UBS GWM Chief Economist Paul Donovan joins Yahoo Finance Live to discuss core PCE data for February, economic uncertainty, real wage growth, and the outlook for inflation.
Video Transcript
- The feds preferred inflation gauge calls in February compared to the prior month. However, this isn't the only inflation story turning heads. As profit margin led inflation grabs the attention of central banks, here to lay out the latest economic picture, we've got Paul Donovan who is the UBS Global Wealth Management chief economist. Paul, great to have you here with us today. As we round out the first quarter of 2023, if there's kind of one common denominator, or one major theme that rings true or rings resounds in your mind, what would that be?
PAUL DONOVAN: Well, I think it has been the development in terms of inflation that so much of the inflation story is behaving exactly as expected. The transitory durable goods price inflation of 2021, early 2022, that's gone. You're we're in complete deflation territory. You've got falling durable goods prices in the states.
- We're in deflation versus disinflation, Paul.
PAUL DONOVAN: No, deflation, outright falling prices. So disinflation is when the inflation rate itself comes down, deflation is when prices are lower than they were this time last year. And that's where you are with durable goods. With energy prices, there we've got disinflation, we've just seen this in the European numbers, it's starting to drag down the headline. What we are left with is in certain sectors companies expanding their profit margin, telling customers, look, you've got to pass on these price increases.
But they're not passing on the price increase, they're pricing on the price increase and a bit more. And that is now the last leg of the inflation story. And frankly it's something which I think our fed has not really properly addressed in its policy discussions.
- So then when you look at some of the fed speakers who are coming out here, then how much does that complicate the picture here. When you're trying to figure out where is inflation versus some of these companies just passing on these extra costs, as you're saying prices are coming down?
PAUL DONOVAN: Well, so what we've got here I think is a lot of relative price moves. So there are some sectors of the economy which are suffering quite a lot where you're seeing either disinflation or deflation. You've got other sectors of the economy where companies are passing on the profit margin expansion. I think the problem particularly with fed chair Powell is that Powell tends to take a very-- let's say economics 101 approach towards policy, which is inflation of, I must hike rates.
Well, the problem is with profit-led inflation, that's not necessarily the best approach because it's not excess demand that is driving this inflation it's pricing power and an unusual pricing power on the part of some companies and the fact that they're able to spin a fairy tale to convince customers to accept the price rises. So I think a more robust explanation of what's going on with inflation if not from Powell, from someone who's a qualified economist at the fed.
That would actually be quite helpful, I think, in helping consumers resist some of these profit expansion price rises.
- And so yes, companies, they are continuing to raise prices or have to either because wages higher or the supply chain for what they were able to lean on before and saying that the supply chain effects are causing them to raise prices. Much of that, even if it has been mitigated, they're still continuing to maintain price where it has been. So how much longer can consumers or should consumers expect for prices to remain elevated or will they start to abate even more at a rapid clip as they push back on where price increases have been put into the market?
PAUL DONOVAN: Well, what we've been seeing actually is a is a fantastic storytelling exercise. So wage costs are rising. No, they're not, real wages are collapsing in the United States. It's been a disastrous two years for real wage growth. Supply chain problems. Global supply has never been as high as it is today. Global trade exploded in 2022, global manufacturing output keeps hitting all time record highs.
But it's a good story. What we're now starting to see I think are two things. Firstly, consumers particularly lower income consumers are running out of the savings from the pandemic. They're finding it harder to access credit. They've got falling real wages. And that's starting to subdue demand and that will help to subdue the profit-led crisis story. But secondly, consumers are actually starting to wake up to this.
Not quite yet in the United States but we've been seeing this in Europe for example where in the Nordic countries, both Norway and Sweden, food prices have actually started to come down at least for certain items because consumers are just saying hold on, this isn't fair, we're not paying this. And politicians, once they hear consumers are upset, obviously also start to get involved. So I think we're on the cusp of consumers starting to rebel a little bit against some of these profit-led price increases.
And that combined with the economic necessity forced by these two years of very, very negative real wage growth. That's going to, I think, accelerate a process of disinflation over the course of the next 3 to 6 months, I would say.
- So Paul then I wanted to get some of your Q2 expectations in your outlook here for how you expect the fed to move? Obviously investors seem to be expecting a pause perhaps a little bit too early at the moment. But what are your expectations for Q2?
PAUL DONOVAN: Well, if I was running the feds, I would have paused already. But sadly because I've got a British accent, I'm not allowed to run the federal reserve. So we've got to try and guess what Powell is going to do.
And the honest answer is, I don't think Powell knows because we do need to assess what degree of bank lending tightening is going to come through over the course of the next few weeks and months. Now bear in mind, we've been seeing a tightening already, so credit standards in the states and indeed in Europe have been tightening for several months. But if that process accelerates because of the events of the last few weeks, then that's something which would cause the fed to pause in its tightening cycle.
Now I would slightly to the optimistic, frankly we don't have the data at the moment to be able to make a really informed decision. But just looking at who was doing the lending, what the constraints are, what middle income families are doing, I would incur slightly to the optimistic in terms of this position. And as a result, I think the fed has got one, probably two quarter point hikes left in it. I'm not sure that's a good idea but that's a wholly separate question.
I think we've probably got one or two rate hikes in the second quarter.
- Well, I certainly feel your pain, I have to take running for fed chair off my bucket list as well. A big thank you there to UBS Global Wealth Management chief economist, Paul Donovan, thank you for your time this morning.
