INSIDE ECONOMICS

Mark Zandi:                       Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist of Moody's Analytics, and I'm joined by a few friends. I've got Cris deRitis and Marisa DiNatale, my two co-hosts. Hi, guys.

Cris deRitis:                        Hey, Mark.

Marisa DiNatale:              Hey, Mark.

Mark Zandi:                       You getting ready for Christmas?

Cris deRitis:                        Feels like I see you every day.

Mark Zandi:                       That's true, we've been doing a lot of stuff recently, haven't we?

Cris deRitis:                        Yeah. Yeah, we had an Ask Me Anything.

Mark Zandi:                       Webinars and Ask Me Anything.

Cris deRitis:                        Ask Me Anything for the Survey of Business Confidence, right folks?

Mark Zandi:                       You want to explain to people what that is?

Cris deRitis:                        Sure, I think we've talked about it on the-

Mark Zandi:                       You can advertise, this is a good point to advertise a little bit.

Cris deRitis:                        Oh, okay, all right. Not selling anything though.

Mark Zandi:                       So, what is it?

Cris deRitis:                        So, I think we've talked about it on the podcast before.

Mark Zandi:                       You're always selling. Chris is always... Marisa, isn't Chris always selling?

Cris deRitis:                        We're all always selling.

Mark Zandi:                       What are you talking to me?

Cris deRitis:                        All of us are selling all the time.

Mark Zandi:                       Yeah, exactly. Right, so you want to describe the Survey of Business Confidence, just to advertise that for a minute?

Cris deRitis:                        Sure, so it's a Moody's Analytics Survey of Business Confidence. It's a weekly survey that goes out to anyone who'd like to join, so that's the advertising part. If you're interested, you can go to economy.com and you'll see a link to our survey.

                                                We ask 10 questions about the state of business, of your business as a respondent specifically, so questions about your confidence over the next six months, information about hiring, pricing, a lot of different questions. The survey's been going on for what, 20 years now? I think 2003 is when you started it, Mark?

Mark Zandi:                       Yeah, exactly. Almost on the nose, I think, 20 years, yeah.

Cris deRitis:                        Yeah, so it gives us a lot of great information. It's very timely because it's weekly and if you participate, the benefits include, you get, of course, a summary of the survey every week and what's going on and then you get invited to an Ask Me Anything event periodically with Mark, so that's the...

Mark Zandi:                       And you.

Cris deRitis:                        And me. And me.

Mark Zandi:                       And you. Yeah, right, and we had Dante on as well, so that was good. It was very good. Good, I'm supposed to-

Marisa DiNatale:              Did you get any interesting questions on that, that you want to share? Anyone have any off the wall questions?

Mark Zandi:                       No, they were all kind of in the strike zone sort of, maybe one curve, but they even out landed in the strike zone, so yeah, I don't think anything... No, kind of AI and credit quality and labor market, kind of the traditional questions that we get here on the podcast.

Cris deRitis:                        Interest rates, lots of questions on interest rates.

Mark Zandi:                       A lot on interest rates, which, maybe this is the time to move forward and introduce Mike Strain. Hey, Mike, how are you?

Michael Strain:                 I am wonderful. I am wonderful, and I'm happy to be back on this excellent podcast.

Mark Zandi:                       Yeah, it's good to have you back. It's good to have you back. And just for folks out there, Mike is the Arthur Burns Scholar at AEI, American Enterprise Institute, and you run the economic studies group there. And Mike, when were you on last, do you remember? It was about a year ago or...

Michael Strain:                 Yeah, it was about a year ago. I don't remember precisely when, but it was in that kind of one year ago ballpark.

Mark Zandi:                       Kind of in the depth of the pessimism around the economy, I think.

Michael Strain:                 Yes.

Mark Zandi:                       That's when the consensus was pretty dark.

Michael Strain:                 Well, I remember the discussion where I was quite pessimistic, and Mark, you were much, much more optimistic, and events have proven you right and have proven me wrong. I will now play the optimist then I will say, "You may have won the battle, but I may yet still win the war."

Mark Zandi:                       Oh, cool, I can't wait to dig into that. And I really appreciate that, Mike, that was very kind of you to say, particularly because Chris has yet to capitulate. He's still hanging on. He's still hanging on.

Cris deRitis:                        Ideal improbabilities, Mark.

Mark Zandi:                       This is a little bit inside baseball, but everyone who listened to the podcast, and maybe, Mike, when you were on last, Ryan Sweet was on the podcast. He has left and gone on to do other things, but I just got a tweet from him saying, "Hey Mark, you were right." So, even Ryan Sweet has capitulated, Chris. What's that? No?

Michael Strain:                 Chris is making a deep metaphysical point that is accurate, and that is, if you use probabilistic reasoning, then you can never be wrong.

Mark Zandi:                       Exactly.

Michael Strain:                 But you can also never be right.

Mark Zandi:                       Good point. Good point. Good point, and I do want to bring in one of our other colleagues, Matt Coylar. Good to see you, Matt, it's been a while.

Matt Coylar:                      Hey Mark, great to see you too. Yeah, it has.

Mark Zandi:                       And congratulations, you have a newborn.

Matt Coylar:                      That's right, thank you very much, that's why I'm in the office as I look for a little bit of serenity, I guess, quiet.

Mark Zandi:                       I'll have to say you do look like a father.

Matt Coylar:                      I'm tired.

Mark Zandi:                       You look like a father.

Matt Coylar:                      Yeah?

Mark Zandi:                       Exactly. You look like a father. Well, it's good to have you on board.

Matt Coylar:                      Great to be here.

Mark Zandi:                       And good to have you back on Inside Economics. So, top of mind, here we are, this is Thursday, December 14th. We're taping a little bit earlier than we typically do, but good day to do it because yesterday the Federal Reserve met, the FOMC met, and wow, I thought that was going to be a quiet nondescript, nothing's going to happen meeting. Mike, what happened? I mean, how do you characterize what's going on here and what the Fed's thinking?

Michael Strain:                 Well, let me answer in two different ways. I mean, I think the Fed is a victim of a many, many year push toward greater and greater transparency and has reached a level of transparency that seems to me manifestly counterproductive. The dot plot, the press conferences, all of this stuff, if you're going to do those things, and if you do what the Fed did yesterday, which was signal 75 basis points of cuts in the coming year, and more after that, then you're going to end up with bond yields falling, you're going to end up with stock prices rising.

                                                Why do I say that's counterproductive? It's counterproductive because financial conditions, which ultimately is what the Fed targets, eased much more than the Fed would like. There is, as a consequence of all this transparency yesterday, a heightened risk that the economy will reaccelerate like it did in the third quarter, a heightened risk that inflation will become more entrenched, and therefore, a heightened risk that the Fed will not be able to do what Chairman Powell seems to want to do, which is to stop raising rates.

                                                We saw the Fed kind of being a victim to transparency earlier in this cycle when it delayed and delayed and delayed tightening, when it continued to purchase mortgage-backed securities at a time when home prices were growing at 20% annual rate month after month after month, because it had pre-committed to a path and it didn't want to deviate from that path. And so, the kind of simple answer is, the Fed told the markets that it was done and that cuts were on the way and markets reacted. I think the deeper answer is that the Fed has gone way too far in the direction of transparency and that is risking its ability to manage the business cycle and really risking its credibility.

Mark Zandi:                       So, just to take one step back for folks that don't follow it like you and I do and everybody else on this podcast does. If you go back one meeting ago, I think in September, the chairman and the committee was still saying high probability or reasonable probability of another rate increase. In fact, in the dot plot that you mentioned, which is where the members expressed their forecast for the funds rate, there was another rate increase in 2023. And then, I can't remember, was there one or two rate cuts in '24? Something like that.

Michael Strain:                 Yeah, one or two.

Mark Zandi:                       Yeah, but at this meeting in the dot plot they released yesterday, no more rate increases this year obviously because the year is now over, they're not going to do that. And then next year, three 25 basis point quarter point rate cuts, and that seems, like what you're saying, that feels like a pretty big swing and because it's a very clear swing, the markets are off and running here. The Dow hit 37,000, we've got bond yields below 4% on a 10 Year Treasury and financial conditions ease, and that may by itself create a problem for the Fed if the economy gets reduced and inflation starts to pick up again.

                                                Now, the Fed knows this. I mean, were they thinking that markets wouldn't react this way? They're well attuned to market perceptions and what investors are thinking, do you think they're surprised by the market reaction or are they saying it's fine, it's okay, it's consistent with getting inflation back down to target and this isn't going to forestall what we're trying to achieve here?

Michael Strain:                 Yeah, I think that's a great question. I would be surprised if they were surprised. I think that they may have been concerned that if they change the language in the statement from additional tightening to any additional tightening, they might be concerned that if they switch the dot plot from showing an increase next year to instead showing three cuts that the market might do this.

                                                What are their choices? Their choices are to completely throw out their entire transparency and communication strategy. That would not have provoked a positive reaction in the markets and it would've been an unpredictable negative reaction. Their other choice is to not say what they think, which is a very bad strategy for trying to preserve long-term credibility.

                                                And so, I think that they looked at a lot of the data that has come out since the previous meeting, that has altered their view of the appropriate course of monetary policy, and then they're kind of in a bind, where given their commitment to transparency, given press conferences, given dot plots, given forward guidance, given all this stuff, they kind of have to say what they think.

                                                And how concerned are they? I don't know, but I would imagine there's concern, for sure. I mean, as you mentioned, the 10 Year Treasury, I don't know what it's doing at precisely this moment, but...

Marisa DiNatale:              It's below four.

Michael Strain:                 Yeah, earlier today it was below four and that's not where I think they want it to be.

Mark Zandi:                       So, here we are, they've been increasingly more transparent since Alan Greenspan when he was chair started this process towards... I mean, when I started as an economist way back in the day, they wouldn't even tell us if they changed the fund rate. We had to figure that out by looking at what was going on in the marketplace, which wasn't easy.

Michael Strain:                 You had to back it up by looking at changes in the money supply.

Mark Zandi:                       Exactly. I mean, so talk about the sea change in transparency.

Michael Strain:                 People used to look at Chairman Greenspan's briefcase.

Mark Zandi:                       Yeah, exactly. Oh, I forgot that.

Michael Strain:                 What color neck tie is Greenspan wearing.

Mark Zandi:                       Right, talk about reading the [inaudible 00:12:50].

Michael Strain:                 That may have been too opaque.

Marisa DiNatale:              I'm wearing the middle.

Michael Strain:                 But now the Chairman gets up there, "Well, we're thinking about thinking about this, and we're talking about whether to think about talking about this," and dot plots and is the Chairman's dot the median dot, which dot is the Chairman's dot. Can the Chairman's dot just come and pound the other dots?

                                                These are literal discussions that are taking place by people trying to invest money and that seems like we've swung a little too far in the other direction.

Mark Zandi:                       Okay, but here we are.

Michael Strain:                 Here we are.

Mark Zandi:                       What would you do? I mean, because the Fed changes its policy framework every so often and it can change things again, what would you have them do here in terms of transparency?

Michael Strain:                 Oh, in terms of transparency, I would walk a lot of this back.

Mark Zandi:                       You would? No dot plots.

Michael Strain:                 Yeah, I would walk that back. I mean, I think they should be communicating their target funds rate. I think they should be obviously appearing before congressional committees when asked to do so. I think putting some press conferences on top of that is a reasonable thing to do. But I think forward guidance was useful following the financial crisis of 2008, I think it's been more harmful than helpful in this kind of pandemic era business cycle.

                                                Again, locking the Fed into a schedule for quantitative easing, quantitative tightening transitions. I think the dot plots are too much. I think there are too many press conferences and yes, I would walk some of that back. You got to do it carefully, and there's no reason to act like there's an emergency and affect that change with little notice, but I think the Fed could say, "We adopted a number of pretty extraordinary communications strategies and transparency efforts following the 2008 financial crisis, and that episode lasted a long time, and then we rolled into a pandemic and we've got both of those in the rearview-mirror and we're going to normalize a little bit."

Mark Zandi:                       What surprised me a little bit was, one way Chair Powell could have influenced the market reaction to this pretty sizable change in the forecast for the funds rate, the "I'm going to raise rates," to, "I'm going to cut them three times next year," would be in a press conference.

                                                And I didn't get the chance to listen to it completely, but I didn't get the sense that he was trying to walk that back or shade it or say, "Hey guys, don't read too much into it." You didn't get any of that, which was surprising to me.

Michael Strain:                 Yeah, and that now, Mark, leads this group on this podcast to try and figure out which dot is the chairman's dot.

Mark Zandi:                       Yeah, right. Yeah, good point, good point. But Chris, let me turn to you real quick, what do you think of that assessment? I mean, how do you interpret what happened yesterday in the Fed's decision and what it means?

Cris deRitis:                        Yeah, I agree with you. It seems as though the chairman just let it be and then kind of fed the fuel, if you will, for the market rally that we had.

                                                I do agree with the... I see limited value in the dot plots, I'm actually surprised that the market puts so much stock in it, they haven't been terribly predictive, so I don't know how much value we get. They may just add more confusion, as Michael's saying, than anything.

                                                I do like the press conferences though, to be honest, that, I think, some ability to question and have a little bit more transparency than what we had in the past is good. But yeah, I think some middle ground here perhaps is what we need.

Mark Zandi:                       Yeah, the weird thing is, if you look at the market forecast for the funds right now, they're pricing three rate cuts and then some, I think the futures are six rate cuts next year, I think. So, the market has taken what the Fed... Pardon me?

Cris deRitis:                        Oh, I'm sorry, the market, yes, that's right. There are six rate cuts, yes.

Mark Zandi:                       There's six rate cuts, right? I mean, that's very aggressive kind of rate cutting. I mean, it feels like you almost have to have a recession. We're back to that. You need a recession, it feels like, but I don't think investors are forecasting recession, do you?

Michael Strain:                 Well, I was wondering about exactly the same thing. If we had recorded this conversation three days ago, I would have offered as a hypothesis for the divergence between market expectations and the Fed's hire for longer strategy that the market thought there was going to be a recession. Maybe, maybe not, but that's at least a plausible theory that fits the facts.

                                                I was very interested, as it turns out you all were this morning, to see that the market thinks that we're going to have a Federal Funds Rate 12 months from now with a three handle. I don't know, I think you got to ask, does the market think there's going to be a recession? I think you've got to ask that question because that is an aggressive pace of rate cuts.

Cris deRitis:                        In an election year, right?

Mark Zandi:                       Well, I always go back to this kind of perplexing situation where the recession signals in the bond market, depending on what bond market you're looking at, I mean, if I go look at the corporate bond market and I look at the yield on junk corporate debt, so below investment grade companies and the interest rate on that debt compared to Treasury, that difference, that spread is kind of a measure of investor angst that they're not going to get repaid by businesses because of some problem in the economy, which will impair cash flow.

                                                The spreads are narrow. You get no indication there that investors are at all worried about recession. So, it feels like, to me, there's something else going on here. It's not a recession signal, maybe it's liquidity? I just don't know. Usually when I can't explain something, it means it's going to get revised or there's a liquidity or a technical issue or some other thing that's going on. It just feels really odd to me. It's hard for me to connect the dots back to...

                                                And the other thing is, would the stock market rally 500 points if investors were thinking recession? That just doesn't square, so it doesn't feel like that's what they're saying. Something else is going on here, I just can't put my finger on it.

Michael Strain:                 It could be the divergence in inflation forecasts. It could be that it's linked with the Fed... I'm sorry, it could be that markets think that inflation is going to fall much more rapidly than the Fed thinks it will. I have the kind of Taylor Rule model that I use that does a terrible job with the 1990s and 2000s, but does a great job with the 1970s, and so, that's why I've been using it for the last few years.

Mark Zandi:                       That's great.

Michael Strain:                 And it looks forward-looking, and that model predicted, before the meeting, I ran it last week, that model predicted a funds rate in the threes, just kind of giving...

Mark Zandi:                       Oh, really?

Michael Strain:                 Yeah, given SPF, Survey Professional Forecasters forecasted core PCE inflation, CBO forecasts of core PCE inflation, nothing fancy. And so, that, I think is one potential explanation.

                                                Another potential explanation, which I think is quite plausible is that the market doesn't believe the Fed is committed to 2%, and the market thinks that, I don't know what the magic number is, maybe it's 2.94% because that rounds down to 2.9.

Mark Zandi:                       Right.

Michael Strain:                 Maybe the market thinks that's what the Fed is targeting. When I tinkered with my forecasting model and changed the target, I've been using 2.25% as the target, when I changed it to 2.75, now I'm down in the low threes.

Mark Zandi:                       Oh, interesting.

Michael Strain:                 That's, I think, another potential explanation. I think at the end of the day, there are a number of members of the FOMC who, for very good reasons, and this is not a criticism of them, but they really want the unemployment rate in the threes.

                                                And they were very excited about how that was able to happen in the years prior to the pandemic, and I think they're less concerned about a 2.7% core PCE than previous Feds would've been. And so, it could be that investors are kind of reading the situation that way as well.

Mark Zandi:                       That's a great point, I hadn't thought of that. In fact, if I recall, if you look at, in addition to the dot plots, the Fed releases their forecast for a number of different economic indicators including inflation, and if you look at the core consumer expenditure flare, which is what they target, that's the 2% inflation target, I don't think they get back to 2%. Correct me if I'm wrong someone, but I don't think they get back to 2% until 2027, or it's '26 at the end of the forecast horizon. Between now and then it's well above two. It's two and a quarter or something like that, even higher than that.

                                                So, it feels like even in their own forecast, they're kind of relaxed about getting inflation back down to that target, which, I completely get it. I mean, at the end of the day, I think if you asked any of them, if they could pick the target de novo right now, what would it be, it definitely wouldn't be two, it'd be something closer to three. That would be my guess.

Michael Strain:                 Yeah, or at least closer to 2.5, I think.

Mark Zandi:                       Yeah, right.

Michael Strain:                 I mean, another possibility, it's good to debate whether there's going to be a recession, that's a helpful debate, but I think couch this in terms of the labor market, if the range of plausible monthly payroll numbers is negative 100,000, to positive 100,000, and that seems plausible, so 40,000 net new jobs a month is a soft landing, negative 40,000 net new jobs a month is a mild recession. This is kind of what we're debating.

                                                And if you think that the neutral Federal Funds Rate is 2.5%, which the Fed, I think, still thinks, then if you're at 3.5%, you're an entire point above the neutral rate, you're still restricting economic activity. And that, I think, could really be affecting investor behavior as well.

Mark Zandi:                       Let me ask you one more question and then we'll move on, we'll talk about the CPI numbers, PPI numbers we've got this week and in the context of what it means for monetary policy, but the election. So, one thought I've had is that all else being equal, the Federal Reserve would like not to change policy if they could the closer we get to the election. And I think most forecasts, our forecast is that they don't have enough evidence to start cutting interest rates. It can't be before March, probably more likely by summertime.

                                                But now you're in the teeth of the election in November, and I think that election is going to be hotly contested, very hard to watch, and a good chance that a Fed is moving policy, certainly if they're cutting interest rates, good chance they're going to get caught up in the election and get politicized, therefore, all else being equal, and I mean, it's in the so-called reaction function, what they look at when making policy, it may one of the last variables they look at, but it's sitting there in their reaction function. Does that resonate with you at all?

Michael Strain:                 Yeah, I think it's something that's barely being discussed. I read a column for Project Syndicate and they asked me to make a 2024 prediction, and they asked me to do it in 200 words, and so this was my prediction, I emailed it a few days ago. But as far as I know, people aren't talking about it, and I think that's surprising because I do think it's going to be a big, big topic in the coming year, and I don't quite know what you do if you're the Fed. I mean, on the one hand, you want to preserve your political independence, you don't want to allow the election to affect you at all, but how do you best preserve your political independence?

                                                If you refrain from cutting, then you're going to be accused of refraining from cutting to appear not to be helping. If you do cut, you're going to be accused of cutting in order to help President Biden. If this were a kind of more politically normal contest where the candidates were more conventional politicians, I think it would matter a lot less. But if President Trump is the Republican nominee, which is, I think, the most likely outcome at this point, then you've got to this whole other dynamic at play.

                                                And so, I think it's very difficult. And if President Trump is hammering the Fed, let's say markets are right and the Fed cuts in the first quarter, if President Trump is hammering the Fed for cutting, does the Fed want to show independence by doing more cuts than they otherwise would? Or does the Fed want to show independence by doing fewer cuts than they otherwise would? I mean, you could argue it in both directions, which is what makes it such a challenging situation.

Mark Zandi:                       Well, here's a Machiavellian theory for you. You're worried about the election next year and you really don't want to get caught up in the politics because the Fed doesn't want to get politicized, I mean, that's the number one priority, I do not want to get politicized because ultimately that would potentially wreck its independence, and that's a cornerstone of a well-functioning market economy, we've got to preserve that at all costs.

                                                So, rate hike here or there, or, I mean, a rate cut here or there is almost inconsequential in the context of, "I can't get politicized, I can't do that," so here's a Machiavellian theory for you. Do what you just did, now the market says six rate cuts, so you give them three, you give them two, you give them one, you may not get caught up in the politics that might prevail.

Michael Strain:                 And you front load them, right?

Mark Zandi:                       You front load them.

Michael Strain:                 Yeah, you do it around the year.

Mark Zandi:                       Anyway, I want to come back to the election in the context of policy, fiscal policy, but before we do that, I want to play the game, we're going to play a statistics game, and before we do that, I want to talk about the inflation numbers because obviously the inflation statistics are critical to what the Fed's doing here and one reason why they are clearly more relaxed about interest rates and cutting rates and what's happening in financial markets.

                                                And to that end, Matt, maybe I can bring you back in, and maybe you can give us a rundown on the CPI. And the other thing, we generally don't pay much attention to the PPI, the Producer Price Index, but that was also pretty good that came out this week and has implications for the consumer expenditure deflator. Again, that's the measure of inflation that the Federal Reserve is using to set policy, so maybe you can give us a rundown on CPI and if you have any comments on PPI, I'm in the marketplace for that as well.

Matt Coylar:                      Sure, sure, so CPI-

Mark Zandi:                       Wake up, Matt, come on, wake up. I know you're tired over there. The baby's crying. Come on, let's go.

Matt Coylar:                      Courtesy of Starbucks, the latest CPI report for November was largely-

Mark Zandi:                       Oh, I forgot, did we tell everyone that you're a father? We did, right?

Matt Coylar:                      We did, yeah.

Mark Zandi:                       Was that before the podcast started or was that during the podcast?

Cris deRitis:                        That was during, right? Yeah.

Mark Zandi:                       Anyway, Matt's a new father, and so he's a little... He's usually three steps ahead of me, right now he's only one step ahead of me, so okay, go ahead, Matt.

Matt Coylar:                      Yeah, thank you. The November Consumer Price Index report came out earlier this week, largely a continuation of what we've seen, which is this graceful, relatively graceful come down disinflationary trend in the US throughout 2023. So, in November, prices, and what we're looking at, average change in prices paid by consumers for a basket of goods and services that is designed to represent the stuff that they spend their money on.

                                                So, those prices rose 0.1% in November. That follows flat growth in October, so a mild increase, but certainly not alarming. On a year ago basis the headline CPI was up 3.1%. That's the lowest since June. Then you had some weird base effects from the year before, so outside of that, 3.1% is the lowest since early 2021, everyone starts getting vaccinated, people are rushing back to the things they didn't do, labor market's all out balance, inflation is on its way up.

                                                Now, we're on the other side of that, so major progress, but you would notice that headline inflation in November was the same as June, but as we've discussed, Fed communication, much different, and that's because this is a much different situation. Then annual comparisons drifted up for a little bit, came back down, now they seem to be pretty firmly on their way down. The last mile, we'll see, and I'm sure we'll talk more about how much harder that will be, but nevertheless, good progress.

                                                So, what's behind this lower growth? Again, in November, as was the case in October, energy prices on the way down negatively contribute to the CPI. So the energy CPI fell 2.5% in October, 2.3% in November, motor fuel prices, so prices at the pump, they've fallen meaningfully recently. Average gallon retail gas prices about $3.25 per gallon last I checked, and that's fallen for 12 consecutive weeks.

                                                We're about halfway done December, we have information about futures contracts, so where prices are headed, and that reliably points to another negative contribution to CPI in December. Probably a milder degree than what we've seen, but still subtracting from headline inflation. Food, another big component, not a ton to say here, the picture hasn't changed, relatively stable.

Mark Zandi:                       Can I stop you on the food though? Can I stop on the food? It just gets to, and I want to bring Mike back into the conversation, there's this debate, a raging debate as to why people don't think the economy's performing well.

                                                I mean, you got sub 4% unemployment for two years, you got lots of jobs, the stock market's at a record high, debt service is very low, there's a lot of cash sitting and obviously high income households have a lot of cash sitting in their bank account because they saved. And the one explanation that kind of sticks with me is, it's not the inflation now, it's the fact that prices rose so quickly a year ago, two years ago, and people are still paying a lot more for whatever it is that they're buying now than two, three years ago.

                                                And in fact, I was teaching a course at Wharton the other day, the business school kids. By the way, I highly recommend doing that because when you do that, you feel like our future is in a really good place. You look at all the turmoil in the world and I get really anxious about that, and I go talk to these kids and I go, "Oh my God, we're in good hands. These guys are really smart."

                                                Anyway, I'm talking to one of the kids and I'm saying, "How do you feel about the economy?" And he goes, "Not so good." I go, "Well, what's the problem?" He says, "I'm paying more for stuff than I was a few years ago." And I go, "Well, what?" He goes, "Ramen noodles. That's really bugging me. That's really bugging me." And I think everybody out there has their ramen noodle, right? That's really bugging them. That's really bugging them. Mike, what do you think? How do you explain this...

Michael Strain:                 Yeah, I think that's exactly right. I think people care about the level of prices much more than they care about the rate at which prices are growing. There's been a lot of discussion about, well, inflation is falling, why are people still upset? We haven't had deflation. We've just had prices growing at a slower rate than they were growing and people aren't tracking the macroeconomic statistics, but this student buys ramen noodles every week and somebody else every Saturday takes his family to lunch at Denny's or whatever, and sees that lunch is 40 bucks when it used to be 32 bucks and that's not a good feeling.

                                                I mean, I follow this stuff pretty closely, obviously, and I remember back when the inflation started a couple of years ago, I would take my family to the same restaurant we go to a lot for lunch on a Saturday, and it was 20 bucks.

Mark Zandi:                       I bet it wasn't a Denny's. I'm just saying, I bet it wasn't a Denny's.

Michael Strain:                 My seven-year-old loves IHOP, so.

Mark Zandi:                       Oh, I love IHOP too. I love IHOP.

Michael Strain:                 We have to do that relatively often, but it was 20 bucks more than it used to be, and I kind of felt like somebody had punched me in the face and took a $20 bill out of my wallet and it didn't feel good to me. I mean, it felt unjust in a way that surprised me. I was surprised by my reaction to that.

                                                I think something else is happening too. I mean, in the kind of debate, Mark, you referenced about is there a disconnect between consumer sentiment and actual economic performance? You got to remember, even in the worst economy, nine out of 10 workers can find a job. So yeah, for sure, I mean, we have a great labor market, but that just means that there are two workers who can find a job that otherwise wouldn't have been able to, whereas these high prices affect everybody.

                                                And so, if you're those two workers and you know that you may otherwise not have been able to find a job, you're probably really happy, but the other 98% of people are unhappy about how expensive everything is. I think there are other explanations as well, but those strike me as...

Mark Zandi:                       That makes total sense to me. People just don't think it's fair, it's, as you said, unjust. I mean, how could it possibly be the case that I'm paying twice as much for the same thing than I was two, three years ago? Someone's ripping me off. In fact, the one thing that I know polls really well politically is if you blame the high inflation on greed inflation, that it's these greedy corporations. It goes right to this, "This is unfair, and I'm getting ripped off."

Michael Strain:                 Totally, yeah. I saw a poll, I don't know how representative this is of the general state of polling, but I saw a poll with something like 75 or 80% of respondents reacted, Mark, just as you say, "These greedy corporations, they're not lowering their prices." And it's pretty tough these days to find three quarters or 80% of Americans-

Mark Zandi:                       Agree on anything.

Michael Strain:                 Agree on anything.

Mark Zandi:                       Except maybe that the Eagles should win the Super Bowl, I think.

Michael Strain:                 For sure. Sure, yes.

Mark Zandi:                       In the Philadelphia Metropolitan, I'm sure you can find-

Michael Strain:                 Yeah, exactly.

Mark Zandi:                       But Matt, let's go back and finish off the CPI. The one thing I want you to focus on though is, and I'm going to ask this as a question because I'm not sure, I didn't look at this month's data, but up until now, it's been the difference between the actual inflation rate and inflation at the Fed's target was the growth in the cost of housing services, shelter costs, and that remained stubbornly high, stubbornly persistently high, and that's the gap. If that comes back into something that's more consistent with historical norm, then inflation is going to get back to target.

                                                Is that factually still correct based on the data we got for November and what's going on there, do you have a view on that? And I know Chris might have a view, Marisa might have a view, and Mike might have a view as well, but I'm just curious.

Matt Coylar:                      Yeah, if you take shelter all the way out, you're at about 1.5%.

Mark Zandi:                       Oh, okay.

Matt Coylar:                      But including shelter, I mean, shelter at its normal growth rate, pre-pandemic, 2.5, 3%, then you're in that ballpark of target range. So, shelter prices did rise again 0.4% in November, and we're up 6.5% relative to a year earlier, so it's trending downward, trending in the right direction, I would say a little bit more slowly than anticipated using the oft discussed rent indices that everyone looks at and says, "Rent growth flattened out, this will kind of filter its way through CPI." That's happening six months ago we thought that shelter CPI would be closer to 6% than it is now at 6.5, but it's trending in the right direction.

Mark Zandi:                       Okay.

Matt Coylar:                      So, again-

Mark Zandi:                       You think that might be seasonal adjustment issues or just some kind of measurement issue, but you feel like it's going to catch up. It's nothing-

Matt Coylar:                      Yeah, and I think our forecasts, at this point, looking forward, what are we talking about next year? Shelter prices growing at about 4%, so again, that's ever closer to that norm you expect given the same kind of compositional effects now that that leaves CPI at target in ballpark or as we forecast it, so it is happening, but yeah, that's mostly grown, yeah.

Mark Zandi:                       Marisa, because I've kind of locked you out of the conversation, let me throw this question at you. I mean, have you been surprised by the persistence of the growth in the cost of housing and shelter costs, and do you have a sense of what's going on there? Just any theories?

Marisa DiNatale:              Yeah, because I think if we went back a year or earlier this year, we were thinking that by this time in the year, we would see a much more significant deceleration in rents, right? We thought it would take maybe nine months, 12 months, again, to see that and it's much more persistent.

                                                And I would say back to your question, to Michael, about why do people feel so bad about the economy when the economy's good? I think food is one thing. I think the cost of housing is the other big thing. I mean, certainly not everyone's out there trying to buy a home, but if you're not, then you're renting. You saw rents shoot up quite a lot during the pandemic. Maybe now they're stabilizing, but again, I think people are more focused on the level of price that they're paying than the change in that price.

                                                And the home buying market, I mean, forget it, right? We've talked about this many times on the podcast, particularly for a first time buyer, it's almost impossible in parts of the country, so I think that's this other sense of, it's unfair, right? This is a basic sort of good, sort of the cornerstone of the American dream, and you're making it financially is your ability to purchase a home, so I think this goes to how people are feeling, and I think it's discouraging that it's not coming down faster too.

Mark Zandi:                       Yeah, you make a great point. In fact, I saw a morning consult, and I should thank them for sending me the survey results a little bit early, but if you look at what's bugging people when it comes to prices across age group, if you're in your late 30s and early 40s, this is the number one thing.

Marisa DiNatale:              That makes sense, yeah.

Mark Zandi:                       Yeah, I mean, as you look at older age groups, housing falls to the bottom. The one thing that's constant is food. Food is kind of number one or two all the way across the board, but housing is for younger people, obviously top of mind.

                                                Mike, did you want to weigh in? I saw you shaking your head there on the growth and cost of housing and services, you would've been surprised too about this persistence of that?

Michael Strain:                 Yeah, I was shaking my head at a few points. I've been quite surprised, and my expectation is the same as Marisa's. I thought that looking at the real-time rent indices, trying to figure out how the marginal rent would map into the average, the average, of course, is what shows up in the CPI, I've been surprised month after month for the last several months that we haven't seen more progress.

                                                The second reason I was nodding in my head is I was talking to a public opinion expert who told me that if you look into the polling data of young people who are renters under age 35, let's say, that there's this kind of rule of thumb that you should be spending less than a third of your income on rent.

                                                And I hadn't thought about that in years, but that was something that, when I first came out of college and got a job, that's the advice I got too, and that is harder and harder and harder, especially in big cities where more and more young people are living than had been true in the past and that may be an under-discussed aspect of what's driving consumer sentiment, is this kind of threshold rent to income ratio for younger people.

                                                And then the third reason I was nodding my head is that it's just harder to buy your first house for a lot of people and that seems to be a big, big problem.

Mark Zandi:                       I didn't realize you were nodding your head three times there. It's all one big head nod.

Michael Strain:                 There was not a word I disagreed with. I was feeling great.

Mark Zandi:                       That was good. That was good. Hey, Matt, real quick, because I want to go to the game, is PPI and what PPI and CPI imply for the consumer expenditure inflator, because again, that's what the Fed is predominantly focused on in setting policy. Anything on the PPI and what it means for PCE.

Matt Coylar:                      So, it bodes well for PCE being a little bit lower, the PPI for November came in flat. Expectations, we were a little bit pessimistic, we thought we would see a modest decline, but generally, there was the expectation that the PPI would pick up, it was flat.

                                                That follows a 4.4% reduction in October. Those things, as we await later in December, the PCE data, the core PCE, the Fed's preferred inflationary measure, are a good thing, we should expect to see a negative effect.

Mark Zandi:                       Small increase?

Matt Coylar:                      Yeah, a smaller increase. Early forecasts now, I think are 0.1% for core PCE, yeah.

Mark Zandi:                       Yeah, that's good. Okay, good. Good, let's play the game The Stats Came, and as the listeners know that we all put forward a statistic, the rest of us tried to figure that out through questions, clues, deductive reasoning.

                                                The best stat is one that is not so easy, we get it quickly and one that's not so hard, we never get it. And if it's apropos to the topic at hand, all the better. Marisa, you want to go first, as tradition has it?

Marisa DiNatale:              Sure. Okay, my statistic is 19.4%.

Mark Zandi:                       Okay, it came out this week? Government statistic? And the Fed is part of the government, just saying.

Marisa DiNatale:              It's not from the Fed or the government.

Mark Zandi:                       Or the government. Okay, I didn't even listen to the answer. It is or it isn't part of the government.

Marisa DiNatale:              It is not. It is not a government statistic.

Mark Zandi:                       It's not.

Marisa DiNatale:              No.

Mark Zandi:                       Okay. Okay, so it's from a trade group?

Marisa DiNatale:              Yeah.

Mark Zandi:                       Okay. NFIB came out, is it from NFIB? National Federation of Independent... No, not the NFIB. Is it from the Mortgage Bankers Association? Is it a housing statistic?

Cris deRitis:                        Yes.

Marisa DiNatale:              It is.

Mark Zandi:                       Oh, so it's from the NBA?

Marisa DiNatale:              Yeah.

Mark Zandi:                       Okay, so it's from their weekly mortgage applications. Oh, okay. Purchase apps were up 19.4% in the week.

Marisa DiNatale:              No, the other one, refi.

Cris deRitis:                        Refi is.

Mark Zandi:                       Oh, refi.

Marisa DiNatale:              You guys really drilled that down.

Mark Zandi:                       Okay, very good, yeah.

Cris deRitis:                        I think I get the cowbell there. Just saying.

Mark Zandi:                       Hold it, wait, you get the cowbell?

Cris deRitis:                        You said purchase, I said refi.

Mark Zandi:                       Oh, jeez. I led you down the golden path. All right, go ahead. All right, okay. Okay, interesting you picked that, why?

Marisa DiNatale:              Well, I mean, so my original statistic was going to be about the PPI, but we blew that because that would've been too easy, but this kind of goes to the Fed maybe not helping the situation here, so now mortgage rates are down to 6.8.

Mark Zandi:                       That feels good.

Marisa DiNatale:              6.8, yeah.

Mark Zandi:                       Yeah.

Marisa DiNatale:              They've been coming in, we obviously saw a huge rally in the bond market yesterday, so they're falling even further, so this is still low, right? I mean, if you look at the whole history of mortgage activity, we're still very, very low in the grand scheme of things, given the level of rates, but people are reacting already to lower mortgage rates.

                                                I mean, even the purchase applications index was up. I mean, this is a volatile series that's weekly, it had fallen in the previous week, but people are refinancing with rates at 6.8%, probably just because they have so much equity to withdraw, to work with just given house prices over the past couple of years.

                                                I mean, I don't know that the Fed wants to be necessarily juicing housing market activity right now, so I'm just trying to tie this back to our original conversation about the Fed potentially loosening financial conditions at a time where it probably doesn't want to do that as much as it's doing it.

Mark Zandi:                       Chris, what do you think of what Marisa just said.

Cris deRitis:                        Housing's always this tough one, right? The problem is not the demand side, it's the supply side, right? So, the Fed actions, yeah, you're right, they might be contributing to even more demand, if you will, but the demand is already there.

                                                I don't know that that should be their guiding post here. I think there's going to be consequences on the housing market, but I don't know that they should be adjusting their policy just to keep the housing market tighter or to...

Marisa DiNatale:              I agree. I agree that shouldn't be their primary objective for sure, but it has big implications.

Cris deRitis:                        You're saying there's fallout, yeah.

Marisa DiNatale:              Yeah, it has big implications. And given the discussion we just had about housing, how important it is to the economy, to people's perception of the economy, to people's feelings about the economy, to the share of GDP that housing makes up, I mean, I think it's one to watch.

Mark Zandi:                       I find this conversation fascinating.

Marisa DiNatale:              Yes, but this is also the refi index, right?

Mark Zandi:                       I find this really fascinating. I mean, it wasn't but a few weeks ago, we were so worried about recession, you get this news, you go, "This is great, we need to support it," now you're sitting here saying, "Oh."

Marisa DiNatale:              I know.

Mark Zandi:                       "We might be juicing up the economy again. This is not good."

Marisa DiNatale:              I know, it's...

Mark Zandi:                       Bizarre.

Marisa DiNatale:              I think I agree with Michael. I'm very worried about this. I'm very worried that they've boxed themselves into a corner and they are committing, although they're not committed, right? But essentially by broadcasting this, they're committing to a course of action that the market is taking as gospel.

                                                And what happens if in a couple of months we get bad data on either the labor market side or the inflation? What if inflation reaccelerates, and then they feel like, "Well, now what do we do, because we told people we're going to cut rates three times, but now we really don't want to cut rates." I just think they're in a bad situation right now.

Mark Zandi:                       Mike, you agree with all this?

Michael Strain:                 I do. I think they're in a bad situation. I think that there is a real risk of a reacceleration. We saw a reacceleration in the third quarter. This isn't just fiction, we saw it happen a few months ago. And again, ending the year with a 25% increase in equity values and 10 Year Treasury note in the high threes or low fours is a way to get a reacceleration.

Mark Zandi:                       You guys are worrywarts. Jeez, Louise, I mean, holy cow.

Marisa DiNatale:              You have to worry about something, Mark.

Mark Zandi:                       I guess so. Jeez, Louise. Hey, Chris, you want to go next?

Cris deRitis:                        Sure, what was it? 2.08%.

Mark Zandi:                       That's pretty precise. 2.08. Is it a-

Marisa DiNatale:              Year over year PPI.

Cris deRitis:                        No.

Mark Zandi:                       Is it government statistic?

Cris deRitis:                        It is not, it's a market statistic.

Mark Zandi:                       It's a what statistic?

Cris deRitis:                        It is a market statistic.

Mark Zandi:                       Oh, I thought so, so is it an interest rate?

Cris deRitis:                        It is an interest rate, yes.

Marisa DiNatale:              It's a low interest rate.

Mark Zandi:                       What's it, a 2.0...

Cris deRitis:                        Or maybe a difference in interest rates.

Mark Zandi:                       Oh, it's a spread between something and something.

Cris deRitis:                        It's the difference, yes.

Mark Zandi:                       I was trying to make it a little more scientific. It's not the spread between...

Marisa DiNatale:              Oh, is it the spread between the 10 Year and the mortgage rate?

Cris deRitis:                        No, no, that's higher.

Mark Zandi:                       The funds rate is five and a half, and the 10 Year is below four, that's not it, it's not the spread between the funds rate and the 10 Year.

Cris deRitis:                        No.

Mark Zandi:                       It's not two year 10 Year. Three month...

Cris deRitis:                        What's our topic today?

Mark Zandi:                       Is it a yield curve, is it measure of the yield curve?

Cris deRitis:                        Nope.

Mark Zandi:                       No, okay. Is it a credit spread?

Cris deRitis:                        No, it's related to...

Marisa DiNatale:              Oh, is it the difference between the Fed Funds Rate and the... No.

Cris deRitis:                        No, more fundamental. It's related to our inflation discussion.

Mark Zandi:                       Oh, I know, it's inflation expectation, it's the five year... Thank you, sorry, that was a great...

Marisa DiNatale:              Five Year forward.

Mark Zandi:                       Yeah, was it five-year forward, 2.08?

Cris deRitis:                        It's the Five Year breakeven.

Mark Zandi:                       Oh, Five Year breakeven, okay.

Cris deRitis:                        Yep.

Michael Strain:                 Wow, I didn't realize... Yeah, that's amazing.

Mark Zandi:                       Yeah. Okay, so why'd you pick that? Why'd you pick the breakeven?

Cris deRitis:                        This is a measure of investor expectations of inflation, average expectations for inflation over the next five years. It's the difference between the rate on a Five Year Treasury bond on the Five Year Treasury Inflation-Protected bond, or the TIPS security, so this implies a 2.08 inflation rate. Very low, it's come in, so the expectations aspect of this seems to be off the table, at least for now.

Mark Zandi:                       Yep, very good, very good. Hey, Mike, did you want to play or you want to take a pass?

Michael Strain:                 I'd be happy to play.

Mark Zandi:                       Okay, fire away.

Michael Strain:                 24.8.

Mark Zandi:                       24.8. A stat that came out this week?

Michael Strain:                 It is a stat that came out last week.

Mark Zandi:                       Okay.

Cris deRitis:                        Okay.

Mark Zandi:                       Units?

Cris deRitis:                        Is it a percentage?

Michael Strain:                 24.8%.

Cris deRitis:                        24.8%.

Michael Strain:                 This is obscure. It's an obscure one.

Mark Zandi:                       Okay, is it a government statistic?

Michael Strain:                 It is.

Marisa DiNatale:              Is it related to the labor market?

Michael Strain:                 It is.

Mark Zandi:                       So is it something in the jobs report?

Michael Strain:                 It is.

Mark Zandi:                       Oh, okay. On the household side, household survey?

Michael Strain:                 It is.

Mark Zandi:                       Okay.

Cris deRitis:                        Is it a percentage increase?

Michael Strain:                 Nope.

Cris deRitis:                        A share.

Mark Zandi:                       It's like a demographic. Right, okay. 24.8%.

Marisa DiNatale:              The labor force participation rate of teenagers?

Michael Strain:                 No, but close.

Marisa DiNatale:              Oh.

Mark Zandi:                       African American teenagers.

Michael Strain:                 No, not teenagers.

Mark Zandi:                       Seniors?

Cris deRitis:                        Oh, the over 65 or over 55. No.

Mark Zandi:                       Is it a participation rate though.

Michael Strain:                 It is.

Mark Zandi:                       And is it African American, Black?

Michael Strain:                 No, but they're included.

Mark Zandi:                       They're included.

Michael Strain:                 It's not only for African American.

Mark Zandi:                       And it's by age, some age cohort?

Michael Strain:                 16 plus.

Mark Zandi:                       Oh, 16 plus, okay. Oh, goodness, gracious. What could that be? Gender, ethnicity? Are we going to kick ourselves when you tell us?

Michael Strain:                 Probably not. It's pretty obscure, but you might.

Mark Zandi:                       Is it participation rates of Native Americans?

Michael Strain:                 No.

Mark Zandi:                       No.

Marisa DiNatale:              That's not published.

Matt Coylar:                      Something with multiple jobs?

Mark Zandi:                       People who live in Guam. People who live in Guam.

Michael Strain:                 No, it's the participation rate for people with a disability.

Mark Zandi:                       Oh.

Michael Strain:                 It is up by rough calculation, about 20% relative to where it was before the pandemic.

Marisa DiNatale:              Wow.

Mark Zandi:                       Oh, interesting.

Michael Strain:                 And I think that's a really important thing for welfare society for sure, really important development. Also, maybe some interesting economic content there.

                                                Is it reflective of labor demand, labor supply and balance where businesses are willing to hire workers that they otherwise wouldn't? Is it reflective of a technological change, where there's more work from home and it's easier for workers with disabilities to participate in the workforce than it used to be because work from home is more prevalent? And again, it speaks to, I think, the benefits to society of having a really tight labor market.

Mark Zandi:                       Tight labor market. Yeah, kind of a high intensity labor market. Yeah, get everyone involved. Yeah, that was a great statistic. Very good. Hey, Matt, do you have a good one?

Matt Coylar:                      I hope it's good.

Mark Zandi:                       It's got to be good. I know you really think about this. Is it good?

Matt Coylar:                      Yeah, I think it's good

Mark Zandi:                       Okay, fire away. We'll do one more because we're running out of time, but we'll do one more. Go ahead.

Cris deRitis:                        Price of diapers. No.

Mark Zandi:                       That's good.

Cris deRitis:                        Right.

Matt Coylar:                      That would be quick. 0.4%

Mark Zandi:                       Statistic that came out this week.

Matt Coylar:                      Yes.

Mark Zandi:                       Inflation statistic?

Matt Coylar:                      Government statistic.

Mark Zandi:                       Inflation?

Matt Coylar:                      No.

Mark Zandi:                       No.

Marisa DiNatale:              Not related to inflation at all?

Matt Coylar:                      Indirectly, but not the main focus.

Cris deRitis:                        Okay.

Mark Zandi:                       It's a percent, you said 0.4%? Increase?

Matt Coylar:                      Yes. Increase, yes.

Mark Zandi:                       Okay, is it an obscure statistic?

Matt Coylar:                      No.

Mark Zandi:                       No? Okay.

Matt Coylar:                      From a report that has not been discussed on this podcast yet.

Mark Zandi:                       Ever?

Marisa DiNatale:              Like ever, or just today?

Matt Coylar:                      This particular podcast, this one.

Mark Zandi:                       That would be really obscure.

Marisa DiNatale:              Wow.

Matt Coylar:                      Yeah, you guys have never heard of this report. The government releases at midnight.

Cris deRitis:                        Retail sales?

Matt Coylar:                      Okay.

Mark Zandi:                       That's it, yeah.

Cris deRitis:                        Yeah?

Mark Zandi:                       Core retail sales, ex-auto, ex-gas?

Matt Coylar:                      Very close.

Mark Zandi:                       Oh, it's control, ex-auto, ex-gas, ex-building material.

Matt Coylar:                      Yes, yeah, control retail sales, so yeah, excluding gas, building materials, restaurants, non-auto retail sales.

Mark Zandi:                       That's a good one, yeah.

Matt Coylar:                      Yeah, if you say yesterday the Fed announces or projects 75 basis points in rate reductions in 2024, post meeting, Jerome Powell saying, he's reminding everybody about the other mandate, which, "We are really focused about employment," just seems like, wow, there must be this really big, dark cloud, was kind of my takeaway that nobody else sees.

                                                And then you get data pretty consistent with what we've had, which is really strong consumption. It's an economy that I don't think needed a jolt of exuberance, which is what happened yesterday, so I find it interesting. I don't know how-

Mark Zandi:                       But that feels pretty good, point four, you what, analyze it, it's four and a half to five?

Matt Coylar:                      That feels right.

Mark Zandi:                       If you divide by inflation, it's still two.

Matt Coylar:                      Yeah. You look at core...

Mark Zandi:                       That's what you want, right? No?

Matt Coylar:                      Core retail a little closer to... It looks like an echo or a continuation of the third quarter, which was 0.7, 0.8 in July and September, kind of these strong figures, so maybe not through the roof, but certainly not an economy that's teetering on the brink and needs financial conditions to loosen.

Mark Zandi:                       All I want to say is, Mike, you come on the podcast and you're messing with people's minds. Now they're all worried about we're growing too fast. Come on, please.

Marisa DiNatale:              Mark, you wanted some upside risk discussion.

Mark Zandi:                       Mind ninja, you've gotten into their minds, yeah.

Matt Coylar:                      He's persuasive.

Michael Strain:                 I'm sorry.

Mark Zandi:                       I got a Mike Strain hat on, I'm not allowing you in. Jeez, Louise. Okay, all right, hey, we're running out of time, but I do want to end the conversation with the election. As you said, Mike, I think people aren't paying enough attention here in two respects, and I want to get your reaction to both.

                                                First, how worried should we be about this election being close and contested and that ending up in a very uncomfortable place in terms of what's going on socially, politically, social unrest, that kind of thing. This is one of those things that keeps me up. I mean, how worried should we be about that? Do you think that's a real issue?

Michael Strain:                 Yeah, I think it depends a lot on who the nominee is. And so, my kind of current view is that if Governor Haley pulls it off, then it's not going to be that close, and she will likely win pretty decisively.

                                                But I think if President Trump is the nominee, people come home to their respective parties, we're kind of a 50/50 nation. There are, I don't know, a dozen counties where the election will be decided. The amount of resources that will be spent in those 10 or 12 counties is astronomical and it'll be close, and that'll be bad for basic social stability. I think that's a real possibility.

Mark Zandi:                       Yeah, I mean, there's so many different scenarios here, but do you think it would be prudent for businesses, financial institutions, governments to be considering scenarios where things do go in kind of dark place? I mean, in terms of social unrest and what that might mean for financial markets and the economy, or is it so far out on the tail that that's not worth even considering? Or is it something that people should be thinking about when they do their planning for 2024?

Michael Strain:                 I would be thinking about it, yeah.

Mark Zandi:                       You would be thinking about it. Yeah, okay.

Michael Strain:                 For sure.

Mark Zandi:                       All right. Yeah, we have an election model, we just dusted it off, where we do it at the electoral college level. And you make a wonderful point that I think it's really important to reemphasize that the President of the United States is determined by a few states and actually just a few counties in a few states, and in many cases, it's not even whether the Republican county goes Republican or Democrat goes Democrat, it's really the turnout in that county.

                                                Everyone expects Philadelphia County to go Democrat, but what's the turnout in Philadelphia is what really matters.

Michael Strain:                 Totally.

Mark Zandi:                       So, I think this is going to be just an incredibly close race. Here's the other thing I wanted to bring up, and that is policy. Okay, so on the other side of the election, whoever wins, they're going to be faced with having to make some big decisions and choices pretty quickly.

                                                I mean, we've got the debt limit that's going to come due again, that has to be increased about that time. You've got the Trump tax cuts, remember all those tax cuts back in 2018? For individuals, they expire at the end of 2025, so something's got to be done about that, some decision around that. And I believe there's also a lot of tax subsidy for Obamacare or health subsidies that are coming due that needs to be thought about and done.

                                                And I'm sure I'm missing other things that have to be done, but those are pretty big things. And all of this in the context of, we've got a very large deficit that isn't going to come in even with an economy that's operating at full employment, 3.7% on employment rate, and if we don't change policy, you look at CBO Congressional Budget Office forecast, something's going to break in the not too distant future because our debt load is going to continue to rise. How do you process all that? What's your thinking around that and how this may all play out?

Michael Strain:                 Well, this is not a good place for optimism. I think it's very troubling. I think one of the big misnomers in conventional wisdom is that there's a lot of disagreement between the parties on this issue. Both President Trump and President Biden are crystal clear on not wanting to cut spending on Medicare and social security. Those programs are the two biggest drivers of the structural deficit and the long-term fiscal imbalance.

                                                Both President Trump and President Biden are crystal clear that they do not want to raise taxes one penny on the bottom 98% of households, so the fight is over what to do with the top 2%, and there's just not enough revenue there to make a material difference to the long-term debt outlook. I don't think there's going to be a big fight over what to do with the expiring household provisions in the TCGA and the Trump tax cuts. I think allowing those provisions to expire on the bottom 98% of households will be interpreted as a tax increase on the bottom 98% of households. And so, you'll see President Biden wanting to extend those cuts. If President Trump wins, he'll want to extend those cuts.

                                                And so, I think if Governor Haley ends up getting elected president, she'll likely be serious about at least attempting to address our fiscal imbalance, but I think if we see President Trump or President Biden winning the election, then they have not left themselves much room to maneuver and I expect to see the can kicked down the road even further.

Mark Zandi:                       Right. Well, I guess that's going to be certainly not my problem, it might be definitely Matt's problem. For sure it'll be Matt's problem.

Matt Coylar:                      Great.

Mark Zandi:                       But that's a problem. That is the problem.

Michael Strain:                 It's a problem.

Mark Zandi:                       Yeah, my hope, and I'll just throw it out because as you can tell, I'm glass half full. My hope is... It's pretty hard to do this, but I'm going to try. I don't think lawmakers, whoever the lawmakers are, are going to be able to make the hard choices necessary to put our fiscal situation in a more sustainable place without pressure, and I do think that pressure will likely come from the bond market.

                                                And we've got a whiff of that just a few months ago when long-term interest rates jumped for lots of different reasons, but we got the 5% 10 Year Treasury yield in part because I think there was a lot of bond issuance. We have a very large deficit, surprisingly large deficit this year. We had a lot of issuance because of the debt limit that stopped issuance, and then all of a sudden they turn on the spigot and there was a lot of bonds issued. And then it's kind of shone a light on this long-term fiscal issue that we have.

                                                Of course, the rating agency either downgraded or they changed their position on stable versus negative rating. And so, I do think we got a whiff of this, but going forward, at some point, it feels like rates are going to rise and those bond market vigilantes that we used to talk about in the 90s, the last time we had a very serious fiscal problem, when the government's interest expense was rising to very high levels of GDP and overall revenue, that that will be the catalyst, that at that point, lawmakers have no choice.

                                                And also, they almost need it because it's very hard for lawmakers to convince the electorate, we got to do something if, well, why do we have to do something? The interest rates are low, everything's fine, the unemployment is low, why do we have to do something here? So, it will take that, but once that happens, once rates start to rise, once a lawmaker can say, "Look, we're spending more on interest expense than we are in the nation's defense. We're cutting a check that's greater to Chinese investors than we are on defending our country". That's when the light bulb goes on and we say, "Oh, okay, this makes no sense, we got to do something," and that's when we'll do something. So, am I just smoking marijuana? What do you think about that?

Michael Strain:                 No, I think an unsustainable situation can't be sustained, so I don't think the situation will be sustained indefinitely. I think the pressure certainly could come from the bond market. Another source of pressure are the statutory requirements of benefit adjustments when trust funds run out, so in the relatively near future, the Social Security Trust Fund will be exhausted. That will require a massive immediate cut in social security benefits that will force political action.

                                                That cut likely won't happen. I mean, it certainly won't happen to the degree it is required by law, and so Congress will have to pass a law that finds a new source of revenue to fund benefits at likely a little bit lower level, but not at the level required by current law. And in the process of doing that, that will create some political space to introduce longer-term reforms.

                                                So, whether or not the forcing event comes from the bond market, whether or not the forcing event comes from trust fund exhaustion in social security, or in certain parts of Medicare, I think there are forcing events that will happen and will then deal with this problem. The tragedy, of course, is that if we dealt with this problem 10 years ago, we would've found a much better solution. And if we dealt with the problem today, we would find a much better solution, so what we end up doing will be very much suboptimal, but it will be better than ruining the nation's finances and destroying the global financial system.

Mark Zandi:                       Right, right. Okay, let's end this way very quickly. We haven't done this in a while, but I want to get you on the record. The probability of recession starting at some point in 2024. Chris, let me begin with you, what's your probability?

Cris deRitis:                        33%.

Mark Zandi:                       Oh, 33, so that's down from where you were.

Cris deRitis:                        That's down, I was at 40.

Mark Zandi:                       Down, down at 40. Matt, what's your probability of recession in 2024.

Matt Coylar:                      Little lower, say, 25%.

Mark Zandi:                       25? Okay, Marisa?

Marisa DiNatale:              I'm still at 20.

Mark Zandi:                       20? Okay, relative optimist. Mike?

Michael Strain:                 60.

Mark Zandi:                       Oh wow, really? Holy cow, you're not just saying that.

Michael Strain:                 Not just saying it.

Mark Zandi:                       Okay.

Michael Strain:                 Not just saying it.

Mark Zandi:                       Okay, what's the catalyst for that, do you think? Anything in particular?

Michael Strain:                 I see a lot of weakness under the surface. The top line numbers look good. You look a little bit below that, and I see some kind of troubling signs, both in the labor market and for consumer spending, and also for business investment, for all three.

                                                Reason number two, things are a little too quiet, there's got to be a banana peel on the sidewalk somewhere. It's been a while since we've slipped on a banana peel. Reason number three... Reason number three, I think that there's a...

Mark Zandi:                       I know

Michael Strain:                 There's a risk. I think there's a risk of an energy price shock in '24. I think President Putin would like for that to happen, and that's an additional risk. And then, I think, my fourth reason is...

Cris deRitis:                        General angst.

Michael Strain:                 Yeah, yeah, I mean, there's a real psychological component to this, and the soft wading narratives ignore that type of recessionary psychology that I think is pretty important.

Mark Zandi:                       Yep, somehow we got to get the banana peel into the title of this podcast, The Banana Peel is Coming. Yeah, I like that, I like that.

Cris deRitis:                        How about you, Mark?

Mark Zandi:                       Hey, Mike, thanks. What's that, Chris?

Marisa DiNatale:              What's your?

Cris deRitis:                        What's your probability?

Mark Zandi:                       Oh, that's right, I didn't tell you.

Michael Strain:                 Negative 10.

Mark Zandi:                       25%. No, no, no, I'm at 25. I think the unconditional probability, I know lots of different ways of measuring, simple measurement, 15% unconditional probability, I'd say 25%, so elevated. I'm wary of the banana peel, and sentiment is fragile, and at the end of the day, recession is a psychological event, and I don't think it takes much of a fall to undermine that sentiment, so I wouldn't dismiss it. I do think that that's a reasonable risk.

                                                But Mike, hey, Mike, thanks so much for coming on, really appreciate it. That was a wonderful conversation.

Michael Strain:                 Yes, thanks for having me.

Mark Zandi:                       We covered a lot of ground, I really appreciate that.

Michael Strain:                 Always a terrific conversation,

Mark Zandi:                       And hope to have you back, maybe a year from now we'll get you back.

Michael Strain:                 Yes, for sure. Love to come back anytime. And again, you've won the battle, we'll see who wins the war.

Mark Zandi:                       Write this down everybody, write it down. Write it down. All right, I love a competition. I've lost my fair share of bets to Mike. He's a damn good forecaster. So, all right, with that, dear listener, we're going to call this a podcast. Take care now.