Deutsche Bank Chief U.S. Economist Matthew Luzzetti joins Yahoo Finance Live to preview June inflation data and discuss Fed policy, the labor market, and the outlook for the U.S. economy.

Video Transcript

- All eyes now turn to new inflation data out this week ahead of the FOMC meeting later this month with recession concerns lingering. Here to dissect what's in store for the US economy is Deutsche Bank Chief US Economist Matthew Luzzetti joining us on the phone today. Matthew, it's good to talk to you today. You know, it sort of feels like, when you look at where the markets have been moving, good news is bad news for investors right now. At least that's what we saw with the jobs report on Friday. What are we likely to see come Wednesday?

MATTHEW LUZZETTI: Sure. First, thanks so much for having me. As you noted, I think last week we had some interesting data. It was stronger jobs report on Friday, some data during the earlier portions of the week, which showed the economy not slowing as much as feared, I think, with the ISM Services indicator in particular.

This week, I think, is all about inflation on Wednesday and the CPI report. And on that front, we're expecting another strong inflation print. We're expecting core CPI to rise 0.6% month on month, headline inflation to rise more than 1% month on month. That likely pushes the year over year rate close to 9%. And so for a market that has been dealing with certainly recession fears, I think this week will be renewed fears about elevated inflation that began on Wednesday.

- Yeah, I guess, the question, Matthew, just like the jobs report we got on Friday, is going to be, well, that's sort of a lagging-- that the word looking backwards here with the data. Where are we right now? I've been looking at your notes here talking about CPI pushing higher to 9%. If that's what we saw in the previous month, where do you think we are today, and are we starting to see the peak?

MATTHEW LUZZETTI: Yes, I think you are. Certainly from a headline inflation perspective with the decline in oil and gas prices that should be very helpful in bringing down headline inflation going forward. But I think what the Fed and what the market should be focused on is core inflation and then, specifically within that, the persistent items that will tell us where inflation is going over the coming months.

Within that, I think rental inflation is the most important. That shot up in the prior month. It's likely to remain strong again. And if you get another strong print there, it's really evidence of broad based underlying inflation pressures in the US economy at a time where very clearly growth is slowing. And I think that puts the Fed in a bind. So far, we've heard them remain hawkish. We think they continue to with a 75 basis point rate hike at the end of this month. But later this year could be quite difficult for them if inflation remains elevated and the labor market begins to weaken.

- Yeah, I mean, everything you're pointing to some would argue suggests that the Fed's rate hikes here have not necessarily had the intended impact yet. I mean, how do you assess that, and is that 75 basis point enough?

MATTHEW LUZZETTI: It certainly had the intended impact, I think, within some of the sectors and growth indicators. So for example, the housing market and activity has clearly showed materially given what's happened with mortgage rates financial conditions have tightened significantly, certainly equity markets are down, credit spreads have widened, and the dollar has strengthened. So all of that, I think, has had the intended consequences of slowing forward-looking growth momentum.

I think the difficulty is that it takes a long time for that to filter through into the core inflation data. And in fact, Fed research shows that as the Fed tightens monetary policy, at least for a period of time, rental inflation can rise as a result of that as home buying-- those who wanted to buy a home then shift to renters.

And so I think we're in a period here where, for the market and the Fed, it's a really difficult one to disentangle, one, how much is the economy slowing in the near term versus how much is inflation slowing in the near term. And I think, on balance, it just keeps the Fed hawkish for the coming months.

- And those recession fears that continue to loom there, I guess there's a debate here among economists who would say, look, we're already in a recession. And where do you stand on that right now? What do you see?

MATTHEW LUZZETTI: It's become a very messy story. We expect that the economy contracted in GDP terms in Q2 as well after contracting in Q1. That would be consistent with a technical recession, two consecutive quarters of negative growth. But it doesn't look like a typical recession on many fronts. In the first quarter, consumer spending and CapEx growth were very strong and alternative measure of GDP-- gross domestic income-- was actually positive in growth terms.

And the labor market added about 450,000 jobs on average over the first six months of the year. Just an incredibly strong number. And so we don't think that the economy is in a recession now. We think that ultimately the strength in the labor market keeps the Fed hawkish, pushes them to raise rates above 4%, and then the recession happens next year around the middle of next year. But simply just given the recent data, there are clearly risks and concerns that the recession and this weakness just continues over the coming months. And so the risks of an actual recession certainly have been pulled forward.

- Yeah. Always great to get the context from you, Matthew Luzzetti, Deutsche Bank Chief US economist joining us on the phone this morning.