Fed landing ‘will be clearer’ in coming months: Economist

S&P Global Ratings Chief Economist Paul Gruenwald joins Yahoo Finance Live to discuss August JOLTS report data, labor market woes, the state of the economy, inflation, recessionary risks, and the outlook for Fed policy.

Video Transcript

BRAD SMITH: All right, for more, let's bring in the S&P Global Ratings chief economist Paul Gruenwald joining us now, joining us here live in living color. You've been hearing some of the employment situation in the JOLTS data that we've been breaking here as well. What does this really tell you about the overall economy at this point?

PAUL GRUENWALD: Well, first of all, it's great to be back and see you guys in person. You are absolutely right to be focusing on the labor market. That's what we're telling our clients and our stakeholders. We know the direction of travel in the economy is slower. But what's the one variable or one sort of thing you should be watching to see whether it's going to be the soft landing or something a bit harder?

So if we can get a deceleration in the labor market-- and the numbers we're describing right now look like it's a deceleration of the labor market-- then you're on a narrative where the Fed is tightening. They're beyond neutral, maybe going to 4 and 1/2. The labor market sort of hangs in there, and we get maybe a borderline recession or not in the US, but certainly not a hard downturn. So given that the monetary policy works with a lag of a couple of quarters, as these numbers come in the next couple of months, I think it will be clearer which of those narratives we're in.

JULIE HYMAN: Well, that's sort of my concern, right, is that we won't know until it's too late, right, for the Fed to then make a quick adjustment because of that lag.

PAUL GRUENWALD: Well, that's the joke about running a central bank is you're driving a car. The windshield is dirty. The steering doesn't quite work well. And you're doing stuff, and you have to wait a couple of quarters for it to actually come through the data.

And yeah, the risk is that maybe they're pushing too hard on the brake now, and that's going to cause a recession. I think the balance of risks, given what we're seeing in inflation, is still that they're going to err on the side of doing a bit more, rather than a bit less. We've got to get to the 2% expectations to ensure credibility of the central bank. So even three 75's in a row, I don't think the Fed is going to be pausing until they see a little bit more progress on the inflation front.

BRIAN SOZZI: What are your expectations around the jobs report on Friday?

PAUL GRUENWALD: Yeah, I don't have a number in my head, but I mean, I think this narrative is what we would want to see, kind of a deceleration. The unemployment rate bottomed at, what, 3 and 1/2 and then we're 3.7. That's probably going to go into the mid 4's, maybe a bit higher. But that's kind of the narrative about where we're going on the jobs market.

But again, it's the lag, right? So we've got three big rate hikes in a row, and that's going to filter through the next couple of months. But if we get this deceleration story going on those numbers, maybe we can expect to see good things in the market while we're on that track.

BRAD SMITH: You've generally lowered your forecast for GDP growth in 2022 and 2023 and raised your forecast for inflation. Perhaps there's a marker on the inflation side that you're keeping tabs on.

PAUL GRUENWALD: Yeah, well, you can torture the inflation numbers however you want. So the headline's 8.3. The core PCE, which is what the Fed actually follows, is 4.6, and the targets, too. So whatever sort of flavor you pick, we're way above target. We're going to need to continue to slow. And I think, again, that's part of the lag thing. Even sequentially, we torture and get the last three months of data. That's still nowhere near 2.

And the Fed is going to have to see a turn in the sequential data, re-unanchoring of expectations around 2, and then we're going to back off a bit. But we're in this really tricky period now. Our growth is clearly slowing. Inflation might be leveling off in total, but the part that the Fed cares about and other central banks care about, which is the core, that's still going higher. So again, that's kind of the lag profile. The next six month's going to be very clear. Clearer, not very clear.

JULIE HYMAN: We've been talking a lot about jobs. I'm curious to ask you about housing because we talk about housing a lot, and how much mortgage rates have gone up, and how it's a problem of affordability. But when you talk about it as an economic driver, how concerned are you about housing?

PAUL GRUENWALD: Well, that is an interest rate sensitive sector. So when the Fed tightens or any central bank tightens, it's not uniform across the economy. You're going to look at the interest rate sensitive sectors. And they should be feeling the pain first. That's housing, durable goods, et cetera. So the housing starts, we have a couple of funny prints recently, but that should be slowing down. Housing demand should be slowing down. Asset prices should be leveling off.

But again, you're looking for a narrative that's kind of deceleration, rather than tanking. But the mortgage rates are pushing 7% right now, right? Not too long ago, they were 3. And some of us luckily locked in lower than that. But that's a big affordability issue. So that should be breaking the economy.

But again, if people have jobs, they think they're going to keep their jobs, they're going to continue to spend, they'll moderate their spending for lower asset prices or a bit higher inflation. But that's the sector-- one of the sectors that's on the short list. If we start to see that really go pear shaped, then we might be in the recession scenario, rather than the slow down scenario.

BRIAN SOZZI: So we have housing prices coming under wraps. We have consumers worried about even rising interest rates. And we have the markets, terrible year for the markets, many parts of it. How does this impact consumer spending into 2023?

PAUL GRUENWALD: Yeah, again, I think employment's the key and confidence is the key. The confidence is a little bit tricky, right? That one almost correlates too much with gasoline prices. So consumer confidence tends to go up and down with the price of gas at the pump.

But again, it's employment, expectations of employment. So consumers will adjust, but if you think you're going to keep your job, you're going to keep spending. And that's kind of the soft landing environment. So, again, watch the labor market on Friday. Those are the numbers, I think, we're going to be using or using most heavily to gauge where we are in the story.

JULIE HYMAN: I want to know a little bit more about what you think is going to be the character of the recession. As you say, we don't have all the data, right? We don't know yet, because I'm struck by kind of what we hear anecdotally from strategists and folks that it's not going to be too bad a recession. But then we're about to talk to the head of KPMG US in a little bit whose survey found that only 34% of US CEOs think it's going to be mild and short recession, which is sort of surprising. And I'm curious how that matches up with what you're seeing in the data and what you're hearing from other economists as well.

PAUL GRUENWALD: Yeah, I think as we've said in the report, we kind of bucketed the three regions. So let's leave China, which is a health policy, and Europe, which is more energy security, and focus on the US. The US is kind of a classic downturn, right? Too much fiscal stimulus in the economy, rates were too low for too long, too much demand. We're above potential for growth. Inflation is way above target. So the central bank is trying to bring it back in. And we don't have the confounding factors of health policy and energy security the way the rest of the world does.

So that tells you, not that there's such a thing as a garden variety recession, but it will be relatively uncontaminated by these other factors. So we've got-- we actually have a recession in our forecast in early 2023, but it looks pretty moderate. We don't have a big sort of disequilibrium to take out. We're just being confounded by what's going on in the rest of the world and coming out of COVID and a lot of things and a funny labor market where people aren't really coming back to work for a number of reasons. So that's where the Fed's got to really kind of figure out where to go.

But the baseline seems to be, it will be difficult to avoid a recession. If we kind of luck out, we might skirt around 0 and not go down. The hard one's kind of difficult to envision. I think the one risk that really worries us is the Fed's been tightening. Inflation really doesn't come down as they want, and they need to go a lot further than they're saying now. When that goes into the market and gets repriced, then they're really going to have to put on the brakes.

JULIE HYMAN: What probability would you assign that baseline?

PAUL GRUENWALD: That's not the baseline, no. I would say that's still relatively low. But I'll just give you one number to think about. That inflation measure that the Fed likes, the core PCE, that's 4.6. Let's suppose that doesn't do much in the next six months. The Fed's going to 4 and 1/2. You get real interest rates basically to 0.

And are we going to be able to slow the economy down and soft land it and have kind of minimal damage if real interest rates only peak out at 0? They've been negative for quite a long time. There's a huge question mark around whether that's going to be enough.

So the labor market's fine to watch, but inflation and sort of the core inflation that they're focusing on, that's got to start to come down. If that's not coming down meaningfully after three big rate hikes and maybe another one coming, then we're going to have to do more. Then we reprice this whole sort of nice scenario we're talking about. And then we get your down, like Julie. But I think that's not a baseline right now.

BRAD SMITH: Another contributor to that, the inflationary pressures that we have seen has been energy costs as well. And even as we think about what a US recession may look like, there's also what we were discussing earlier in the show in OPEC and some of the cutting in some of their production, what that may mean in Europe, but also how much of a European or a global recession, more broadly, may also trickle into the US economy.

PAUL GRUENWALD: Yeah, I mean, energy-- oil prices are in the 80s right now. And OPEC's kind of talking. It looks like strategically, they might want to keep them in that zone. But energy prices are down quite a bit, right? So going around town, there were five handles on gas not too long ago. Now we're in the 3's. So that's sort of-- that source of inflation has come down. The supply chain source of inflation has come down. Food's still a bit elevated.

But if we put all that in a non-core bucket, that part of the inflation is pulling down the headline numbers. But the part we just talked about two minutes ago, which is the core, is still going up. So that's going to help. If that helps drag down the other stuff, that's good. But we still have a core inflation problem in this country and a lot of other countries. And that's what central banks have to look at. The other stuff is great for the headline, but they're really focused on the core.

BRIAN SOZZI: Good to see you back in person, S&P Global Ratings chief economist Paul Gruenwald. We'll talk to you soon.

PAUL GRUENWALD: Great. Thanks, guys.