Matt and Marisa join Mark, who called in from an undisclosed location, to discuss this week’s CPI report and FOMC meeting on interest rates. They all agree that the CPI numbers were unambiguously positive and that the Fed will begin to cut interest rates this fall. They play the statistics game, made more difficult by the dearth of economic releases so far this week, and take a few listener questions related to inflation/deflation, OER, and the Fed. For a deeper dive on inflation and how it's measured, check out the bonus episode--a replay of a webinar hosted by Mark, Cris and Marisa on inflation and the Fed.
Matt and Marisa join Mark, who called in from an undisclosed location, to discuss this week’s CPI report and FOMC meeting on interest rates. They all agree that the CPI numbers were unambiguously positive and that the Fed will begin to cut interest rates this fall. They play the statistics game, made more difficult by the dearth of economic releases so far this week, and take a few listener questions related to inflation/deflation, OER, and the Fed. For a deeper dive on inflation and how it's measured, check out the bonus episode--a replay of a webinar hosted by Mark, Cris and Marisa on inflation and the Fed.
Guest Hosts: Matt Colyar - Assistant Director, 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
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by two of my colleagues, my trusty co-host, Marisa, Marisa DiNatale. Hi, Marisa.
Marisa DiNatale: Hey, Mark. How's it going there?
Mark Zandi: How are things hailing from Southern California? All okay?
Marisa DiNatale: All's good here. Yeah.
Mark Zandi: Good, good, good. No earthquakes, no mudslides, no nothing?
Marisa DiNatale: No natural disasters to speak of today. No.
Mark Zandi: We want to keep it that way.
Marisa DiNatale: It's a good day.
Mark Zandi: A good day in Southern California. And Mr. Colyar, Matt Colyar. Right, Matt, I got it?
Matt Colyar: Hey, Mark.
Mark Zandi: Yeah.
Matt Colyar: Yeah, you got it.
Mark Zandi: I stumbled a little bit. Sorry about that.
Matt Colyar: It's no problem.
Mark Zandi: Yeah. And how are you doing?
Matt Colyar: Busy with stuff today, but good.
Mark Zandi: Yeah, a lot going on.
Matt Colyar: Yeah.
Mark Zandi: Got the Fed, we got the CPI, the consumer price index. A lot to talk about. And I'm not going to tell you where I am. It's a deep, dark secret, but you could see in the background, it's a little different here, but I'll just be mysterious. Will be mysterious, but it's all good. It's all good. It's all good.
Okay, so a lot to talk about. We'll talk about the inflation, the new inflation reading, the CPI for the month of May. I know we have a bunch of listener questions that are related to inflation, so we'll do those. Then we'll play the stats game and then we'll turn to monetary policy, the Fed, because they met and have opined about future rate cutting, made a change there. And then we'll call it a podcast. We'll keep this short, just given where I am and what's going on. And again, I'm going to be very mysterious. I'm not going to let you know what's going on, but it's all good. It's all good. Sound okay?
Marisa DiNatale: We're missing Chris today because he's straight through the Dolomites in Italy.
Mark Zandi: Is he? Is that where he is? He's in the Dolomites?
Marisa DiNatale: Yeah, he is.
Mark Zandi: Good for him. I've never been. I never to the Dolomites. Have you?
Marisa DiNatale: Yeah, I studied abroad in Italy when I was in college, so I went then, but that was a very long time ago.
Mark Zandi: Yeah, it looks like a beautiful, beautiful place.
Marisa DiNatale: It's so beautiful. It's amazing.
Mark Zandi: Reminds me a little bit of Jackson Hole. Has anyone ever made that comparison? I've just seen the pictures of the Dolomites. They feel very Jackson Hole-esque, but not sure.
Marisa DiNatale: It's a little more, it's sunnier. I mean, Jackson Hole's a little more wintery, I think. I don't know. I was also in the Dolomites in the summer too, so I think of it... It reminds me of The Sound of Music, like that setting.
Mark Zandi: Yeah, my wife's favorite movie.
Marisa DiNatale: Really?
Mark Zandi: I used to like it. I've seen it so many times.
Marisa DiNatale: Now you don't.
Mark Zandi: I can't do it again. Yeah. Anyway. Okay, the inflation numbers. Hey, Matt, what do you think?
Matt Colyar: This one doesn't require a lot of nuance. It was a great report. It was as good as anything we've seen since late 2023. Don't pin me down on a specific report, but there really wasn't the kind of yeah, but number in this report, which is great. So the headline consumer price index, this basket of stuff that we... The BLS tries to estimate represents what US consumers spend their money on was flat. So it was unchanged from April to May. That is a little bit softer than we and consensus expectations had, which was for a 0.1% increase. Both of those are a deceleration from the 0.3% growth in April. So price pressure's slowing down. That lowered the headline inflation rate from 3.4% to 3.3%, the annual headline inflation rate.
A lot of that decline, which we expected, which we baked into our forecasts and others did as well, is due to declining energy prices, which fell 2% from April to May. Under the hood there, its gasoline, 3.6% decline monthly in gasoline prices. So we have a lot of daily moment to moment trading data on what energy markets are doing. So we have by mid-June, we have a pretty good idea of what May's prices looked like and that estimate was built into our forecast.
Food prices continue to move sideways as well. Another encouraging story, and that's been more of a trend, whereas energy's a lot more volatile. Food prices have really moved sideways in 2024.
Mark Zandi: And that's food at home, groceries, not food away from home?
Matt Colyar: Yeah, I'm looking here at the aggregate of the two and-
Mark Zandi: Oh, you are?
Matt Colyar: ... it's a .1% increase in May. So again, that's a rate we can probably live with. Relative to a year ago total food prices were up 2.1%. Food at home, as you alluded to, we'll refer to as grocery prices. They were flat in May, and that's after declining by .2% in April. And there, the year-over-year growth rate is 1%. So again, the worst is, as we've been saying for months now, worst is over and we're moving further and further from that high food inflationary period.
But restaurants, so food away from home, dining out, there's still big premium for doing that. So food away from home prices rose .4%, and that's a slight acceleration from April, and those prices were up 4% relative to a year earlier. So that's a pain point that's above total CPI. That's above the Fed's targets. That's the kind of thing we look at and say, "That needs to come down further," because it's not a small component in the CPI basket.
Mark Zandi: It's restaurants. So groceries, food at home, basically flat on the month, flat on the year over year. Obviously, up a lot from where prices were three years ago because of the surge in grocery prices back in '21 and '22, but over the past year, flattish?
Matt Colyar: Right, exactly.
Mark Zandi: Got it. Got it.
Marisa DiNatale: Grocery prices haven't risen since January.
Mark Zandi: Is that right?
Marisa DiNatale: Mm-hmm.
Mark Zandi: Oh wow, okay.
Marisa DiNatale: That's on a month-over-month basis. Yeah.
Mark Zandi: Yeah. Because I think we've talked about this in the past. I think it's the increase in food prices back '21, '22, early '23 that's really got under people's skin. I think really that's what really bugs people the most is that they're paying more for some food item that they buy on a regular basis. This is good news in that regard.
Matt Colyar: Of course. And the essentials argument, you get put forward, it's the essentials are rising and that's more of a pain point. That's what's manifesting in downbeat consumer sentiment, but grocery store prices are the essential of the essential. And so moderation there, I think, is unambiguously positive story.
Moving to core CPI, so we ignore food and energy prices. This is, I think, the reason financial markets reacted really positively. I think they should have. This was, again, core CPI. We expected we were... Right now I'm kicking myself. Our forecast was .26%. We rounded up to .3%. It came in at .2%, so we were a little bit high on the higher side.
Mark Zandi: And even there, it's the second significant digit, right? It was-
Matt Colyar: .16, so it was almost rounded down the other way. So that was the very good sign for this morning's report. I think that's a growth rate that you have these first quarter of inflation data that spooked everybody, including the Fed. And what you needed to see from there was these offsetting reports. And if you're looking at on the razor's edge between .1 and .2% core CPI growth, that's I guess you would say, right in the strike zone, as you're phrasing it, right?
Mark Zandi: Right down the strike zone. Yeah, right down the fairway.
Matt Colyar: Yeah.
Mark Zandi: Year over year, what is core CPI?
Matt Colyar: Dropped from 3.6% to 3.4%.
Mark Zandi: Okay, that's good.
Matt Colyar: So getting there. Three month moving out of the annualized. So if you really want to take a near-term look, that rate fell from 4.1% to 3.3%. So drifting, dripping lower, which again, very encouraging. Shelter is I would say additionally, the reason this is relatively encouraging is that even that high number wasn't supported by shelter. It was kind of everything else is falling. So shelter prices, frustrating, painful, and didn't accelerate, just continue to move at the same pace, which is .4% growth month over month for shelter. That's true for both actual rent, the market rents that people mostly think of, and then the wacky owner's equivalent rent, which is the estimate for what it costs somebody to own a home relative to what they could rent it for, which we've gone into kind of that hypothetical cost, both rose .4%.
Mark Zandi: I haven't had a chance, and I know the Bureau of Labor statistics has stopped publishing the so-called harmonized consumer price index. So that would be the CPI excluding owner's equivalent rent, the OER, the implicit rent that homeowners pay. Do you have a chance to look at that because, okay, so you're waiting for the BLS to publish?
Matt Colyar: Yeah. I look at CPI excluding shelter, just so it's not specific to OER, and that's produced by the BLS in this report, not the harmonized version. And that fell .3% and is up-
Mark Zandi: Fell?
Matt Colyar: It fell to, yeah, .2%. And again, that's not core CPI, that's CPI ex-shelter. And so year over year, fell from 2.2% to 2.1%.
Mark Zandi: My goodness. Goodness gracious. It's alive. That's another Zandi-ism. Come on.
Matt Colyar: Okay. Okay.
Mark Zandi: 2.1% year over year, yeah, that's CPI less-
Marisa DiNatale: Shelter.
Mark Zandi: ... shelter, both for rent and for OER, 2.1%. And that's the CPI. That's not the PCE, that's not the consumer expenditure plater, which always runs a half a point to percentage point below CPI. So that's pretty good. Okay. So what in the core part of the CPI drove, if it's not shelter, what drove it down or the rate of increase down? Why .16?
Matt Colyar: We don't get the wacky auto insurance jump that we've had, which is nice. And not only do we not see that rise at 1% as it's been for what seems like two, two and a half years. Auto insurance prices actually ticked down .1%, which that was the difference a lot of times in recent months between a good report and a bad report was what the heck is going on with car insurance premiums. So that was a nice source of deflation that offset the persistence of shelter.
And then vehicle prices more broadly. So used vehicle prices fell .5% in May and we're almost down a full percent from a year earlier. Used vehicles, the longer run trend is one that is declining and one we expect to continue, but there was a .6% increase in May. New vehicles are getting more weight than used vehicles, so that's more of an offset. So taking them together, vehicle prices were also shaving off of core CPI. So between those two items, that offsets what we see in shelter and you get that .16%, core CPI.
Mark Zandi: So the weakness was a new vehicle prices and motor vehicle insurance, which has been rip-roaring up in last month, massive increase, but this month we saw a decline. Okay. Probably the reality somewhere in between, right? I mean there might be seasonal adjustment issues or other measurement issues would be my guess. To see this big increase one month and then a decline the next doesn't... that doesn't feel right. But it's probably some seasonal, some measurement issue here, I think.
Matt Colyar: I think that's fair. I think it's fair to assume that prices will roll over though. I mean car insurance prices, just knowing what we know about the vehicle market, that is an unsustainable trajectory. So that would be a lot of relief. That's a big part of people's monthly budget with the bills they have to pay. So some relief there.
Mark Zandi: One thing I did notice, I saw some pretty substantive declines in things related to travel, like airline tickets, which I guess goes back to maybe to the cost of jet fuel. I think hotel room rates, they declined, I believe, and didn't rental car prices decline? I think I might be stretching it.
Marisa DiNatale: Yes.
Mark Zandi: They did? Yeah.
Marisa DiNatale: Yeah. And airfare fell almost 4%.
Mark Zandi: Yeah, 4%. Yeah.
Marisa DiNatale: Yeah.
Mark Zandi: So that feels like those are more one-off, more seasonal adjustment, more measurement. I wouldn't count on that continuing, be my sense of it. Agree?
Matt Colyar: I think that's fair. And those are also the kinds of things I, in arguing, hey, auto insurance rising or a healthcare or shelter prices, that inflation is not indicative of on the ground today inflation. If you look at things that are, like a bunch of people clamoring for hotel rooms or airfare, those things, as you said, there is not much upward pressure there. So I guess strengthens the argument that underlying inflation is where it needs to be or will soon be.
Mark Zandi: Yeah. So my takeaway was core CPI, .16, that probably overstates the case a bit given potential... Because earlier in the year, measurement went off. Things were driving things up temporarily. Now we've gone the flip side of that perhaps, and that's giving us some of the better numbers, but the reality is somewhere in between. But even if the reality is somewhere in between, let's say .2, that's very consistent with... That's, what, 3% annualized. That's very consistent with the Federal Reserve's 2% target on the consumer expenditure plater. Would you concur with that kind of perspective?
Matt Colyar: Yeah, absolutely.
Mark Zandi: Yeah. Okay. All right. Before I turn to Marisa and get her take on it, anything else in the bows of the report that stood out or you want to mention?
Matt Colyar: No, nothing jumps out too much.
Mark Zandi: Okay. Okay. So bottom line, it was a very positive report. You were surprised on the upside here. You were thinking we'd get a .26 on core CPI for the month and we got .16, which is pretty meaningful difference. Yeah.
Matt Colyar: Yeah. And at .26, I still think we would be saying, "This isn't so bad."
Mark Zandi: [inaudible 00:15:24].
Matt Colyar: So .16 is all the more positive.
Mark Zandi: Okay. Okay. Marisa, anything you want to add to that kind of description or any other thoughts on inflation generally?
Marisa DiNatale: Yeah. I mean it was a great report. I mean, I think we can say goods prices, broadly speaking, are falling for most of these categories. If you look at the household furnishings category, that's falling. It's been falling. Apparel prices are falling. Food is flat at home. Recreation goods are falling. So goods is really bringing it down. But there's obviously, as Matt went through, good news and services too. It's just how much of that is here to stay versus just one-off monthly things. But yeah, it's good. I can't really find anything bad to say about it. Obviously we'd like to see shelter coming down instead of staying where it is, but at least it's not going up
Mark Zandi: Right. In so-called Supercore Service inflation, the beast that Chair Powell called out. Did you get a sense of that? What was that?
Marisa DiNatale: Yeah, that was going to be my statistic.
Mark Zandi: Oh, sorry. Sorry.
Marisa DiNatale: That's okay. We can talk about it.
Mark Zandi: Yeah. Okay.
Marisa DiNatale: Yeah, it was actually zero over the month.
Mark Zandi: Zero? Okay.
Marisa DiNatale: It did not change over the month, and that's the first time that's happened since August of 2021. It's still 5% year over year for the third straight month. So the year-over-year measure didn't change, but if you look at it on a three-month moving average basis or a six-month moving average basis, it's coming way in. So for example, three month moving average, it went from 5.6 in the previous month down to 3.9%. And on a six-month moving average basis, it went from 6.2 to 5.1. And supercore, I don't know if we defined it, it's taking out energy services and it's taking out shelter from the core services measure.
We had a webinar last week and I spent some time talking about all these other measures within services that had been moving higher since the start of the year. So this is good news, and the reason it's important is because it is reflective of the wage bill in a lot of these service industries where that's the highest cost that employers have to face. And if they see rising wages, then they are likely to pass that on to consumers. So we're seeing wage growth come in across the board and now we're seeing some relief in those service measures as well.
Mark Zandi: I'm sorry, I missed it. What was year over year for Supercore Service inflation?
Marisa DiNatale: It's 5% and it's-
Mark Zandi: 5%.
Marisa DiNatale: ... been kind of stuck there the past three months, but if you look at it on these other measures, it's coming in.
Mark Zandi: Well, certainly I'll take the zero.
Marisa DiNatale: Yeah, the zero's good.
Mark Zandi: That felt good. That felt good. And just to reinforce a point, when I look at necessities, staples, things like food, groceries, if I look at gasoline, if I look at, I guess not the CPI for rent, but for market rents, they all feel pretty good. They're all flat-ish, maybe down a little bit. So from that perspective, that also is good news.
Marisa DiNatale: Yeah.
Matt Colyar: Excellent.
Mark Zandi: Okay. All right. Okay, very good. So maybe well let's turn to those listener questions, Marisa, that you have that are related to inflation, that would be good, but you want to fire away?
Marisa DiNatale: Sure. Do you want to talk about the Fed?
Mark Zandi: I thought we do the... Just to split it up a little bit, we talk about inflation and then maybe we'll play the stats game and then we'll go back to the Fed. Is that okay?
Marisa DiNatale: Yeah, of course.
Mark Zandi: Does that sound like a good game plan?
Marisa DiNatale: Of course. Okay.
Mark Zandi: Okay.
Marisa DiNatale: So we have a couple of these questions that have come in over the last year related to inflation where the listener is asking why is it okay that we just get inflation back to a 2% growth rate, when we look at the core PCE. We've had all this growth in inflation. Overall prices, if you look at the CPI, they're up what, 20, 21% or something since the pandemic. Shouldn't we want prices to actually fall? Why aren't we targeting declines in prices as opposed to prices just growing more slowly than they have been?
Mark Zandi: Yeah, good question. I guess, well, I've got a couple of answers, but maybe Matt, anything you want to say on that regard?
Matt Colyar: It's a very fair question. I'm sure we have a similar answer. If people expect prices to go down, they wait. If they wait, that's a spiral that weighs on consumption. That is kind of a doom loop for an economy. I think certain things should come down in moderate, but in general, an economy that's deflating is one where consumption is going to collapse, if that's not too strong of a word.
Mark Zandi: Well, actually that's a good answer. I wasn't going to give that answer, but that's a good point. You're saying if prices are falling and people expect them to fall, then they delay purchases, which it creates more weakness in the economy, exacerbates the price declines, you get into this kind of self-reinforce, as you call it, doom loop. So yeah, that's an interesting way of articulating that.
Well, I was going to say a couple things. One, in the Federal Reserve's own framework for monetary policy, they target 2%, but they target it kind of through the business cycle. So if you're going through a period of suboptimal inflation, say inflation that's below 2%, you want a period of inflation above target 2% so that the price level kind of evens out, not for a specific item or service, not like for food or gas, but in aggregate, they're looking to do that.
And of course, for 10 years roughly after the financial crisis up and through this recent bout of inflation that began in 2021, and certainly during the teeth of the pandemic, inflation was well below the target, 2% inflation target. In fact, in the teeth of the pandemic during the shutdown, we did see some real price weakness. I think overall inflation came to a standstill.
So early on when inflation took off in 2021, in the wake of the passage of the American Rescue Plan, which helped support an increase in demand, that was deemed to be good inflation because here we were, the Fed was struggling to keep inflation from going further down and wanted to keep it around two and was struggling to do that. And here we were able to get it. And so it was no problem, no big deal.
Of course, it turned into a bigger deal when the pandemic and then the Russian war kind of kicked into a higher gear and did more disruption to supply chains and labor markets and it's caused gasoline and energy prices go higher, then that's when inflation became a real problem.
And so if you kind of look through the past 10 years or so, let's say through the business cycle, I think the price level is probably a little on the high side where the Fed would want to see it, but not really that much over where the Fed would want to see it. It's high, because we saw very high inflation in '21 and '22. But broadly speaking, I think the price level is probably pretty close to where they'd like to see it. We probably should do the arithmetic on that, but just to make sure I'm right, but I think that's roughly the case. So I am sympathetic to the listeners questioning if you're through a period of high inflation, you want a period of low inflation to iron that all out or even it all out.
The other thing I'd say is I don't think you want to get broad-based deflation price declines. Matt had a really good way of thinking of why not. You get into kind of a self-reinforcing cycle down. The other problem is that when you get into actual price declines, that is very difficult for businesses to kind of navigate, right? If prices are falling for the goods and services that they're producing, then how do they respond to that?
They start cutting jobs, they start cutting wages. And then once wages start declining, then you got all kinds of problems with people who have credit card debt or mortgage loans or... Because those debts, well, you still owe them. You still have to pay the same amount. It's just that now you have less of an income, lower wage. And that's when you get into defaults and that causes problems in the financial system. And then as going back to Matt's point, it becomes, you get into that kind of self-reinforcing vicious cycle, kind of a doom loop.
And we've had experience with that. If you go back into the 1930s, of course, the Great Depression, we had bouts of deflation, outright price declines, and that was pretty tough to navigate. The other thing that happens is that workers resist the wage declines, but then businesses will start cutting jobs because again, if prices for whatever they're producing are falling, they got to make money, they got to figure out a way to do that. So one way or the other, they're going to get there and they'll start cutting jobs and you get into a very dark vicious cycle.
So I don't think we want broad base price declines, but the last thing I'll say is I'd be okay with declines in grocery prices. I think that'd be okay. Food prices go up and they go down, they go all around. They go down, up and down. So I think it would be very helpful to the collective psyche if we actually saw grocery prices come in a little bit here, come down a little bit.
And I think there is evidence that folks in the, and I'm speaking with a broad brush, and it's not true for every business in every part of the food industry, but I think margins are pretty wide in many parts of the food industry. They got high as a result of the pandemic and the pricing power that offered businesses. And so some pullback in those margins might not be such a bad thing. So not broad base price declines, but if you saw targeted price declines and things, again in staples like food or even rent or gasoline, I'd kind of be okay with that, at least for a while. Matt, Marisa, what do you think? Does that sound reasonable?
Marisa DiNatale: Actually, Target just announced that they're lowering prices on a whole bunch of grocery items-
Mark Zandi: Oh, is that right?
Marisa DiNatale: ... that they sell.
Mark Zandi: Oh, interesting.
Marisa DiNatale: Yeah, yeah.
Mark Zandi: Did they say why?
Marisa DiNatale: Well, they said to help out their consumers, and then there was some backlash like, "Oh, well, if you could..."
Mark Zandi: What took so long?
Marisa DiNatale: "... do this all along, why didn't you do this a year ago?" But I mean, I think it goes to some goods and services just do really react, can react quickly. The price can change quickly. We see it with gas prices every day, right? To market forces and supply and demand. Other things are much stickier and aren't going to change as quickly.
So you do see prices for some things fall and adjust very quickly. But yeah, I mean, overall, I was thinking about deflation kind of in the way that Matt was, and thinking about countries like Japan that saw extended periods of deflation and it just killed the economy, right? Because people just did not spend any money because why would I make a big purchase on something today if the price is falling? I wait six months and maybe it's even cheaper. And then you get into this reset, just malaise, this economic malaise for a long period of time.
And then, yeah, the other thing I was going to say was wages, right? There's two sides to the coin. There's the prices that we pay, but there's also the wages that we earn, which are impacted by the prices that we pay. So people don't want to see their pay get cut, which would be a logical extension of seeing broad-based price declines. And as you said, that doesn't usually happen. Usually what happens is employers just lay people off.
Mark Zandi: Yep. Yep. All good points. This is kind of a related topic, is the, so-called greed inflation, the idea that the inflation that we've suffered through is in part or in significant part related to businesses just taking advantage of the pandemic and the shortages that resulted and just jacked up their prices and that their profit margins are now extraordinarily wide.
And I've been skeptical of that argument, but if you go look at economy-wide corporate profit margins, meaning take a look at overall corporate profits, that's the money that businesses are making, and you divide by some measure of output or revenue, that's the margin that they have. That is very high by historical standards. I mean, you have to go back to right after World War II to see them as high as they are today. So there is some, unless I'm missing something that feels like some reasonably strong evidence that businesses have been pricing very aggressively.
Now, I do think over time as competitive pressures kick in, and maybe that's what we're seeing at Target, that there's now price resistance and consumers are becoming just more choosy about what they're buying and looking at the prices more carefully or deciding to go buy something else. And if the price is too high and competition is starting to kick in, then we'll start to see those margins start to come back in.
I don't know if that means actual price declines, but what it means is that price growth inflation just won't grow as quickly as wages or other input costs, that kind of thing. But that would also be very helpful here.
Okay. Very good. Oh, any other questions, Marisa? Any other? We'll take another one if you got one.
Marisa DiNatale: Sure. This one's from Matt Martis who writes to us almost every week with questions.
Mark Zandi: Oh, is that right?
Marisa DiNatale: He has, yep. He's with State Farm. He has a whole bunch of questions.
Mark Zandi: Is he a fan? Is he a fan?
Marisa DiNatale: Oh, yeah, I think he is a fan.
Mark Zandi: Oh, okay, good. I take the question, even if he wasn't a fan, but it's better if he's a fan.
Marisa DiNatale: Don't discriminate. Yes, he's clearly a fan, I think.
This is a question. So we did a webinar last week, I don't know how many people listened, me and Chris and Mark, and we got into the nitty-gritty on inflation and the various measures, and Chris did a whole segment on owner's equivalent rent and explained what that is and how it's measured and its drawbacks and alternatives to it.
One thing that I don't think he said or any of us said, and Matt here is asking this, what should be done? So we have owner's equivalent rent. We know that it's problematic right now. It's overstating overall inflation. There are other ways to measure inflation like the harmonized CPI and PCE that you mentioned where you take out OER and you just measure observed prices rather than this implicit stuff. What should the BLS do? Should the BLS do away with OER?
Mark Zandi: No, I wouldn't do away with it. I would keep it in its arsenal of measures that it continues to produce. It's really not a question of what else should be done. There's other ways of doing it, but it's really a question of what the Fed should be focused on. When you're saying monetary policy, should you be focused on an inflation measure that includes owner's equivalent rent, particularly in the context of the current period when the housing market is topsy-turvy?
We've got a very severe shortage of affordable housing. We have a surfeit of high-end housing. It's really complicating this calculation and making it very difficult to get to anything that is useful in trying to understand inflation dynamics. So I wouldn't argue... My argument wouldn't be to do away with OER or the current way of measuring the kind of headline that the BLS is currently focused on with the CPI.
Although what I'm in favor of is trying to figure out how to look at a range of inflation measures and not just an explicit inflation target of 2%, but something that's broader than that. Because 2% is just, I think it's just too specific and it complicates things in terms of a good conduct of monetary policy. So I would argue that that's what the Feds should be focused on. That's the kind of thing we should be focused on changing, not getting rid of OER or not using OER. They're doing it. They should continue to do it. They should try to improve their methodology. It would be nice if they got some more resources from the budget so that they could invest in improving the quality of what they're doing and the timeliness of what they're doing. But I don't think I'd argue about changing what they're doing, but just how we use it. That's what I would focus on.
Marisa DiNatale: And how do you think the Fed would communicate that?
Mark Zandi: Well, I'm not sure. That's something I think we really have to think hard about, but I think it's really broadly two things. One, don't focus on... There's no one inflation measure they should be focused on. They should be focused on a number of inflation measures and using all of the above in terms of trying to get a sense of what so-called underlying inflation is.
And there's different statistical techniques you could use to combine those different measures into one, if you really wanted to do that. But I'm not sure I would even encourage that. I would say, "Look, we're looking at a half a dozen different inflation measures. All of them are important in our decisioning." It's not just top-line consumer expenditure deflator inflation I'm focused on. I'm focused on all of these things. You may want to consider some wage employment cost index and other wage measures as well, because once you focus on one measure, then you get yourself in a trap like the one we're in now, and you're focused on the wrong measure because of circumstance.
And then the other thing is I'd say why a 2% target exactly? That, I don't get. I mean, and I'm not sure I would want to pick another number, but maybe a range. And I think other central banks say two to 3%, something like that, buy themselves a little room. Everything I'm suggesting here is to become a little less specific, a little less transparent. And I think that probably makes a lot of sense in terms of conducting policy well. The one risk you have is that if there's not an explicit, "This is what exactly what I'm looking at, here's the exact target that I have," that you might get in a situation where inflation expectations become on more people don't believe or trust what you're doing in terms of inflation. But I think they can finesse that and they can manage that.
Marisa DiNatale: So where did the 2% come from?
Mark Zandi: That's a great question. I mean, it's been around implicitly for a long time. I think the Fed codified it back not too long ago, about a decade ago. I think it was 2012 in policy framework that they did back then and they used 2%.
My explanation for it has always been that at 2%, that means because if you look across the economy, 2% is the average, and then there's going to be some industries, businesses with inflation below two and some above two. In all likelihood, you won't get many businesses that are seeing deflating prices, prices that are actually declining. So if you've got that zero to two, that's going to encompass almost everything. You're not going to get below zero, at least not through the bulk vast majority of businesses. And that's what you want. Again, you don't want deflation, outright price declines on a consistent basis because that's very tough for businesses to manage and navigate. So if you have some that are basically flat pricing, you're okay with that.
So that's the way I explained the 2%, but I don't know precisely where that came from, to tell you the truth. That would be good to know. We should do a little investigation. I know other central banks adopted 2% before we did. I think New Zealand was the first central bank. I believe I'm making this up, but someone can check it, but I think it was the first to adopt an explicit 2% target. So it's been around in central bank circles for a long time, but I don't know precisely why they picked 2% except for the explanation I gave, which is the intuitive one.
Marisa DiNatale: Okay.
Mark Zandi: Good. Any other questions there, Marisa, before we move on to the stats game?
Marisa DiNatale: No, I think we should do the stats game.
Mark Zandi: Okay. Let's do the stats game. We each pick a statistic. The rest of the group tries to figure it out through questions, deductive reasoning clues. 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, which obviously is inflation, all the better. And Marisa, we'll start with you.
Marisa DiNatale: Well, we took my stat at the beginning.
Mark Zandi: Sorry.
Marisa DiNatale: My stat was Supercore and I haven't had a chance to pick a backup. So why don't you guys just-
Mark Zandi: Okay, we'll do that. Matt, you want to go?
Matt Colyar: Sure. We'll go with-
Mark Zandi: That was a hesitant sure.
Matt Colyar: It was a lot of writing today. Not so much-
Mark Zandi: Preparation for this.
Matt Colyar: ... a good number. More than-
Mark Zandi: No worries.
Matt Colyar: ... the nitty-gritty.
Mark Zandi: No worries. No worries.
Matt Colyar: No. But I got it. I got it. I got it. We'll go with 90.5.
Marisa DiNatale: The NFIB small business?
Matt Colyar: Yeah, it was too easy, wasn't it?
Mark Zandi: I was going to say that. Yeah.
Matt Colyar: Damn it. Yeah, that's right.
Mark Zandi: Matt, that's known as a bad stat.
Matt Colyar: Yeah, I was buying Marisa time, I think.
Marisa DiNatale: Well, in Matt's defense, there wasn't a lot other than CPI to pick from.
Mark Zandi: Yeah. That's true. That's true. That's true. You want to explain?
Matt Colyar: Well, I just focus so much on sentiment because it's so interesting that there's all these good things to point to, and it's a hard argument to make to say, "Hey, why is everybody so downbeat? Why are businesses so pessimistic? Look at these abstract economic data, these figures. It's actually not so bad." That's a hard argument to make. But I do think there is a case to be made that we should be a lot more optimistic about the US economy. And I focus on all kinds of sentiment measures and theorize why they might be so negative.
Generally, it's an inflation story. People hate... That's usually the way it's summarized, people just really hate inflation. And I mostly buy that, but I do think there's something else going on, just very hard to prove and to study. But yeah, and that 90.5 that I referenced, that's two months in a row of an increase of increases, still well below its historical average, but it is modest.
Mark Zandi: I think it's 98 is the-
Matt Colyar: Is where it usually hovers.
Mark Zandi: 98 is the average. Yeah.
Matt Colyar: So it's below and nobody's throwing a party just yet, but it's improving and it's a good sign that the people are starting to feel a bit better. And especially if you're like me, if you're somebody running for office again this year, that's the kind of thing you're focusing on and you want to see the people are beginning to feel better about the US economy.
Mark Zandi: Yeah, I like our business survey better. Well, that sounds self-serving. I guess it is self-serving. But we run a weekly business survey and often historically it's lined up with the NFIB Small Business Survey in terms of people are feeling good, people are feeling bad. Right now, there's a big difference between the two.
The NFIB, even with the improvement over the last couple months is, as you point out, very, very weak. Whereas our survey has actually improved quite a bit since the beginning of the year. It's a global survey. But even if you look at the responses coming from the US, they've improved quite a bit. They're not rip-roaring. People aren't really excited about what's going on, but they're feeling pretty good, particularly when we asked nine questions. And two of them are kind of broad-based questions. "How's business now and how's business going to be six months from now?" And the responses to those have improved.
One thing that's interesting is, and I think this is a problem for many surveys, is that the number of people, the respondents that were responding in a neutral way has increased very significantly compared to history. So generally, these measures are kind of diffusion indices, a positive response, a negative response, or no change, or a neutral response. And right now, if you look at the share of the responses that are neutral, neither positive or negative, it's really high.
And that's the same in our own survey, same as in our own survey. So it makes it much more difficult for these surveys to show real optimism. And it may go to some fundamental shift in people's thinking about baseline and how they feel. And this seems all to go back to the pandemic, and this is all kind of materialized since the pandemic hit. So it's another reason to be cautious about using these surveys, and putting them in the broader historical context.
But even if you do, even those caveats aside, our survey seems to suggest that people are feeling better. And those survey responses are consistent with an economy, a global economy, US economy that's expanding pretty close to its potential, very close, which is I think what we're seeing globally and here in the US. Does that all resonate, Matt?
Matt Colyar: Yeah, it does.
Mark Zandi: So next time, pick our survey, not the NFIB survey when you pick a survey.
Matt Colyar: You guys would get that, too. Okay. Noted.
Mark Zandi: Okay. Very good. Marisa, you want to go next or do you want me to go?
Marisa DiNatale: I can go. I got a new one.
Mark Zandi: All right. You're so good at this. See how fast she is?
Matt Colyar: It's intimidating.
Marisa DiNatale: Well, you'll probably get it right off the bat. 15.6%.
Mark Zandi: Is it in the CPI report?
Marisa DiNatale: No.
Mark Zandi: Is it an inflation measure?
Marisa DiNatale: No.
Mark Zandi: Oh, is it a statistic that came out this week?
Marisa DiNatale: Yeah.
Mark Zandi: Government statistic?
Marisa DiNatale: No.
Mark Zandi: Oh, okay. What do you think, Matt? 15.6%. And I should point out, we're recording this early in the week. This is a Wednesday.
Marisa DiNatale: That's true.
Mark Zandi: Yeah.
Marisa DiNatale: Yeah. We don't have a lot to pick from.
Mark Zandi: Yeah.
Marisa DiNatale: Like we normally do, right?
Mark Zandi: That's right. And again, it goes back to where I am, mystery. There's a mystery.
Marisa DiNatale: That's right.
Mark Zandi: But I'm not telling anybody. I'm not telling anyone.
Matt Colyar: Is it anything related with the CME probabilities on Fed rate cuts?
Marisa DiNatale: No.
Matt Colyar: Okay.
Mark Zandi: That sounds low, 15.6.
Matt Colyar: Maybe July. I don't know. People are starting to feel more optimistic. Yeah.
Mark Zandi: July.
Marisa DiNatale: No, it's not.
Mark Zandi: But it's a non-government release that came out this week. I've been so busy. Matt, you want to... I don't know. Do you want to give us a hint? Can you, without giving it away, Marisa?
Marisa DiNatale: I mean it's not inflation-related.
Mark Zandi: No.
Marisa DiNatale: It's like the one other release that came out this week.
Mark Zandi: Oh, really?
Marisa DiNatale: It's housing market-related.
Mark Zandi: It's the home builder survey. No? That came out-
Matt Colyar: Mortgage applications.
Marisa DiNatale: That's right. It's-
Mark Zandi: Oh, mortgage applications.
Matt Colyar: Is that their-
Marisa DiNatale: Yeah, it's the Mortgage Bankers Association composite index for mortgage activity, both purchase and refi. It rose 15.6% last week. And that is the biggest increase since January of 2023. And it was driven by refinancing.
Mark Zandi: Really?
Marisa DiNatale: Yeah.
Matt Colyar: Did mortgages fall that much? They fell that much?
Mark Zandi: Because they're down a little bit.
Marisa DiNatale: They did. They fell, which it's interesting how sensitive this is to small declines in a mortgage rate that is quite high.
Mark Zandi: Oh, so the NBA refi index was up a lot and-
Marisa DiNatale: It was up almost 30% over the week. Yeah.
Mark Zandi: Wow. But still low by historical standards? Must be. It's got to be low, the level. I would assume, just given where rates are.
Marisa DiNatale: Yeah. Yeah.
Mark Zandi: Okay. Okay. Okay. Anything else you want to say about that, Marisa?
Marisa DiNatale: I didn't want to talk about it at all. It was my backup statistics, so no, not really.
Mark Zandi: Sorry about that. All right. All right. I got one. I think it's reasonably good. 2.8%.
Marisa DiNatale: Inflation-related?
Mark Zandi: No, no, it's not inflation.
Matt Colyar: I had one, too.
Mark Zandi: What's the other big event of the week, which we're going to talk about in just a second?
Marisa DiNatale: Oh, the Fed.
Matt Colyar: Fed meeting.
Mark Zandi: The Fed, yeah.
Marisa DiNatale: 2.8%. Oh, is it their forecast for inflation at the end of the year?
Mark Zandi: No.
Marisa DiNatale: End of next year?
Mark Zandi: But it is a forecast.
Marisa DiNatale: GDP?
Mark Zandi: No. No, now you're flailing. You're flailing.
Matt Colyar: I swear, their core PCE forecast I think is 2.8 for the end of this year, maybe.
Mark Zandi: Oh, is it?
Matt Colyar: Could be a coincidence.
Marisa DiNatale: It's close to that.
Mark Zandi: Yeah, it could be. That wasn't what I had in mind. You guys-
Marisa DiNatale: But it's in their forecast?
Mark Zandi: Yeah, it's in their forecast, the summary of economic projections.
Marisa DiNatale: Is it productivity?
Mark Zandi: No, they don't forecast that.
Marisa DiNatale: Okay.
Mark Zandi: Yeah, no. Okay, I'm going to put you out of your misery.
Marisa DiNatale: Please do.
Mark Zandi: It's the forecast for the Federal Funds Rate target in the long run, quote-unquote, "long run." That's their estimate of the equilibrium rate, that rate, which is neither supporting or restraining economic growth. Kind of like our star. My interpretation of long run is through the business cycle. So if you look over the next eight, 10 years, what it's going to be, 2.8%, which seems reasonable. That's very close to where we have our funds rate settling in out there in '26, '27 in that period. After that starts cutting interest rates.
I would argue that the equilibrium rate today is probably higher than 2.8, just given the interest rates... we've talked about this in the past, the interest rate insensitivity of the economy. Households, businesses have locked in the low rates, and so they're less rate sensitive. But 2.8 in the long run, that feels about right to me, pretty close. And the reason I bring that up is because that's slowly moving higher. If you go back a year ago, was two and a half percent. I think the last meeting in March it was 2.6. Now we're at 2.8, so it's starting to migrate higher here.
Good. Well, let's talk about the Fed. And I've been pretty busy since they released their decision and Chair Powell gave his press conference. Marisa, have you been paying attention? What do you have to say about the Fed meeting?
Marisa DiNatale: By the way, 2.8% was their forecast for core PCE.
Mark Zandi: Oh, was it? Okay.
Marisa DiNatale: Yeah.
Mark Zandi: Okay. There you go.
Marisa DiNatale: So I wasn't totally losing my mind. Okay. So they did not make any change to the Fed Funds Rate at their meeting this afternoon, and they met a couple hours after the CPI report came out. This decision was probably already in the bag by then, but they indicated that inflation remains elevated, although they note that it's eased over the past year.
And Matt, you said they changed the language a little bit in this statement by saying, "In recent months there has been modest further progress toward the committee's 2% inflation objective." They reiterated that. And I mean this is encouraging if you parse the language, that the 2% rate of inflation they're targeting is a rate they want to see over the longer run. So I do interpret that as giving them some wiggle room that they don't need to see. They don't need to see a PCE report that says 2% in the next couple of months necessarily for them to cut later this year. As long as they are convinced that it's moving in that direction, that they'd be open to cutting. They say the economic outlook is still uncertain and they're highly attentive to risks to inflation.
They also committed to reducing the size of their balance sheet. They've been saying that and doing that for a long time by letting their holdings of treasury securities and MBS mature and roll off the balance sheet.
They've mentioned the 2% target objective several times in the statement. The decision was unanimous among all members of the FOMC. No one had a different opinion on what to do with rates. Then they produce these projections that we just talked about. They put out projections for the next couple of years and long run projections for things like the unemployment rate, GDP, various measures of inflation, and mark your statistic, the long run Fed Funds Rate. A lot of those things moved slightly higher. So their expectation of what inflation will be at the end of this year, at the end of 2025, those things are a little bit higher than they were at the March meeting. So for example, they expect 2024 core PCE to come in at 2.8%. At the last meeting, they thought it would be 2.6%. So the inflation measures, they do expect to move a little bit higher.
GDP forecasts were not changed. Then there's the so-called dot plot, which is where they take each voting member of the FOMC and they ask them to put in their forecast for the mid-range of the Fed Funds Rate over the course of the next few years, so we can see how that all lines up. So the difference here compared to last time is it looks like they are... The median forecast here is penciling in just one quarter point rate cut for this year. At the last meeting, it looked like two quarter point rate cuts for 2024. Our forecast has them cutting in September and then again in the fourth quarter.
Mark Zandi: Was it two or three? I thought they had three, Pennsylvania?
Marisa DiNatale: Was it three at the last meeting?
Matt Colyar: In March, they expected 75 basis points.
Marisa DiNatale: Oh, okay. I'm sorry.
Matt Colyar: They introduced in December, helped do it in March, but then it was-
Marisa DiNatale: Okay, I'm sorry about that.
Matt Colyar: ... it didn't look great.
Marisa DiNatale: So now we're down to one.
Mark Zandi: Yeah. Right. So what do you think about that? Does that make sense to you? I mean, we have two rate cuts in our forecast, one in September, a quarter point and one in December, a quarter point, and then cutting after that once a quarter a quarter point each until we get back down to that equilibrium rate in the '26 or '27. Does the one rate cut... I mean, they saw the number this morning. I suppose that the one reflects that CPI number, right? Maybe they were surprised too, and I don't know.
Marisa DiNatale: Like they wanted it to be better than it was?
Mark Zandi: No. Yeah, I don't know. I mean-
Marisa DiNatale: Maybe they're spooked by the jobs number last week.
Mark Zandi: Yeah, I guess. What do you think, Matt?
Matt Colyar: I think you can start with investors. I think they're putting more weight on the CPI report. If you look at just bond yields today than the dot plot. So they're down seven basis. If you look at two year, it's about seven basis points, which is about half the decline that we saw between CPI and before we knew what the FOMC was going to wipe off, the median expectation for the Fed Funds Rate.
But I also, yeah, I think it's reasonable not to have overreacted, I thought and just say, "Okay, let's drop this by half a percentage point or reduce the amount of cuts we expect in 2024 from three cuts to one cut," if you interpret it that way. But if you look at it the other way, it's the dot plot still has eight of the 19 voting policymakers that they make up that dot plot. They still expect the multiple cuts. It's just that there's a few that expect none. So the kind of balance shifts over that way, which wasn't well articulated by me, but if you listen to Fed Chair Powell's press conference-
Mark Zandi: That's interesting.
Matt Colyar: ... what he's saying is this is, and I believe this, and it goes back to I think a point Michael Strain with AEI was on this podcast. It made a really good point, which we mentioned again today, which is this over transparency, like all this speculation on, okay, now the Fed expects one basis or one quarter point cut. It's really just where the median expectation fell. And there's still a big cohort in that group that expects two.
So what happens between now and there's another CPI report between now and July or July's meeting. So I don't put too much stock in it. I think investors are doing the same and 50 basis points in 2024 is kind of consensus right now. So I think where we should be.
Mark Zandi: Oh, so you're saying the core of the FOMC, the actual members, the standing members of the FOMC, it feels like they kind of stuck together still around two cuts this year, and it's really the Fed President's that may have swung it to just one? That's kind of your-
Matt Colyar: I can't decide that kind of particular-
Mark Zandi: You don't know. There's no way of knowing. But that's certainly a plausible explanation.
Matt Colyar: I look at the cohort, it's a big enough cohort no matter who it is that I could see that being you wouldn't take much to tip into the 50 basis point cut camp. Yeah.
Marisa DiNatale: Yeah. There's like four members at no cut this year, but everybody else has-
Mark Zandi: I see.
Marisa DiNatale: ... one or two cuts.
Mark Zandi: Yeah, I mean, the market reaction was... I mean, market was very... When I say market, I mean the stock market, the bond market, very, very happy with the CPI number. Everything was moving in a very positive direct... Bond yields were down, stock prices were up. Then the Fed meets, you see the one rate cut and the market took a little bit of that optimism euphoria back. But we're ending the day here still in very positive territory that you're saying that bond yields are still down pretty meaningfully. The stock market, at least on the S&P 500, it's still up and therefore net-net-net market feels pretty comfortable with the two rate rate cuts this year.
Matt Colyar: Yeah. And the futures data that we have, investors are increasing the probability they assign to a rate cut in September. It's been 45, 55, 60% range. So bouncing around a majority, and now it's on the higher range of that.
Mark Zandi: Okay. So it's well over 50% now?
Matt Colyar: Last I checked, it was about-
Mark Zandi: Last you checked? Okay.
Matt Colyar: ... 58%, 60%. And that was this afternoon after the Fed.
Mark Zandi: Okay, well that makes sense to me. Yeah, of course I've been arguing for quite some time the Fed should be cutting interest rates. I mean, I don't know, I think they've hit their target on both the unemployment rate and full employment, where they're 4%. And by the way, that's migrating higher, right? I mean, we were three and a half percent I think a year ago. So really pushing up here. It's very low, but moving up.
And then on inflation, exclude the crazy OER, we're there and then some. Just feels like we're... And even if you throw in OER based on today's report, it feels like we're headed back to target here in a reasonably timely way, graceful way. So I don't know, it feels like they should be starting to cut rates. And I think that ultimately that argument will win the day by September and we'll get those rate cuts. Okay. Anything else on the Fed? No? Marisa, anything else you want to add on that? Matt, no?
Marisa DiNatale: I don't think so.
Mark Zandi: I'm trying to think. Okay. Well, I have to say it was a good day all around, right? I mean, can't argue with those CPI numbers. That was a really good day.
Okay, I think we're going to call this a podcast. We're going to keep this short because again, the mystery continues. I'm not going to tell you.
Marisa DiNatale: Shrouded in mystery.
Mark Zandi: Yeah. I think we covered a lot of ground. And with that, dear listener, we'll talk to you next week. Take care now.