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Inflation: Even if we plateau, ‘we’ve got a lot more work to do,’ economist says

S&P Global Ratings Global Chief Economist Paul Gruenwald joins Yahoo Finance Live to discuss inflation, Fed rate hikes, and the outlook for markets.

Video Transcript

- Stocks lower today as fresh data and earnings means more food for thought for investors. And our next guest says the inflation reduction versus growth trade off still front and center for US policymakers. Joining us to discuss is Paul Gruenwald, S&P Global Ratings global chief economist.

Great to have you on the program this morning, Paul. We were just talking about retail earlier in the show. And retail sales data coming in, kind of flat month over month. I'm wondering if there was anything you gleaned from just kind of the overall story of what the American consumer looks like and what that tells us about the inflationary story going forward.

PAUL GRUENWALD: Right. Well, I listened to your earlier segment. I think you guys did a pretty good job of describing what the Fed's trying to do. We're trying to soft land the economy. So we had a modest rise in retail sales once we stripped out the volatile stuff. So that's just another data point in this narrative where the economy is slowing, but it looks like the key part of the economy, which is US consumer spending, is still kind of trundling along. And again, the objective here is to cool the US economy.

We know inflation is too high. Unemployment's too low. And what we call the output gap is positive, which means we're running a bit hot. But we need a little bit slower growth. And the question is, are we only going to get slower growth or are we going to go into a recession? Last few data points have been a little bit on the side of maybe we can do this with slower growth. But the jury's still out.

- Yeah. Let's pick up on that point, Paul. I mean, we are seeing all three major indices down today. But last week, we saw a big rally on the back of some of that inflation print that we got through. The expectation at least from the markets rate is that, look, we may have peaked here in terms of inflation. How did you break those numbers down?

PAUL GRUENWALD: Yeah. That's a tricky call because last year about this time, we were also saying that if you look at the sequential monthly inflation data, it looked like we were peaking. I think we need some more data prints to come in. I would put a word of caution around some of the year over year numbers. We saw that this morning from the UK. Last summer there, prices were flat.

So I think their year on year rate is going to continue to go up. But, yeah, look, the headline US rate is 8 and 1/2. What the Fed focuses on, which is core PCE, is around 5 to 6. So we're still way above the 2% target. So even if we're plateauing, the Fed's below neutral. We've got a lot more work to do to get inflation and inflation expectations down to 2 in the US.

- Paul, broadly speaking, when we take a look at what's been happening in markets, stocks have gone up. Rates have gone down. It seems like the broad story seems to be that markets and investors feel like they know exactly where the Fed and other central banks are going to stop tightening. Do you feel like the message is being received? Or do you feel like because inflation is still high and the Fed and other central banks are not done with the job yet that there is still considerable uncertainty out there?

PAUL GRUENWALD: Yeah. That's a key question because we know the Fed is trying to still provide some forward guidance. I know we've stepped away a bit from that particular term. But if you also look at the financial conditions indices, which is kind of the markets application of the Fed funds rate-- so if you look at asset prices, if you look at bond yields, if you look at spreads-- I checked this morning on the Chicago FCI, and it's a little bit shy of neutral, which is essentially where the Fed funds rate is right now.

So there seems to be some alignment between the policy rate and where the markets are. But, again, we're in a volatile period coming out of COVID. We've all know about the economy being whipsawed between durables and non-durables. And in services, you guys just talked about inventory. So again, we're going to need some more data points to get a better path of whether we're in a slowdown or maybe a deeper downturn like a recession.

- Paul, earlier this week, we got weaker than expected economic data coming out of China. A surprise rate cut from the PBOC on the back of that. It certainly doesn't look like they're going to now meet that 5 and 1/2% growth target. But talk to me about how you're looking at the ripple effects there. I mean, there's certainly a lot that's happening internally domestically in China that raises concerns, whether it is high youth unemployment, whether it's what's happening in the real estate market. But what are you most concerned about in terms of the impact coming out of there that it could have on the broader global economy?

PAUL GRUENWALD: Right. Well, I think first of all, Akiko, you and I both spent some time in Asia. This year is really interesting because this is the first time in my career I've seen such a big miss of the Chinese official growth rate. Li Keqiang came out earlier this year in March with the work program and said growth was going to be 5 and 1/2. Now it looks like we're going to be in the low 3's, given the current data, with some downside risks.

So it's a huge miss for the government on the growth side. I think maybe the good news for the rest of the world is Chinese economic weakness right now is coming from the household sector. And that's not the part of the economy that spills over to the rest of the world. It looks like the Chinese manufacturing and exports are still doing well. And we've got the whole commodity demand story coming out of that.

So that really kind of radiates into a whole bunch of trading partners through both the manufacturing supply chains and the commodity channels. So even though Chinese growth is coming in a lot slower than we think, the fact that it's mostly in the consumer and the household sector means it's going to be more domestically focused. But, clearly, China's been driving growth, as we all know, for a couple of decades. And for China to be putting up a three handle rather than a five or six handle is going to really drop down global growth.

- What about the impact from the zero-COVID policy, though? It certainly doesn't look like there's going to be any change on that front. Xi Jinping looking to basically have this smooth next few months going into what looks like his third term. But we have seen the impact from those shutdowns on global manufacturers, automakers in the US. And then of course, that raises concerns about demand coming out of China, especially if you're looking at something like the oil markets.

PAUL GRUENWALD: Yeah. That's a little bit of a puzzle because China stuck with the zero COVID. And we know that at least with the latest wave, there's been a lot of lockdowns. We know the impact on supply chains and manufacturing. And we know the impact on labor mobility and consumer spending and confidence and a weak housing market and everything else. I mean, it's clearly a domestic political call. But if we divide the world into the three big regions, the US, Europe, and China, we've been focusing on China as the weak link relative to trend. And I think as long as the COVID-19 virus continues to circulate and they're sticking with the zero-COVID policy, that risk is going to stay with us.