June’s Consumer Price Index brought good news to Wall Street as it signaled inflation cooling more than expected. As all eyes are on the Federal Reserve’s first interest rate cut, Moody’s Analytics chief economist Mark Zandi joins the Morning Brief to discuss the state of the economy and what may happen if the Fed continues to hold rates at a high level.
“The economy is under a lot of strain from the higher rates. It’s doing some damage. The labor market is the most obvious place. I mean, hours worked are down, temp. jobs are down, the hiring rates [and] quit rates are down. The job growth is slowing. All the revisions we’re getting now are to the downside,” Zandi explains. If the Fed keeps holding rates at these high levels, he believes that the economy could take an even bigger hit.
Zandi adds that the broader financial system is under pressure: “The yield curve is inverted, short-term interest rates are higher than long-term rates, and that is a very uncomfortable place for folks in the financial system trying to make some money on their net interest margins. And so I worry that we could see some other type of event in the financial system.”
He says the bond market (^TYX, ^TNX, ^FVX) feels “really choppy,” pointing to poor liquidity and quantitative tightening (QT). He explains, “The Fed is pulling out of the bond market through its QT. And that means some other buyer has to step in. And it turns out that that buyer are hedge funds. And hedge funds are obviously very price sensitive… and that creates a lot more volatility, makes the bond market more fragile.”
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This post was written by Melanie Riehl
Video Transcript
There.
There’s been more and more focus on some of the weakening that’s happening within the labor market right now.
Even, uh Chair Powell uh, commented on that down the hill this week.
If we don’t see a September rate cut, how much further weakness do you think we could potentially see in the labor market then in the coming months?
Yeah, I, I think that would be a mistake.
I mean, I, I think the economy is under a lot of strain from the higher rates.
Uh, it’s, it’s doing some damage.
Uh, the labor market is the most obvious place.
I mean, hours worked are down, uh, temp jobs are down, hiring rates, quit rates are down.
The job growth is slowing all the revisions we’re getting now, uh, are to the downside of reducing estimated job growth.
Uh So, uh unemployment insurance claims are up that, you know, that might be more seasonal than anything we’ll have to see.
But it does feel like businesses are, you know, starting to lay off a bit more.
So, yeah, I worry about that if the fed keeps rates here too high for too long.
And then, of course, the other kind of uh stress point is the financial system, the banking system and the broader financial system because the yield curve is inverted, short term interest rates are higher than long term rates.
And that is a very uncomfortable place for, for uh uh folks in the financial system trying to make some money on the net interest on their net interest margins.
And so I, I worry that we could see the uh some other type of event in the financial system.
So I, I, you know, I, I think it’s really important that the fed follows through here and starts cutting rates.
Mark, what does that type of event potentially look like?
And talk to us a little bit more about what maybe some of those stressors could trigger when we talk about that wider fallout.
Well, there’s a few, I’ll, I’ll call out one, you know, the bond market, it feels uh uh uh uh really choppy.
It’s uh the liquidity in the market is very poor and that goes to a number of things.
Uh most significantly the, you know, the broker dealers that the divisions of big banks that uh do the trading in the bond market, they haven’t increased the size of their business, their balance sheet to be consistent with the growth in the amount of debt outstanding.
How about what this treasury debt?
You know, that’s been uh because of the large budget deficits and the, the, the broker dealers have not kept up, that goes to capital rules and it’s not economic for the banks to invest in these broker dealers.
And that’s adding to the, the, the problems of liquidity.
The other is the quantitative tightening.
You know, the fed is pulling out of the bond market uh through its QT.
And that means some other buyer has to step in and it turns out that that buyer is our hedge funds and hedge funds are obviously very price sensitive.
Uh They’re there when things are going well and they immediately leave when things aren’t going that well.
And uh you know, uh that creates a lot more volatility makes the the bond market more fragile.
So, in this high rate environment, with that QT uh that’s a, that’s a flash point, that’s a, a stress line in the system that you know, could get.
Uh it could be a problem if the, again, if the fed keeps rates here too high for too long, you know, as we were taking a look at at one more component within this, that had been part of the sticky inflation um kind of narrative that we had seen uh report over report essentially that moved a different direction and offset housing.
It was, it was energy, you know, that’s gonna continue to be kind of one of the more volatile pieces perhaps of this.
But, but is there some stability that energy could even bring to the inflation print on a go forward basis from here.
Well, well, as you point out energy prices, particularly oil prices go up down all around.
So that, that always makes me nervous.
I mean, you know, that’s the one thing that could upset the apple cart here.
But having said that it does feel like, uh, uh, oil prices should stay down.
I mean, we’re getting a lot of, uh, production coming out of the US.
The Frackers have done a marvelous job ramping things up here in the US.
We’re producing well over 13 million barrels of oil a day brad just for context.
The Saudis and the Russians are producing 8.5, 9 million barrels a day.
We’re the largest oil producer on the planet by rules of magnitude and that’s helped to fill the void left by the Russian sanctions and OPEC plus production cuts.
So that’s, that’s helped quite a bit.
Also demand.
Global demand has been on the soft side, you know, given the weak Chinese economy, given the, the, the the the the move here to hybrid and ev reducing the demand for, for gasoline to power our cars so that all augers.
Well, but having said all of that, uh I really worry because there’s a lot of cross currents, global demand supply uh factors uh that uh that uh affect the price of oil and you know, could blow in the wrong direction here.
But right now it feels, it feels ok, it feels uh We got a, a tenuous uh bit of a calm here at the moment.
Mark Zandi.
Always a pleasure to grab some time with you and thanks so much for breaking down this CP I report with us, Moody’s Analytics, chief economist.
Great to see you, Mark.
Thank you.