The markets are closely watching the Federal Reserve to see if the hiking cycle is nearly over. Following the Oct.1 to Nov. 1 Federal Open Market Committee meeting, we will have a live discussion with Scott Anderson, chief U.S. economist and managing director at BMO Economics, who will review what the panel did and what Chair Jerome Powell said and explain what this means for future rate hikes and the bond market.
TRANSCRIPTION:
Gary Siegel (00:10):
Hi, welcome to another Bond Buyer Leaders forum event. I'm your host Bond Buyer Managing Editor Gary Siegel. My guest is Scott Anderson, Chief U.S. Economist and Managing Director at BMO Economics. Today we're going to discuss monetary policy including yesterday's Federal Open Market Committee meeting and the economy. Scott, welcome and thank you for joining us.
Scott Anderson (00:39):
Thanks for having me, Gary. It's great to be here.
Gary Siegel (00:42):
So was there anything in the statement or Chairman Powell's press conference that surprised you or grabbed your attention?
Scott Anderson (00:51):
Well, there really wasn't much new in the statement itself. It was almost a carbon copy of what we saw coming out of the last FOMC meeting in September. There were some minor tweaks In the first paragraph, they upgraded their assessment of third quarter GDP growth to strong from solid and one add that was a little bit interesting is they did add tightening financial conditions to their statement on tighter bank credit conditions as expected to weigh on activity, hiring, inflation. So the Fed now is looking at tightening financial conditions. They're looking beyond just bank credit tightening, but they're also now citing higher long-term interest rates, which seems to be doing some of the work of slowing the economy down and softening growth for the Fed. Also, Powell yesterday, in the press conference, mentioned the strong dollar and the possibility of equity price declines as other factors that could be slowing the economy down in the months ahead.
Gary Siegel (02:02):
Well, Powell went out of his way to not commit to be done raising rates, suggesting that the panel would be data dependent. The SEP, which was released after the previous meeting, suggested another hike this year, and most analysts believe the Fed is done. What are your opinions on the Fed rate hikes? Are they going to have another one? Will it be next month, will it be in January?
Scott Anderson (02:32):
Yeah, no, I do think most likely a path forward is the Fed is in a prolonged pause here. I do think our own baseline forecast of the Fed is probably done, but I do think there's this higher for longer element to this because I don't think it's going to be a straight line down to the Fed's 2% inflation target. We're going to see ups and downs, especially if we get other global supply issues or the geopolitical risks around wars pop up. So it's going to be a bit difficult, but I do think the spike we've seen in long-term interest rates is a substantial change to the macroeconomic environment. Just to review a little bit, Gary, just back in April of 2023, the 10 year treasury yield was at 3.3%. Now after the Fed hikes last time in July, it moved up to about 4% and as you know, just a couple of weeks ago, the 10 year was just shy of 5% at 4.99%.
(03:44)
Now since the Fed meeting yesterday, long-term yields and other bond yields have moved down. I think we're trading around 4.68 today on the 10 year, but still that's equivalent in my view to almost three or four Fed rate hikes by themselves. So this really does increase some of the pressure on consumers and businesses and should weigh more heavily on durable spending both at the consumer level and the business level. Now Powell was very measured in his statements yesterday at the press conference. I did want to review a little bit of what I kind of picked up on from the meeting yesterday. I mean I think he definitely cited a number of factors that could force them to hold for a prolonged period of time. He was talking about things like the full effect of tightening as yet to be felt. He mentioned the committee is proceeding carefully.
(04:49)
The restrictive stance of policy today is already putting downward pressure on economic activity and inflation. He talked about financial conditions quite a bit and as it has tightened significantly, but he did add that tighter financial conditions must be persistent for it to really affect and now post FOMC meeting now we've seen those long-term rates moving down about 30 basis points or so. So we'll have to see how that plays out. I agree with him on that. I do think the tighter financial conditions must be persistent for this to really work out in the Fed's favor. He did also let on that he does see higher interest rates already having a dampening effect on the housing market. He talked about surveys of durable spending that seem to have turned down again in October and still the need though he believes for the economy to soften enough that we get below potential growth for a period of time, we see further softening in the labor market.
(05:54)
So that's going in the Fed's favor would suggest more of a prolonged pause from the Fed, but then almost in equal numbers of comments, he talked about the forces that could force the Fed's hand to do more and a couple of things that he mentioned was the economy has been surprisingly resilient, really pointing to that third quarter GDP number that came in at 4.9%. Consumer spending jumped 4%, not a sign really that a recession or a major slowdown in the economy seemed to be imminent if you look at some of the third quarter data, also talking about how we've been wrong, the labor market resilience has exceeded all economists' expectations this year. Labor demand remains above labor supply even though supply is improved in the labor market. Inflation, he reminded all of us, that it remains well above their 2% goal. And so he did want to emphasize and was really trying to say that, hey, we're not even thinking about rate cuts at the moment. We're really trying to figure out whether we need to do any more in terms of rate hikes. Really going in that meeting-by-meeting sort of environment where they're extremely data dependent. And you mentioned they've got a couple more inflation reports, a couple more job reports to review before the December decision and they haven't made any decisions yet on what they're going to do in December. So he's going to emphasize and they're going to be looking at the full range of economic data including financial conditions as they set up for the December meeting.
Gary Siegel (07:30):
The Fed uses the term higher for longer. How do you interpret that? How long do you think rates will stay? When do you think they'll make the first cut?
Scott Anderson (07:42):
Yeah, so I don't think they're going to raise again, but I don't think they're going to cut probably. We have our first cut in our baseline forecast in September, so really in the third quarter I think by that point, and it's really not going to be slower growth that I think is going to prompt the Fed to start easing interest rates. I think they'll welcome a pretty sharp slowdown, even contraction for a quarter or two. It can't be completely ruled out. What I think will really drive their decision is whether inflation is sufficiently low enough that they feel they can move off of in the 5.25, 5.50 on the Fed funds rate. So it's really that slowing path of inflation as opposed to slower or an economic downturn that's really going to drive the Fed's hand. And we do think the Fed's on the right path here. Core inflation in the third quarter, core PCE was still at 3.9% quite a way away from the Fed's 2% goal, but we think by the fourth quarter or the third quarter next year we'll be closer to 2.5% on PCE. So I don't think it has to go all the way down to two before the Fed starts cutting rates, but I do think it's got to be within spitting distance. And so I think somewhere in the two and a half percent range, the Fed will feel more comfortable about reaching their 2% goal.
(09:13)
Just add one more thing. The Fed doesn't, as inflation comes down, that actually increases the real interest rate on the Fed funds rate, which really affects the economy, so they really don't have to do any more tightening for monetary policy to continue to be even more restrictive going forward as long as that inflation rate comes down. Now, if inflation doesn't come down and economy remains above potential, then the Fed might have a problem where they're going to have to actually continue to raise the nominal rate further.
Gary Siegel (09:46):
When the Fed measures inflation, they're looking at backwards looking data. Is this a problem? Are they discounting that monetary policy works with a lag?
Scott Anderson (10:01):
It's a problem, right? Monetary policy, I think the famous line is conducting monetary policy is like driving a car while looking through the rear view mirror. I think that's been widely cited. It's certainly very, very true now. Yeah, I do think there's a risk here. I think the risk is, and this has happened in other Fed tightening cycles, it's not unique to this one, that they tend to be a little late. They tend to overtighten in terms of rates and they tend to be a little late in cutting interest rates. And that's certainly one of the risks I see for the Fed as we move into 2024 because they are primarily looking at backward-looking data as you mentioned on the economy on inflation, and even the survey data doesn't give you a real strong future view, but I do think they're looking at a broad cross section today.
(10:53)
They're trying to make their best judgments to inform their forecasts. Unfortunately, the economic and inflation forecast haven't been super helpful for the Fed in this pandemic cycle because a lot of economists, including ourselves, have underestimated the resilience and strength of the economy as well as how transitory transitory actually was. It turns out transitory right now is about three years and counting. So in terms of our forecasting profession, we have to be a little bit humble here in terms of how we view the economy and certainly the Fed doesn't want to get stuck in a corner that they have to fulfill some sort of implicit guarantee or something that people have seen in the dot plot and feel like they have to move forward. I think they do want to emphasize the point that they have to be flexible here and attentive to the data changes, any risks that might emerge between now and December.
Gary Siegel (11:51):
Well, certainly Chairman Powell has said that they're proceeding cautiously, but if you look at recent speeches, it seems like some of the officials are not on the same thinking level as others. There are about three or four who expect more rate hikes and there are three or four who expect that the Fed is done and then there are a bunch that aren't sure and yet the vote is unanimous. What do you make of that?
Scott Anderson (12:30):
Yeah, well I think Powell's done a good job of herding all the cats and getting everybody on the same page for these FOMC statements. Well, I think they do believe that they have some ability here to pause, they've already raised the Fed funds rate 525 basis points. I think I go all the way back to the 1980s to see a tightening cycle of that magnitude, but there's no doubt, Gary, I agree with you. There's real differences of opinion on the FOMC, which isn't surprising given the great uncertainty we still see in the economic and inflation path going forward. And I think the decision though, and I think Powell tried to make this comment in his press conferences, in the grand scheme of things though, the differences of opinion are really relatively modest in his view. Maybe one or two more rate hikes is kind of around the median view.
(13:26)
And there's obviously some long woofs out there that have been getting a lot of press. I mean, Michelle Bowman, Neel Kashkari of course are some of the ones that come to mind here calling for the possibility of more rate hikes. But I do think that's a natural occurrence. I think it is a minority view now, and I think one thing has changed a lot of view and why this September dot plot really haven't penciled in one more hike and why nobody's really talking about that today. And Powell kind of walked back, I think from that a little bit in his press conference is the fact that the long-term rates have moved up and I don't think even I had a view that they might have to go again in December or September or November two, three months ago. But once that ten year moved up, then I threw in the towel on another rate hike view because I do think there's enough downward pressure now we're starting to see, I think we'll see more evidence of this, but things like housing starts, permits, you're going to see more affect as mortgage rates hit near 8%. I think it's going to have a pretty big psychological impact on mortgage and housing activity. Powell alluded to that in his comments yesterday.
Gary Siegel (14:50):
Do you think the full impact of past hikes has worked through the economy yet or are they still working through?
Scott Anderson (15:00):
My gut reaction? Nobody knows for sure, right? I mean that's a pretty big debate among U.S. bank chief economists and our discussions with the Fed. I don't think so. That's my opinion. I do believe in this long and variable lag history we've seen from monetary policy in the past. There's some reason to believe that the lags might be even longer this time than what we've seen in past cycles. One thing I could point to is that we're not as reliant economically today on bank credit as we once were 10, 15, 20 years ago though I'd like to say we are, but we have a lot of other sources of financing now from private equity, venture capital and the bond market itself. And so that limits the ability of monetary policy to some extent, to tighten conditions to the extent that we've seen in maybe some past cycles.
(16:02)
I also think you got to point out that coming out of the pandemic consumers had a lot of excess savings, some Fed researchers think that some consumers may have used up most of their pandemic savings, but there's still a lot of extra liquidity still sloshing around in the banking system in bank deposits. And it may not be equally distributed, but there's still quite a bit out there that can go to work and keep the thing going. And then I guess the final element that economists really kind of underestimated at the beginning of the year, Gary, was the fact that the government spending federal government spending was going to be so strong this year. We had the CHIPS Act, Inflation Reduction Act adding to some of that spending, but that's been something that's been working against tighter monetary policy and slowing the economy down and has really helped keep the economy afloat this year.
Gary Siegel (16:56):
Consumers are spending according to the data, but consumer confidence is decreasing. This seems like an oxymoron. Why is this happening?
Scott Anderson (17:08):
Well, yeah, there's a few things. I alluded to them a little bit. I mean, I think at the beginning of the year, one thing that happened in January was we had a big cost of living adjustment in Social Security, affecting more than 70 million Americans, increased by 8.7%. We had a nearly 20% annualized increase in real disposable income that month and they went out and spent that. Now spending has been pretty uneven volatile month to month. We got another burst of spending in July that carried over a little bit into August, but we've had ebbs and flows there. But the consumer, you're right, is pretty solid. I do think the household balance sheets are much improved even with the rate hikes we've seen from the Fed, a lot of people locked in low mortgage rates. When I look at the Fed's debt service burden data, it's maybe back to pre pandemic levels, even with the rate hikes the Fed has done, but not worse than that.
(18:01)
So people have been able to pay down their debts. The debt to GDP ratio, household debt to income ratios are kind of down about 25% from where they were before the Great Recession, for example. So people have been able to refinance at lower rates, pay down those debts, and that's allowing the consumer to keep spending. And then of course, don't forget the strong job market and the fact that inflation came down. We actually saw some real income growth, real wage growth earlier this year. I think that helped out. Now I think some of those tailwinds that I just mentioned probably are going to fade a bit more as we move into the fourth quarter. And again, that's why we have this slowdown in our forecast and I think you'll see it. We're already seeing, as you mentioned, consumer confidence is already trending down. People are starting to have to pay back their student loans again starting in October we had the UAW strike that may affect some of the new October and November data. For all those reasons I think, and along with higher rates, we're going to see the consumer starting to pull back, I think more aggressively as we look into the fourth quarter, first quarter, first half of next year.
Gary Siegel (19:18):
So Scott, the yield curve has been inverted for over a year, which many believe signals a recession is coming. LEI has been down for nearly a year and a half. That also suggests the recession is coming. Why does the economy continue to surprise forecasters and defy the doomsayers?
Scott Anderson (19:41):
It's a very good question. You're right. I mean there are a lot of traditional indicators of recession that were flashing red, especially last fall and has continued to flash red most of this year. I think we're getting a little bit of a false signal from some of these indicators. For example, let's take for example the inverted yield curve, which obviously has had a great track record for past downturns in the U.S. economy. If you'll go all the way back to the data that we track going back to the eighties and even earlier than that, but it doesn't necessarily mean it's a downturn. What it's really signaling I think this time is just how tight the Fed has gotten, how restrictive monetary policy is and the fact, but you got to remember the difference this time around is we're coming from an overheating economy situation where a demand was way ahead of supply.
(20:36)
And so it may be just signaling the tightness of monetary policy today and the fact that growth is likely to slow sharply. I don't know if it necessarily signals an outright recession. It might feel like a recession when you go from 5% GDP growth down to zero, but it technically won't be a contraction that we'd see a significant increase in the unemployment rate. Now I do think we're going to be very close to a recession. I think we've got 1% penciled in for GDP growth now in the fourth quarter. That's down from, as I mentioned, 4.9 and the third. That's a pretty sharp slowdown. We think consumer spending's going to probably come in at a closer to 1.9% in the fourth quarter than the 4% we had in the third. And I think that will continue as we go into the first quarter next year.
(21:31)
We're still looking for GDP growth of only 0.2% now in the first quarter next year. So we're a little bit below the consensus right now on our GDP call and maybe a little bit more pessimistic than what the Fed has penciled in and the Summary of Economic Projections. But we're pretty comfortable with being in that place right now given how much the long-term rates have moved up in the past couple months. And if that stays at those levels, which we think we could, I don't think we'll stay at above 5%, but I think the 10 year is probably going to be in this range of 4.6 to 4.9 for quite a while, probably into the first half of next year that it'll continue to weigh more heavily than spending. So it's not a baseline Gary, but we still have an elevated 40% probability of recession over the next 12 months, which I think is notable.
Gary Siegel (22:27):
And the severity of that recession?
Scott Anderson (22:30):
Yeah, I wouldn't expect it to be super severe. Like I said, we've still got modest growth in our baseline call. If there is a downturn, I think it'll be relatively mild, probably standard in length. I don't think it'll be any longer than normal downturns. If it occurs and we're a little bit higher than the Fed on where we think the unemployment rate could go nationally, we think it'll move up to around 4.4 on the unemployment rate by the second half of next year. I think the Fed is pencilling in about 4.1 or something like that. So that's the baseline view. Certainly can move a little bit higher than that, but by historical standards, that's a pretty soft landing for the economy in the Fed tightening cycle of this magnitude. So you've got counter blessings in that regard.
Gary Siegel (23:21):
Many economists expected a recession earlier this year, and of course we haven't had a recession. Will the fact that there was no recession or that it was delayed till next year or maybe even the following year, will that slow the rate of disinflation going forward?
Scott Anderson (23:40):
It could in the fact that, and as Powell mentioned this as well yesterday, we need to have a prolonged period of below trend growth. Now we don't have to have an outright recession, but we need that GDP number, I believe to be below 1% for a couple of quarters at least to continue to get that for the inflation rate to move down from the current 3, 3.5% that we're trending at to something closer to the fed's 2% target. And so that will mean further slowing that will mean further increases in the unemployment rate. I think this year, and one thing I am kind of flagging, I sit here in the bay area of California. We were the epicenter of the Silicon Valley Bank First Republic blow up back in March and April, and I think at that point our recession call, we were close to 70% chance of recession following that move, really looking at the tightening of bank credit conditions and what that could do to consumer confidence and business confidence and spending that didn't happen in the economy stabilized and even California Bay area had a nice second quarter with a nice rebound in job creation.
(24:59)
But I do want to point out to this group that last Friday, California went out and revised their jobs data for the third quarter downward significantly, both at the state level and for the Bay area. Now we're seeing net job loss in the Bay area over the last three months starting in July. So that's maybe not something that's reached the national radar yet, but something that we're keying in on because we do think it could be a little bit of a canary in a coal mine of where the national job numbers might be headed going forward. And we're seeing that weakness redeveloping in technology. Some of the growth we had over the summer in construction seems to be fading, and there was a big downward revision in some of the services payrolls, particularly professional business services that was really driving the downturn. It was pretty broad based and it's been three months in a row now. So that's something to keep an eye on. It doesn't mean the national economy, will get that bad, but it gives you some belief here that we're going to see some further weakness in the job and economic data at the national level going forward.
Gary Siegel (26:15):
So BMO produces a blue book and in that blue book you see a slowing economy in 2024. What do you see in the economy that prompts that thinking? How slow do you expect it to get and how long will that slowness last?
Scott Anderson (26:34):
Yeah, that's right. We do a blue book report. We have our national view, but we also talk about a lot of the major markets and states that we operate in the U.S. and down to that level. And I do think we're anticipating further slowing in the U.S. economy. The primary driver of course is the tightening financial conditions, a higher rate environment that we will continue to be in next year, but we think we'll show up more significantly in terms of spending and confidence measures. We're also tracking a lot of risks and slowdown globally. Asia and China are struggling. Europe looks like they may have moved back into recession in the third quarter. UK also looks like they're on shaky ground. So we do expect a weaker global environment as we move into 2024. And it's a cumulative effects of not only just us tightening, but the tightening we're seeing from other global central banks that are playing out here.
(27:39)
I also do think some of the tailwinds, like I mentioned that we had this year, are going to go away. The excess pandemic savings, some of the government spending support we had this year, some of the last remnants of the pandemic relief spending has probably already been spent, and so there's a lot less tailwinds there. I also think we're probably going to see some more headwinds in terms of household wealth. Stock market has been quite resilient and solid this year, but we are now seeing a sell off in equity prices. We saw a return to home price growth this year that's been pretty substantial, but I do think that's going to stall or even reverse a bit as we go into next year. So obviously there's no one data point to hang on here, but when you look the evidence here and then some of the risks that we're tracking on the geopolitical front, the possibility of further geopolitical shocks, oil price shocks, can't be discounted with war in the Middle East, continuing war in Ukraine and the possibility of conflict in South China Sea or other places. So these are some of the things that we're looking at as we try to pencil in our view for the coming year and what we're probably up against in terms of the economic headwinds.
Gary Siegel (29:05):
So the war in Ukraine has been going on for a while. Have you seen any economic impact from that? And at this point, if we haven't seen any economic impact, is there a possibility of economic impact or that ship has sailed already?
Scott Anderson (29:26):
I do think there's a possibility of impact, no doubt about it. I think a lot of it would be transmitted to the U.S. through food and energy prices on the global stage. Certainly expansion of the war and attack on a NATO member. That's something that could have serious implications for the growth in inflation outlook. One thing we've seen in the government spending data this year has been a huge surge in defense spending. We saw that in the third quarter, I think defense spending was up 9% on an annualized basis. So those are some areas that could surprise on the upside. The president's looking for a new package for military aid and support for Israel and Ukraine to be passed another a hundred billion package is what he's looking for. So I wouldn't be surprised. We had a blowout deficit this year close to 1.7 trillion 6% of U.S. gross domestic product. I think it came in several hundred billion above the CBO's estimate that they put out at the beginning of the year. Wouldn't be surprised if we saw another upward surprise in those deficits and debt numbers as we get into 2024 based on all those risks that we're talking about.
Gary Siegel (30:40):
So getting back to the Fed, is the market finally on the same page as the Fed believing in the higher for longer?
Scott Anderson (30:49):
I think they're much closer, especially as we look at the rest of this year into 2024. I think the market has it about right if you look at where the Fed funds futures and over-the-counter markets are trading. I think though, as you look out further into 2025 and 2026, I still think there's a pretty big gap between the market expectations and what the Fed has been putting out in their dot plot and what we're currently forecasting. I do think the Fed has some more scope to cut rates in 2025 and 2026 than is currently priced into the market. So I think the market might be a little bit too pessimistic right now on the Fed's ability to cut rates as we go into 2025 and 2026. If you look at the Fed fund's features and where they think the Fed funds rate is through 2026, it is still well above 4%, I think over the next three, four years. That would be almost unprecedented. I don't think the Fed's ever held monetary policy that restrictive for that long. So I think they're maybe taking this higher for longer mantra a little bit too far, but that plays into the Fed's hand. I think the Fed doesn't mind that seeing that being priced in because that helps them with raising long-term rates and slowing down the economy inflation.
Gary Siegel (32:05):
Scott, what do you see as the biggest risks to the economy going forward?
Scott Anderson (32:11):
Yeah, I guess, and I alluded to this a little bit, I think the geopolitical environment we're in today worries me a lot. And these are things that economists aren't very good at predicting. So these are things that could come out of left field or really not being factored into our baseline forecasts, and they have the possibility of being supply shocks. So we're talking about things that could worsen the supply of labor, shortages of food or energy, muck up the global supply chains. Again, maybe further accelerate the decoupling between the U.S. and China. These are some of the things that I worry about as I look into my crystal ball for 2024. I think there is a real risk. The Fed does too much in terms of staying too tight for too long. So that's another thing that I think they're trying to be cautious and careful.
(33:15)
But again, the track record historically hasn't been super good on that front. And that's why I think a lot of economists were calling for a recession this year is because they've looked at past Fed tightening cycles and the Fed's success record of bringing down inflation without a downturn in the economy has been virtually zero, mid nineties, I guess, is the closest people can come to a successful soft landing story for the Fed. So there's some reasons for skepticism there as well. So those are some of the things that really I guess stand out to me as things that I need to be thinking about and we try to factor in.
Gary Siegel (33:59):
You mentioned in that answer that one of your concerns is that the Fed stays too tight for too long. Do you think, I mean now that we are looking back at it, do you think the Fed should have started raising rates a little bit earlier than they did?
Scott Anderson (34:18):
I think there's no doubt about that. I mean, the Fed has been, obviously they haven't done a huge post-mortem on what happened. I think they were obviously slow in recognizing the sustainability of inflation. Now, to be fair, it wasn't just one shock that drove inflation to higher. And at the time when Powell was saying transitory was primarily focused on the pandemic shock and COVID shock and that impact, which he was rightly believed was going to fade over time. The problem is we had a number of other shocks that occurred, one being the Ukraine war, the spike in energy prices last winter, the global slowdown that we've seen. So there's a number of things that have played out. And then of course some of this fed into the service sector, which I think the surprise really has been how resilient the housing market has been this year with the extent of the policy tightening.
(35:18)
Usually the housing market's the first one to take it on the chin, and I know a lot of economists early in the last year were really predicting fairly big declines in home prices this year because of what we saw in the fall of 2022 after the Fed started hiking rates, we were seeing home prices dropping and sales dropping significantly. But then this spring selling season happened and housing market took off and home prices started going back up again. So I think that's a real difference of what we've seen in past cycles and probably one of the reasons also why the economists got it so wrong this year. In terms of outright recession,
Gary Siegel (35:57):
In the housing market the inventory seems like it's still low. Is that what you're seeing as well?
Scott Anderson (36:05):
We are seeing that even in California where affordability is extremely, extremely tight, and I think we talked a little bit about this, it's because people have locked in those low 30 year mortgage rates, some of them below 3%. Nobody's anxious to move and have to take on a mortgage of 8% at the current point. Now eventually life events happen and people have to move and refinance and that sort of thing, but as many people as can are going to try to hold onto that. And what we've also seen is demographically the baby boomers have been very slow to downsize and they're kind of aging in place here. And we're seeing this uptick in demand for housing from millennials and in even some Gen Z that are kind of getting to the age now in their careers with their families where they want to move into bigger housing in the suburbs.
(37:00)
Of course, the pandemic and the work from home movement has also thrown another wrench into the housing markets and they've created a lot of surprise. But again, those are all those things that the Fed's trying to factor in. Now, I do think once you look at mortgage rates close to 8%, now that gets a little more serious. And if you top onto to that next year a slower job market, maybe some more layoffs, then you might see a little bit more movement downward crisis and a little bit more response from the title military policy we today.
Gary Siegel (37:39):
What questions are you getting from your clients, Scott? What are they worried about?
Scott Anderson (37:45):
Well, that's a great question, Gary. I think we're still hearing quite a bit from our customers about complaints about labor shortages. Now, I don't think that they're as shrill as they were six months ago, but that's still one of the top, I say top three sort of complaints. The other thing we're hearing a lot is just the high inflation, high need to increase wages, high input costs are still on their radar, still a concern and higher rates are now starting to move into that conversation as well. I think credit availability has been a little bit further down the curve than you might've expected after what happened to Silicon Valley and First Republic Bank. And we track that data from the Fed every week, the H8 data and stuff, trying to track how the Fed's rescue packages and credit facilities they put in place following those events, how they played out.
(38:47)
And it really seems to be a really good news story for the banking system and for the Fed itself. The banks seem to be having to rely less and less on those credit facilities every week. It's about half the amount of credit being extended then was extended back in April and May. So everything seems to be healing quite nicely. I think the banks are still under quite a bit of financial pressures. You can imagine that interest margins with an inverted or flat yield curve certainly being challenged and we're now bracing for higher credit losses, I think as we look into 2024 in 2025. But the banking system for the most part remains sound and resilient. I participate in the bank stress testing process with CCAR and all the other stress tests that the banks run, and they're actually very comprehensive. There's been some negative feedback that maybe we didn't run a high rate scenario or inflation scenario. Some banks might not have, but we did. So we felt well prepared for this higher for longer environment, though not all financial institutions were as prepared, but again, I think we were worried back in the financial crisis of just the tightness of credit and the loss of the bank credit channel. That's not a concern today. Why we don't believe the downturn does one develop year will be relatively large.
Gary Siegel (40:19):
So what does all this mean for the bond market?
Scott Anderson (40:24):
Well, one thing I'm watching, and this is not necessarily the treasury curve or money markets, but I'm watching a little bit on the credit spreads on the corporate side, the B-double-As, the high yield spreads. I'm looking for any sign that we're going to see some of this weakness priced in bond yields. Spreads are still relatively attractive here. So the bond market's really pricing in a non-event in terms of a slowdown next year. I think that may be a little bit of a Cinderella story. And so I'll be watching that kind of carefully. I still think in terms of the balance of risks, probably still a little bit above the consensus on my rate view on the long end for this coming year. Like I said, I don't think we're going to stay above 5%, that's going to be too much for the 10 year treasury, but to maintain.
(41:21)
But yeah, I don't see any real relief, at least not in the next six to eight months on the 10 year really I expect towards the end of next year to still be well above four in my view. So that's a big shift from where people's forecasts were six, nine months ago. And I think we still look at the blue chip consensus view. I think it's still looking for quite a bit of a downturn in long-term rates. Usually late in a tightening cycle, you kind of get this trade off where the Fed starts to hold or starts to cut rates, and then the long end moves higher, and that's how you get a normalization of the yield curve. And so I think we're in that second stage now in the bond market where the long end starts to respond. You see that the Fed's tightening has been priced in beyond the curve.
(42:21)
I do think we went through a structural shift or we are going through a structural shift, not only in the bond market, but in our economy as well. Right now, since the pandemic really when the COVID crisis hit, one thing that's really on my radar and should probably be on bond investors' radar screens right now is the treasury refunding the pace of that, the fact that we're having to finance now deficits of around 6% of GDP, and if rates remain near these levels, the interest payment expense that the government's going to have to finance really gets unaffordable very, very quickly. So I hope we're not going back to the bond vigilante days of the seventies, but this is something that we're trying to factor in our long-term rate forecast. Now, how much do we have to pencil in or factor in these higher deficits and debts? Because I do think, especially as you get credit rating agencies downgrading the federal government credit ratings, there's some concerns there. And more investors, even international investors may start to question those AAA credit ratings and put some upward pressure on yields going forward.
Gary Siegel (43:47):
Well, we're out of time and I'd like to thank you, Scott. My guest was Scott Anderson, chief U.S. Economist and Managing Director at BMO Economics, and I'd like to thank all the people who tuned in to listen today.
Scott Anderson (44:01):
Thanks for having me.
