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Inflation: There’s a possibility that ‘globally we all go down together,’ economist says

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Citi Global Chief Economist Nathan Sheets speaks with Yahoo Finance Live about inflation, global recession risks, central bank policies, and more.

Video Transcript

- Interesting note from you and your team this morning-- the headline was "Global Recession, A Clear and Present Danger." So how much of a risk do you see that we do go into some form of synchronized global recession?

NATHAN SHEETS: Well, I would say that the recent economic data have been central banks' worst nightmare. But, on the one hand, I'd say there's very clear evidence of a slowing in global demand. And, on the other hand, there's also clear evidence that inflation pressures are persisting.

And you kind of put that together, it's really hard for central banks to fight that. And I'm cautious to use the word. But it feels at the moment that we're going through a period. I expect it to be a transition, but transitionary stagflation.

Now, specifically in response to your question about a synchronized global downturn, right now, we have a recession penciled in for Europe at the end of this year and early next year and then a recession in the United States during the second half of 2023. Given the data we're seeing and the vigor with which central banks are attacking inflation, I think there is a reasonable chance-- and we apprise that it's roughly 50%-- that globally, we all go down together, and it's a synchronized downturn.

- Nathan, I said a moment ago there are some concerns that we continue to sort of talk ourselves into a recession, so to speak. Do you think that that is what's happening, or do you think that there is real resi-- you know, on the one hand, consumer spending, even if you-- I was surprised, for example, to see the numbers from June to show a tick up, even a very small one, in real consumer spending.

Consumer spending still seems to be OK, particularly on services. So is-- what-- I guess it's just difficult to get to the bottom of what is going on here.

NATHAN SHEETS: It is. There are a lot of competing dynamics at the moment. And as you say, I think that there is some substitution going on in the consumer sector. And over the last couple of years, we've spent a lot of money on goods, specifically discretionary goods. And I think we're at a place where people are now substituting back towards services.

And that, along with the ongoing strength of the labor market and wages, which we saw this morning as well, is supporting the consumer. But, at the same time, this high inflation of, particularly for essentials, is reducing real incomes and destroying demand. And I think that is the worrisome process and the pernicious process that's weighing on the economy.

Now, in addition, as you say, sentiment matters. And as we read the newspaper and the stories are emphasizing the weakness in the economy, rather than some of these ongoing persistent signs of strength, is that having an impact on the way consumers see things? I think the answer is yes. But there are also fundamental factors at work, and specifically, this high inflation that's cutting into real incomes and weighing on the consumer's outlook.

- OK. So, Nathan, you basically answered my question with regard to how necessities and how much more those costs right now, how much that's actually changing where consumers can spend on other products or even services. But then, I guess, the other question, as a follow-up to that, is, how long will there be a dampener on some of the margins that companies right now are reporting?

NATHAN SHEETS: Yeah. I mean, in my mind, very clearly, consumers have no choice. Given the surging prices, they've got to spend more on necessities. They have limited price elasticity there. So that's consuming a larger share of their budgets.

They want to spend more on services because many families haven't gone on vacations or spent on other kinds of services over the last couple of years. And that's the reality-- more on necessities, choosing to spend more on services. And it's this consumer discretionary sector that's really getting hit at the moment.

In terms of margins, I think that's a really interesting dynamic. Until recently, I think firms were generally able to pass through the costs to the consumer. But what we're starting to see is the consumer saying, whoa, there's a limit to how far we can go with this. And the consumer is starting to pull back, substitute into cheaper kinds of alternatives, and find other ways to limit expenditures given the reality of these rising prices.

- Nathan, Elizabeth Warren has been making the rounds this week, saying that the Fed risks putting the US economy-- or creating a devastating recession. Those are her words. Do you see that happening?

NATHAN SHEETS: I think the Fed is behind the eight ball on this one where, if they don't act aggressively, the economy is gonna be plagued by high inflation. And at the end of the day, if a central bank cannot deliver price stability, it's not gonna be able to deliver its other objectives. So the Fed's got to proceed and go after the high inflation that we're seeing.

And as it does so, are there recession risks? Absolutely. Jay Powell alludes to them in his press conference and in his communication. He doesn't want to be too graphic about it, but absolutely, there are recession risks.

There's a case that this recession will not be devastating or severe. And in fact, that would be my expectation, that many of the vulnerabilities that tend to amplify the severity of recessions are not in place.

But, nevertheless, we don't know how much contraction in activity, how much slowing in the economy ultimately may be necessary to get this inflation and this inflation pressure that we're feeling out of the system. And there is a risk that it could be a more severe downturn. But I really think that the Fed has no choice other than to continue to hike rates to fight inflation.

- Nathan, I want to just ask quickly about another area of inflation that has gotten less attention-- not the CPI stuff, but wages, right? Because this has been a period where we have seen power to employees like we have not seen in decades, in terms of not just rising wages but union efforts, for example, people sort of dictating whether they want to be in the office or not and how they're working. How quickly do you think we could see a deterioration in that wage growth and that power that we've seen in employee hands?

NATHAN SHEETS: Right now, the labor market remains very tight. And I think it reflects the fact that there are some workers that have left the labor force as a result of COVID and other factors. And it's not clear what it's gonna take to get them back.

And at the same time, I think firms have learned the labor is valuable. And they are demanding labor more vigorously than we might have thought, given where the economy is otherwise. And you kind of put that together, and that is a tight labor market with upward pressure on wages.

Now, when does that process start to soften? When does it start to diminish? I think, ultimately, it depends back on spending and the strength of the consumer.

If the consumer is willing to continue to draw down savings buffers and so forth, I think that supports the economy and gives firms scope to continue to keep hiring. But this relationship between the labor market and consumption-- and they kind of drive each other. Right now, that's the nexus is particularly services consumption that's critical that's driving the economy.

And if we're gonna somehow skate through this without a recession, we're gonna have to see a relatively robust labor market and the consumer continuing to spend, maybe drawing down, as I said, some of those savings buffers and other financial resources that were accumulated during the pandemic.

- Nathan Sheets, Citi global chief economist, always good to get some time with you. Have a great weekend.