: For the jobs number?
Cris deRitis: Yeah.
Marisa DiNatale: You're putting me on the spot.
Cris deRitis: I'm putting you right on the spot.
Marisa DiNatale: No, I don't want to want to ... I need to think about it a little more.
Cris deRitis: Higher or lower than 175. Direction.
Marisa DiNatale: Higher. The UI claims data looks really good. [inaudible 01:16:15]
Cris deRitis: Yeah.
Mark Zandi: What would you say, Matt? Matt's pretty good at this. What do you say, Matt?
Matt Colyar: I'd go higher. 200.
Mark Zandi: 200? Cris?
Cris deRitis: Higher or not, I may be 190.
Matt Colyar: Oh, jeez.
Mark Zandi: Yeah, he does that.
Cris deRitis: Yeah.
Mark Zandi: Yeah, I think a couple hundred thousand sounds about right to me. Feels about right. Yeah. Okay, we're going to call this a podcast. So thank you, dear listener, for listening in, and we'll talk to you next week. Take care now.