After hiking interest rates in July, how confident should the Fed be as inflation continues to show signs of cooling? The Fed should be "taking a lot of solace" in PCE prints, Moody’s Analytics Chief Economist Mark Zandi told Yahoo Finance Live, believing officials don't need to continue with any more rate hikes. Zandi goes on to outline various economic headwinds, including consumers' ability to repel a recession and the potential for a government shutdown.
- All right we are wrapping up a big week for the economy.
Investors are passing through a series of reports showing inflation in the US is moderating.
The Fed's preferred inflation gauge PCE showing signs of cooling.
The core PCE index is up 4.1% in June from a year ago.
The annual rate was the lowest since September of 2021.
Joining us now, we want to bring in Mark Zandi Moody's Analytics chief economist.
Mark, it's great to see you.
So let's talk about some of the reports that we got this week and also what we heard from Fed Chair Jay Powell so that PCE print this morning, the latest in a series of inflation prints really showing that pricing pressures are easing.
How do you think the Fed is looking at these series of reports and this trend that we're starting to see?
MARK ZANDI: Well, Seana, they've got to be taking a lot of solace in it.
I mean, these are pretty good numbers.
I mean, inflation obviously is still too high.
4% is still double the Fed's inflation target.
But everything is moving in the right direction here and all the trend lines look pretty good.
I do a lot of forecasting, forecasts lots of different economic data.
Some of that, I'm very confident in, some not so much.
But I'm feeling pretty good that inflation is going to be lower six months from now and probably pretty close to target a year from now.
And that won't require any more Fed rate hikes.
So I think the Fed should be taking, again, a lot of solace in these numbers.
MARK ZANDI: I do.
I do.
I mean, obviously, there's a lot of script to be written here and things happen.
But barring something that comes out of completely out of left field, I think the Fed's getting what it wants-- it's getting inflation back in the bottle, economic growth is slowing, the unemployment rate is low and stable.
The financial system is under a lot of pressure because interest rates are high.
And I think raising rates further would undue pressure.
So I think you add it all up, it suggests Feds should be pretty happy where things are and where they're headed.
- Well, Powell did talk a little bit earlier this week just about potential cuts.
He was saying that it's not going to happen anytime soon looking ahead into next year.
My question to you, though, Mark, is what is it going to take for the Fed to cut.
What do they need to see in order to feel more comfortable easing back on their policy?
MARK ZANDI: I think inflation back to target, Seana.
I mean, I think they've got a pretty high bar for cutting rates.
Again, the core consumer expenditure deflator-- that's what they are targeting is at 4%, just over 4.
It needs to be closer to 2.
We're at least certainly headed in that direction.
So that's still a way to go.
So I think they need to feel absolutely positively sure that we're in that ballpark before they start cutting rates.
And once we get there, I think they'll start slowly lowering rates.
But that probably won't be until second half of next year going into 2025.
- Mark, the PCE print this morning, when it comes to the consumer side of things, personal savings, that number-- personal spending, excuse me-- coming in to the upside, it was the biggest jump that we've seen since the start of the year.
What's your assessment just of the consumer, the resiliency that we have seen and whether or not that sort of strength can continue here in the second half?
MARK ZANDI: Yeah, incredible resilience.
Consumers are just hanging tough, doing their part.
They're not out spending with abandon, they're not doing that.
But they're spending like they typically would, something around 2% real growth.
And that's what it's been for more than a year now.
So it kind of just rock solid.
And all the consumer fundamentals look pretty good.
Wage growth is now stronger than the rate of inflation.
So that means real wage gains.
That's real purchasing power starting to improve.
Paying with a broad brush, you're obviously there's big differences across income groups.
But in totality, debt loads are light, people have locked in the previously low record interest rates.
And now stock prices are within spitting distance of the record high, housing values are pretty close to the record peaks, set back about a year ago.
And middle and high income households still have a lot of cash sitting in their checking accounts built up during the pandemic that they can use if they get into a scrape.
So I think if you add all that up, it suggests that the consumer, which is the firewall between recession and continued growth-- that firewall is holding up very well, holding firm.
- Mark, when we talk about the fact that the economy has been holding up extremely well, much better than many of the forecasts had expected here, that print that we got this morning, Atlanta Fed GDP now model starting Q3 growth at 3.5%.
What signal does that send in just in terms of the fact that some of these worries about this recession that we have not seen come to fruition, that maybe we're not going to see a recession at all?
MARK ZANDI: Oh, I missed that, Seana.
I didn't see the 3.5.
It's way too early in the quarter though.
We do the same thing they do, take the monthly data and translate that into what it means for current quarter GDP.
And there's just really no data at this point.
So I don't think I'd put a lot of weight on that.
But it does suggest that we're coming into Q3 or in Q3 with some strength, some momentum.
And very clearly, recession is not at all likely, certainly not in Q3.
I will say there are a few risks though that make me a little more nervous about Q4, Q1.
The one that's coming to the fore here is the potential for a government shutdown.
It now looks, I'd say, more than likely that there's going to be shutdown with the start of the federal fiscal year on October 1st.
And that could extend out through the entire quarter into next year possibly.
And if that's the case, that could be a threat.
The other thing is student loan borrowers do need to start repaying on their debt.
Now the president did give them a bit of a reprieve, telling servicers not to report delinquent borrowers to the Bureau.
So there's no penalty for not paying.
But still, there will be some increase in payment there.
So there are a few things that are coming together that make me a little bit nervous about growth going towards the end of the year or beginning of next, but not enough to think that recession is imminent here or even around the corner.
- Mark, let's talk a little bit more just about the risk of a government shutdown, what that potential impact could look like, what the ripple effects could be.
When we're trying to model that out and exactly see or gauge the extent of that risk, what should we be thinking about?
MARK ZANDI: Well, if it's a week or two or three, no big deal.
Obviously, if you're a federal government employee.
You're not getting a paycheck, that's a deal.
But for the broader economy, I don't think it's big enough.
But if it extends out for a month, that probably shaves two, three, maybe 4/10 of a off of the GDP growth in the quarter.
If it goes on for a quarter, if we're shut down in October, November, December, that's a point off of GDP growth, roughly.
And the economy probably is going to be, without it, growing about a point.
So you could construct a scenario where you get a negative print in Q4.
And then the other thing that's going to happen is there would be a potential so-called sequestration under the rules 1% cut across all discretionary spending.
And if that hits in the start of 2024, then that's going to be pretty significant headwind going into next year.
And this is, in most times, not enough to really push this kind of an economy into recession.
But clearly, the economy is going to be soft in the weak here in the next two, three, four quarters and thus vulnerable to things like this.
So hopefully, lawmakers get the message and don't do that.
That would not be very good for the American economy, the American people.
So hopefully, they don't do that.
But that's certainly a risk.
- And Mark, one of the other risks that you mentioned there, that you have your eye on right now is what's playing out within the banking sector.
We had thought that maybe the worst was behind us when we talked about some of the stress in the regional banks.
How big of a risk do you still see this potentially being here in the second half?
MARK ZANDI: I worry about it, Seana.
As long as interest rates are high, as long as the Fed's got its foot on the brakes and short term rates are 5, close to 5.5%, and as long as the yield curve is inverted with short term rates higher than long term rates, that means the operating environment for financial institutions, banks and non-bank financial institutions is pretty tough.
The other thing to consider is that we are going to see more credit problems that we know, a lot of hand-wringing about commercial real estate which there should be.
But there's going to be more credit problems, consumer lending, and CNI lending.
The regulatory environment is getting more difficult for banks for understandable reasons, but their costs are rising.
And loan growth is going to be weaker because they're more cautious.
So you kind of add all that up, that's a lot of pressure on the system.
And I'm not as worried about the banks because the Federal Reserve and the Treasury and FDIC have made it clear they're backstopping the banking system.
But the other part of the financial system that provides about half the economy's credit, the non-banks-- there, the risks are much higher and it's hard to know what might break.
So as long as interest rates are this high, the risks are not inconsequential that something happens that could derail things.
Not my baseline, but certainly a threat, certainly a risk.
- Certainly something to keep in mind here as we get ready to look forward to the last two quarters of the year.
All right, Mark Zandi, thanks so much.
MARK ZANDI: Sure thing.