INSIDE ECONOMICS

Mark Zandi:                       Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics. And Marisa, you're back.

Marisa DiNatale:              I'm back.

Mark Zandi:                       How was vacation?

Marisa DiNatale:              It was great. It was probably, I was just saying to Chris, it's probably the longest vacation I've ever taken. I was gone for about 17 days and I was in Japan, went to four of the five islands, went to South Korea. Yeah, it was wonderful.

Mark Zandi:                       Good weather, everything okay?

Marisa DiNatale:              Yeah, it was very hot in Tokyo, in Kyoto. When I first got there, it was about 90 degrees Fahrenheit. And then as we went more south it was kind of rainy and cooler, so that was nice. But it was wonderful and I got to see our colleague, Stefan, I had dinner with him.

Mark Zandi:                       Big guy.

Marisa DiNatale:              My last night there in Tokyo. So it was really nice. And you had them on the podcast.

Mark Zandi:                       I did. Yeah.

Marisa DiNatale:              You had met Steve while I was gone. Yeah.

Mark Zandi:                       Stefan as well.

Marisa DiNatale:              It sounds like it went well.

Mark Zandi:                       Yeah, he's great. I think he speaks 10 languages or something. Very smart fellow.

Marisa DiNatale:              Yeah, it was fun.

Mark Zandi:                       Good. And had you been to Japan before?

Marisa DiNatale:              No, this was my first time and it was one of my top of my bucket list for travel.

Mark Zandi:                       I was there last year this time, and I think I might have been the first foreign traveler to Japan after they've lifted their COVID restrictions.

Marisa DiNatale:              Yeah, there were a ton of tourists there.

Mark Zandi:                       Oh yeah, I can imagine. Yeah, I remember with great intrepidation going there because they had this app, you had to fill in all your information, you get off the plane and I would walk from the plane to the immigration area and I'd get stopped every 10 yards by another Japanese official-looking person. And the app, they asked, "Let me see your app." If it turned green, you could move forward. If it turned red, I don't know what happened to you. What would happen to me.

Marisa DiNatale:              It was like contact tracing or something?

Mark Zandi:                       I don't know what they were doing. I couldn't quite figure it out, but I am not making this up. I think probably I got asked to show the red-green thing almost 10 times and every time I had to hit the button, the red-green, of course, I'm sweating. "Please don't turn red. I don't want to go in that room." But I made it through. But I'm glad you had a good time. That's great.

Marisa DiNatale:              Yeah, it was great.

Mark Zandi:                       Yeah, very good to have you back. You mentioned Chris, our colleague, Chris Lafakis. Hey Chris. You're on mute.

Chris Lafakis:                     Oh, rookie mistake. How you doing, Mark?

Mark Zandi:                       Good, good to have you on board because we are going to talk about inflation and oil prices are a key part of that, so thought we'd have you on again. So thank you for coming on.

Chris Lafakis:                     Thanks for inviting me. Happy to be here.

Mark Zandi:                       Very good. And also on the inflation front, we've got Matt Colyar. Matt, good to see you.

Matt Colyar:                      Hey Mark. Happy to see you. Great to be here.

Mark Zandi:                       You've been on Inside Economics before, haven't you?

Matt Colyar:                      Yeah, a few months back talking labor market stuff.

Mark Zandi:                       Yeah. Very good. Well, we're glad to have you on board. And finally, Gaurav Ganguly. Gaurav, good to see you from London, no less. Are you in London? You were in India not too long ago.

Gaurav Ganguly:              No, no. I was in India not so long ago on a business trip and in the Middle East, but now I'm in London, so a big hello from gloomy London.

Mark Zandi:                       Yeah, and you look like you're in a nondescript Moody's office.

Gaurav Ganguly:              I'm very much in a nondescript Moody's office, which is very, very quiet on a Friday afternoon.

Mark Zandi:                       I mean, literally you must be the only, this is Canary Wharf, right?

Gaurav Ganguly:              Yes, exactly. And I think you're right-

Mark Zandi:                       Is anyone else there?

Gaurav Ganguly:              There might be two other people on this floor and I think this floor seats over a couple of hundred.

Mark Zandi:                       Yeah. Well, I think that's the future. That's the here and now and the future, I suspect.

Gaurav Ganguly:              And the future. Yes.

Mark Zandi:                       Yeah, good. And we're going to dive into inflation in Europe as well. Might give us some insight as to what's going on with inflation here, I thought. And so we're looking forward to that conversation. With that as introduction, let's turn to Matt, the big news of the week, the Consumer Price Index, CPI here in the US. Do you want to give us the rundown, what did it say and what's your interpretation of it?

Matt Colyar:                      Yeah, absolutely. So before placing any value judgments, I'll just kind of go through the top line numbers.

Mark Zandi:                       We're all about value judgments. We're all about value judgments.

Matt Colyar:                      Yeah. We'll build the anticipation, I guess.

Mark Zandi:                       Okay, there you go.

Matt Colyar:                      Yeah. So consumer price index, headline inflation in September rose 0.4% from August. So we're looking at average prices for a basket of goods and services. Track it closely to see how inflation is behaving in the US. That 0.4% increase in September was, as we expected, a little bit higher than consensus expectations, but in the ballpark of, let's assume for the month relative to a year earlier CPI was up 3.7% in September. That's the same annual rate as we saw in August.

                                                In August, the big story was energy prices. Energy prices jumped 5.6%. In September, much more modest but still positive increase, which contributed to headline inflations increase. So energy prices rose 1.5% in September after that 5.6% acceleration in August. So not major relief, it's early, but hopefully October and we're about midway through the month. Looks like that'll turn around and be a different story next month. So good segue probably to remove energy and look at core CPI where we exclude energy-

Mark Zandi:                       Did you mentioned food? Food, I guess it was basically not much. 0.1% or something.

Matt Colyar:                      0.2% increase, so not a dramatic contributor-

Mark Zandi:                       No big deal there.

Matt Colyar:                      Yeah, in either direction.

Mark Zandi:                       So energy was up, no surprise. Food was kind of typical increase. And so now core ex food and energy.

Matt Colyar:                      Where we saw a 0.3% rise in September. So again, aligning generally with the expectations. The annual inflation rate for core CPI in September was 4.1%, so a little tick down from 4.3% in August and its lowest rate in two years. And we back up just one year, September this time last year. Core CPI was 6.6%, which is its high during the post pandemic inflationary fight in the US. That's a 2.5 percentage point decline in core inflation.

                                                Still too high for the Fed and maybe not at the pace that everyone would've liked to have gotten here, but unambiguously a success story because there hasn't been this simultaneous increase in joblessness and a reason why yesterday's report, like the past several, should generally be received warmly and give an encouraging outlook about inflation's trend in the US.

Mark Zandi:                       I'll say you nailed this, because you kind of predict based on other data what you think the CPI will be. And you were at 0.4% on top line and 0.3% on core and that's what we got. So you nailed it, but I'm not sure that's... A lot of people got it roughly right, I think.

Matt Colyar:                      Yes. And there's some offsetting surprises that makes it hard to gloat because the 0.4%, yes, it landed where we were.

Mark Zandi:                       You can gloat. I would've gloated. I don't know, Marisa definitely would've gloated.

Matt Colyar:                      Yeah, I would've had excuses if we were wrong, but-

Mark Zandi:                       Oh, there you go.

Matt Colyar:                      I'll have some modesty that we got it right. So what those surprises were, I think caught a lot of people off guard where shelter costs. There's this story that the way the BLS measures shelter costs, there's this ongoing moderation. Rental prices shot up in 2022 and have moderated since and we're pretty confidently expecting this moderation in shelters positive contribution to inflation. But in September there was a 0.6% increase from August.

                                                In July and August it was 0.3, 0.4%. That was our forecast, kind of a continuation of that pace. So given the weight that shelter gets within CPI, the acceleration was surprising and carried a lot of influence. It was responsible for about half of the increase in overall CPI in September. So surprising but would be really surprising should it be sustained given what we know about rental prices.

Mark Zandi:                       Yeah. I mean, this goes to noise versus signal. This felt like a lot of noise to me.

Matt Colyar:                      Yeah, I think and I look in the more granular details and there's nothing there that jumps out that would appear to be an inflection point and a turnaround in what we're looking at. Hotel costs were really high.

Mark Zandi:                       That's part of shelters lodging away from home or hotels and that was-

Matt Colyar:                      Yeah.

Mark Zandi:                       Yeah. But that's a small part of it, right?

Matt Colyar:                      It is. And I haven't heard any convincing argument as to why this represents a change in trends. So I think we can be as confident that the coming months show more of the moderation disinflation that we see in shelter costs.

Mark Zandi:                       When I say noise, it's statistical, it could be seasonal adjustment, who knows? It's just this isn't going to be sustained. We're going to go back to those 0.3%, 0.4% kind of months we were getting before this number. And it's not atypical that every once in a while you get kind of a wacko number that's kind of off the rails and what you're saying, I don't mean to put words in your mouth, but-

Matt Colyar:                      I think that's a reasonable characterization. So I know other measures you can start to cut out shelter. So if you look at CPI just removing shelter costs, it's a 0.3% increase and year over year inflation is 2%. So you'll see a lot of that, especially on Twitter, people trimming off different price metrics to get it underlying inflation.

Mark Zandi:                       I did that.

Matt Colyar:                      I think it's with shelter costs, it's... Well, Paul Krugman did one that I think cut a lot of flack. He might've cut too much.

Mark Zandi:                       Yeah, he cut a little too-

Matt Colyar:                      Too much. Yeah.

Mark Zandi:                       I think it's fair. I used, tell me if you think I overdid it. I said core CPI ex-shelter, that was a 0.1% in September. This is my Twitter @markzandi, by the way. I haven't done that in a while. 0.1% in a month and 2% on the nose year over year through September. Do you think I'm cutting out too much? I mean, my thought was we look at core because that gives us the best forecast of the future. And of course if shelter is the thing that's driving core and you take that out, you get a sense of underlying inflation broadly that's going to be key to the inflation outlook. That was my logic. Does it make sense?

Matt Colyar:                      I think that does make sense and I think the rationale being fluctuation in the items that you're excluding, it's hard to see how those things represent the wage growth that everyone's really concerned with. So shelter costs aren't directly representative of wage pressures and the main concern for the Federal Reserve. So I'm sympathetic with cutting those things. I think what people see more than one end excluding energy and food and housing and used cars. I think that's a bridge too far. But-

Mark Zandi:                       Yeah, but on the used cars, I mean those prices have been falling, so I'm not sure that helped him out when he did that. We were talking about Paul Krugman and his tweet. It didn't help out his case.

Matt Colyar:                      Which was the next surprise. And like you mentioned, it moved in the opposite direction. We had expected used vehicle prices to drop 0.5% from August to September and they fell 2.5%. The decline was we foresaw, given what we know about wholesale prices and how they on a lag lead into retail prices. So what dealerships are going to auction and buying used cars for and then selling, that's a pretty good indication what they're buying at the auction, what retail prices are going to be a few months down the road.

                                                Talking with our resident expert, Mike Brisson about why was this substantially more than we anticipated. It seems like a lot of that decline from wholesale to retail prices seemed to be condensed into a month. We expected to take the rest of the year for that decline to happen. We might've pulled forward for any number of reasons, but in a given month it kind of canceled out a little bit and helped us stay on track for our forecast given the increase in shelter cost that we did not anticipate.

Mark Zandi:                       Of course the weight in the consumer price index for shelter is a lot bigger than the weight on used vehicles. That's a small piece of the pie. I don't know what it is, but it's 1% or 2% at most of the index for used vehicles. Yeah.

Matt Colyar:                      Yeah, it's under 3% but the scale of it moved in that direction to a degree, but you're right. That's the general synopsis of it. Of note too, with September's report that closes out Q3, that's what Social Security Administration uses to dictate the following years increase in social security payments. So that 3.2% increase that has been well published over the past 24 hours came from the final price information we have from September. So that follows an 8.7% increase in January of 2023. And now by when we turn the calendar to 2024, you'll see a 3.2% increase in social security payments, which is about reasonable given what inflation has done over the past year.

Mark Zandi:                       Of course that big cost of living adjustment last year provided a lot of juice, didn't it? I mean, that was an over 8%, you said, increase. That's a pretty significant increase for social security recipients and that I think could probably help the consumer spending a bit. This might not help it quite as much even though inflation's back in, it just feels like we're not going to get as much juice.

                                                Okay. So those are the big surprises. What's your sense of where we're headed? I mean bottom, what really matters here is are we headed back to an inflation rate that we all feel comfortable with and probably more importantly that the Federal Reserve feels comfortable with? And on the CPI, the Consumer Price Index, the target is probably somewhere between 2%, 2.5%, no higher than 2.5%. Just by construction, it's different than the core consumer expenditure, which is the official inflation measure of the Fed uses for its target, which is 2%. What do you think? Are we still on track to get back to that kind of target over the course of the next 6, 12 months?

Matt Colyar:                      My belief is that this story that we've been telling for the past year has kind of played out as expected. There could be gripes about pace and about monthly vagaries, but in general the declining contribution from shelter is something we are confident in. Looking just to next month, I think we'll see a negative contribution from energy. So you won't have the top line boost that we've had the past two months, particularly in August. That last mile will be really hard for the Federal Reserve to finally feel comfortable that inflation is at a sustained near their target range. But I see no reasons now why that would... The economy is too resilient and policy would need to be restricted a lot more than it currently is to get there. I think we're on the right track. Maybe patience is the right word.

Mark Zandi:                       So connecting the dots back to the Fed, Fed Chair Powell, I don't know how long ago, maybe a year ago, identified super core inflation and that was service inflation I believe ex-housing, energy and housing services, I believe if memory serves. Did you look at that at all? Have you looked at that?

Matt Colyar:                      I know on a year I have that in front of me. I haven't looked at it's like three month moving average trend, which I think is the most useful, but a year ago I believe it's just under 4%. Right now it's about 3.7%, 3.8%. So in the same spirit of disinflation but not ready to [inaudible 00:17:23].

Mark Zandi:                       Not quite there.

Matt Colyar:                      Yeah.

Mark Zandi:                       Yeah. Okay. And of course he picked that because that's the part of the inflation index that is most closely related to the labor market wage. These are labor-intensive activities, healthcare, hospitality, that kind of thing, labor-intensive and that's the health of the labor market, the strength of the labor market is the one thing that the Federal Reserve can influence through monetary policy, raise rates, cause the labor market to ease and take pressure off wages and get that inflation rate down. So that's why he focused on it. And so you're saying it's still too high, but moving in the right direction.

Matt Colyar:                      Yeah, that's how I would characterize it. And I don't think the labor market is sending materially different signals right now. Still really tight, but certainly not accelerating wage growth.

Mark Zandi:                       Okay, very good. Hey Marisa, you heard all that. Any gaps in the rundown that you want to point out or anything you want to emphasize?

Marisa DiNatale:              I think that was very comprehensive and generally I agree that things are moving in the right direction. I think getting core inflation under control is a little trickier. Core inflation is now back above 3% on a three-month moving average basis, so it's ticked up the past couple of months. Matt talked a lot about shelter. The big pop was this lodging away from home. That was the big turnaround in the data. So that had fallen for two months straight and then it had a big increase last month. I know that's a small part, but that's one of the items in the shelter category that contributed to the popup in shelter inflation.

                                                But so is owner's equivalent rent accelerated over the month as well, which is the implied price that a homeowner thinks they could rent their home for. So that was up a bit over the month as well that accelerated. So it seems like the shelter generally is moving in the right direction. It may take a little bit longer to get back down enough to bring core inflation under control. If you just take core, shelter contributed 70% I think to the increase in core inflation over the month.

                                                I think the real key, and Matt mentioned this, is looking at other service segments that have seen higher costs. So if you look at food away from home accelerated again, so this is kind of restaurant takeout prices, that kind of goes back to the tightness in the labor market. It goes back to the strength and wages and leisure hospitality, which have come down quite a bit but are still running over 5% year over year. So I think that's going to be key to getting kind of all of that under control.

                                                Just a few other items I would point out kind of in the line item of CPI to watch, homeowner's insurance and rental insurance has been very strong in terms of price increases and that too contributed to the shelter number over the month. So those are just other items to watch. I think stripping out all these things out of core, you're not left with a whole lot, but I do agree that shelters coming down, we have good data on real-time rental signings to know that new leases being signed are showing disinflation, or in some cities deflation from where they were a year ago. So that points improvement. Say that again?

Mark Zandi:                       When you say deflation you mean outright decline in market rents.

Marisa DiNatale:              Yeah. So we know in some markets rents that are being signed today are lower than where they were a year ago. In other cases, the increase in rental prices is just slower than it was a year ago. So that-

Mark Zandi:                       The nationwide market rent are basically flat, I think.

Marisa DiNatale:              Yeah, right.

Mark Zandi:                       Okay.

Marisa DiNatale:              So you have some up, some down, right?

Mark Zandi:                       Yeah.

Marisa DiNatale:              So I generally agree with that take. I think given the strong jobs report that we had last week too, I think that the Fed definitely would not be surprised if they do another rate hike this year. They still have a very strong labor market, even some of the data that we got this week on the labor market continues to be strong and it's really going to be key to getting wage growth under control. We'll get another reading on wages at the end of the month. The employment cost index will come out I think on the 31st of October, so we'll see what wage growth looks like for Q3. I think that'll be key to what they do in the coming months.

Mark Zandi:                       Yeah, appreciate that Marisa. Matt, one more technical question. I've been waiting for new vehicle, we've talked about used vehicle prices, they have declined and it feels like they're based on auction prices, wholesale prices as you mentioned. Looks like those declines are now largely over, not that we'll get increases, but the declines are over. But I've been waiting for new vehicle prices to roll over. Of course, they went skyward too during the pandemic because global vehicle producers couldn't produce, inventories collapsed, and prices went skyward. And with the UAW strike, I suppose we shouldn't count on those prices coming down until the strike is over when we get production back up. But shouldn't we see new vehicle prices start to come in on the other side of the UAW strike?

Matt Colyar:                      The offsetting strike just looking near term, the idea that inventories are not going to be able to keep up [inaudible 00:23:20].

Mark Zandi:                       Beyond the strike, after the strike.

Matt Colyar:                      Yeah. I don't have a strong sense on whether that will, if the strike were to extend past November and longer than we're anticipating, I have thought about whether that's where you see prices increase or at least slow down any kind of disinflation, but that would be the kind of things I hit my person up and talk to have a better sense.

Mark Zandi:                       Okay. So you don't have a view on whether, because they're very elevated, they're not rising significantly, although they rose last month a little bit, a couple times, but they seem very inflated relative to what would be affordable at this point and you would expect, again, on the other side of the UAW strike when production normalizes that we would start to see some price declines there.

                                                Okay. Well, in my view, the report was right down the strike zone consistent with the idea that while inflation is still too high, uncomfortably high for the typical American household or for the Fed, it's definitively moving in the right direction and everything points to it continuing to moderate and getting back to something we all feel comfortable with including the Fed by this time next year. And it really, we forecast so many things and some things I feel pretty confident, in some not so much.

                                                This I feel pretty confident in because going to the cost of shelter that is tied to market rents with a long lag. And by construction with these flat to down market rents, we're going to get much slower growth in the cost of housing services as we make our way into next year and through this time next year. And again, if you look at underlying inflation excluding shelter, we're already back to target. We're already back to that 2%, 2.5%. And if shelter sticks to the script that I just enunciated and everything suggests that it will, that means inflation should be back to target as well.

                                                So I feel pretty good that we're on track here and I'd be pretty surprised if the Fed would raise rates another time at this point. I just don't see it. Not only because inflation's coming in, not only because the labor market is easing, but the other thing is financial conditions have tightened, meaning long-term rates have risen, the stock market is softer, the value of the dollar has increased. And you're now hearing beneficial saying, "Oh, okay, maybe with the tightening and financial conditions we don't need to raise rates." And I suspect at this point there will be no further rate increases. Not that they're going to cut rates anytime soon, but I'd be at this point pretty surprised if they start to raise interest rates any further. They're already pretty high.

                                                Okay, let's dig into this a little bit deeper. Gaurav, let me bring you into the conversation. If you look globally, particularly in Europe, which is kind of where you planted your flag, the inflation there also took off here a couple years ago and also remains very elevated. In fact, it feels like it's being more stubborn in Europe than it is in the United States. First of all, let me ask you, what do you think is behind the higher inflation broadly, particularly in Europe, and what's behind? Did I characterize things about it being a bit more sticky and what's behind the stickiness? Why isn't it coming in as quickly as would be here in the United States or other parts of the world?

Gaurav Ganguly:              That's a lot to unpack, so let me just [inaudible 00:27:08].

Mark Zandi:                       Yeah, that was a lot. I apologize.

Gaurav Ganguly:              That's all right. It's Friday afternoon, Mark. Brain's not working that well.

Mark Zandi:                       Oh, that's true. It's Friday evening there in London.

Gaurav Ganguly:              Exactly. And it's gloomy. But let me take a step back perhaps and as you say, inflation took off a while ago across the world. Well, I plant my flag in Europe and also the Middle East as you know. And in the Middle East, inflation never really took off for a whole bunch of different reasons, but we can park that for now. But it certainly took off in Europe and there was the pandemic and the spring back from the pandemic, supply chains were scrambled and that's already started to add to inflationary pressures to price pressures back in 2021 and then Russia invaded Ukraine.

                                                And when that happened, oil prices went up around the world, but Europe got slammed on a couple of other fronts as well and that contributed significantly to European inflation and drove a wedge between European inflation and inflation in other high-inflation areas of the world. So European gas prices went up a lot. Europe relied a lot on Russia for imports of gas and was completely slammed by the Russian invasion of Ukraine. So European gas prices went up really quite a lot and Europe couldn't move around.

                                                Gas prices are much more regionalized as you know, so Europe wasn't able to just quickly substitute away for gas in other parts of the world and there was a lot of significant price differential. And then European food prices went up by more than in other parts of the world because Europe was also particularly exposed to grain imports from Russia and Ukraine and also to fertilizer imports from Russia and Ukraine. And fertilizers, the fertilizer imports that went away and Europe had to make its own fertilizers with higher gas prices, gas being quite a significant input into fertilizers. So European food prices went up a lot as a result of some specific factors. And gas prices went up a lot.

                                                All in all, European inflation went up to, well, Eurozone and the UK, I'll take those two together or just compare and contrast those, inflation went up to about 11% by October last year. Since then there's been a climb down. And when you talk about sticky inflation, I think it's useful to compare and contrast the UK and the Eurozone because price persistence or sticky inflation does seem to be much more of a problem in the UK. So right now on August data, UK inflation was 6.7%. And in the same month, inflation in the Eurozone was 5.3%. And we have preliminary data for inflation in the Eurozone in September and it's dropped like a stone to 4.3%. 1% come off Eurozone inflation not expecting such a big drop in inflation in September.

                                                In the UK it's probably going to come down 0.3 of a percent or so, standard about 6.4%. That's year-on-year price growth. So that's the difference. Much more price persistence in the UK, much less so in the Eurozone. Looks like in the Eurozone things are coming down quite fast now. I wouldn't be surprised if in October-

Mark Zandi:                       Just for context, so this is through the month of September, 6.7% consumer price inflation year over year in the UK. You said what is it in the Eurozone?

Gaurav Ganguly:              So we don't have data for the same month.

Mark Zandi:                       You don't have September yet?

Gaurav Ganguly:              Yeah, exactly. So August inflation in the UK was 6.7%, September inflation in the Eurozone was 4.3%. August inflation in the Eurozone was 5.3%. So if you compare the same month, it's 5.3% versus 6.7%.

Mark Zandi:                       And Matt, what is it in the US? It is what, 3.7% or something top line inflation year over year? I think it's 3.7%.

Matt Colyar:                      3.7%, yeah.

Mark Zandi:                       Okay. So that gives us some kind of context.

Gaurav Ganguly:              So that gives you the range of inflation across these three regions.

Mark Zandi:                       So you're saying the Eurozone is coming in pretty consistently with the US, maybe a little bit hotter, but we're splitting hairs here now.

Gaurav Ganguly:              Yeah, exactly. And I think there's some similar themes. Despite all these differences in food and energy and the natural gas story, there are also some similarities in the themes that we see now. Core inflation has been dropping in the Eurozone and actually dropped a lot in September and we can see a weakening in goods prices and we are also starting to see some healthy weakening in service sector prices. Service sector prices were boiled up by increase in demand spring back from the pandemic and also high energy and food costs, but that's starting to come down now.

                                                And you can really see that this is not just a one-off, I feel like this is quite structural now. So these disinflationary forces in goods and services will continue. In the UK, that's also evident, particularly in the good segment. That's evident. You can see that cooling off of goods prices. You can see the beginnings of a climb down in the service sector, but I'd say the key difference between the UK and the Eurozone is really price persistence in the service sector, service sector inflation. So that difference between 6.7% and 5.3%, that almost 1.4% difference, a lot of that is service sector inflation.

                                                And that looks like it's set to stay in. If I had to take the next step and say, "What's driving that difference in service sector inflation between the UK and the Eurozone?" I would bet on the wage differential, the difference in wage growth. So in the UK wage growth is running at about 8%. In the Eurozone, wage growth is running at about 5%. So I think that's really a key determining factor in the wedge in service sector inflation across the two areas between the Eurozone and the UK. And it also helps explain why UK inflation is so much more persistent than in the Eurozone.

Mark Zandi:                       So one of the reasons why I thought it would be useful to have this conversation about European inflation is that it highlights a broader point. And that is the inflation we're experiencing here in the US is not just a US phenomenon, it's really a developed world phenomenon and Europe is a good example of that. And that goes to the fundamental reason why inflation is the problem that it is. And in my view, and I think you said this in not so many words, but you said it, it's really about the supply shocks that the global economy has been struggling through.

                                                I mean, it was the pandemic, supply chain disruptions that resulted, labor market disruptions that resulted. And you also mentioned the Russian war in Ukraine that reverberated around the world, but Europe obviously took it on the chin more than anywhere else. So it's those supply shocks that are at root here. Would you concur with that perspective?

Gaurav Ganguly:              Absolutely, and in fact, let me add some more supply shocks. Ones that we don't really talk about that much and that are quite specific. So food inflation in Europe has been quite high and it's taking its time to come down. It seems to be very, very hesitant to climb down. And I was taking a look at this trying to understand what it is that's driving food inflation in Europe? And my prior had always been fertilizer prices. And that's the piece I was talking about earlier. Europe was of course slammed by high energy costs and also by the fact that it couldn't get fertilizers from Russia and Ukraine any longer once the war started.

                                                But there are other supply side shocks affecting agriculture in Europe. So it's things like climate change. So very hot summer last year has decreased the fertility of herds, so pig breeding has gone down and cattle breeding has gone down. There's this climate change policies in place that are also making it difficult for farmers to expand their herd size. And so that means that meat production's down basically supporting higher meat prices while at the same time farmers are also facing higher input costs. So you've got supply-side shocks of all sorts.

                                                There's an interesting report out there that suggests that El Niño might simply add another 10% to food prices over the next couple of years. So we've got to watch out for further upward shocks to food prices from climate change. So there are a bunch of supply side shocks occurring of all sorts. The big ones have been the pandemic and the Russian invasion of Ukraine, but when you drill down into specific sectors, you can find some other supply shocks there as well.

Mark Zandi:                       Well, that is fascinating. I was thinking more optimistically until you said all that climate risk. The idea being, hey look, the supply shocks, the pandemic, Russian war, they're increasingly in the rear-view mirror, the economic fallout is fading and that's why inflation is coming in. And this is another point of comparison, the inflation here in the US is coming in at the same time as the economy's remained solid. I mean, creating a lot of jobs, unemployment remains very low. We have not had to see a significant weakening of the economy, certainly not a recession, certainly not higher unemployment to get inflation back in.

                                                And that's again, because if the inflation is due to the supply shocks and they're fading, then inflation should fade without a weaker economy. Same kind of dynamic playing out in Europe. Abstracting from these other shocks you just mentioned in terms of climate.

Gaurav Ganguly:              Yes, exactly. Similar sort of dynamic playing out in Europe.

Mark Zandi:                       Because you've seen some weakness in Germany for example, where it's more on the frontline of the problems in Russia and Ukraine and they've got other issues with regard to China. But generally, but even despite that, unemployment in the Eurozone remains very low, I believe.

Gaurav Ganguly:              Yeah, the labor market is the one bright spot in the economy across the economies of Europe. They're really amazingly low unemployment rates, some softening in the labor market is visible now. So we're starting to see in the UK for instance, this is a good example. We've seen a pickup in the unemployment rate in recent months. And that small pickup in unemployment rate is not because firms are letting people go, but it's because more and more people are coming back into the labor market, people that left during the pandemic and said they never wanted to come back again into the labor market.

                                                Well, the cost of living squeeze on these people is such that they're reentering the labor market and that's not happening in a graceful way. So they're not all coming back into jobs. In fact, many more are coming back into the unemployed pool than reentering into the labor market and getting into the employed pool. So that's driving up unemployment a little bit.

                                                Firms are also toning down their aggression and hiring, so vacancy rates are coming down. Employment expectations, particularly in the good sector softening. You mentioned Germany, that's a good case in point. German manufacturing is quite weak for a number of reasons. One of these is just weak global manufacturing conditions over the course of the year. We've talked about we've hoped for a pickup in manufacturing conditions globally, particularly once China reopened, but that's not happened yet. So manufacturing in Germany is quite weak. So there's another spot of weakness, potential weakness in the labor market.

                                                But overall the labor market's been really good. It's been the one source of support. Consumption hasn't been as good, particularly in the Eurozone. Consumption's been really weak. It contracted in Q4, it contracted in Q1. We sort of hope it'll pick up in Q3 and Q4 that consumers are fed up, they've had enough of tightening the belts and they're going to go out and spend a bit. But we're not that hopeful. In the UK, consumption is probably going to slow down as high interest rates bite.

Mark Zandi:                       I think that is one big difference between Europe and the US. In the US, consumers have had no problem spending their so-called excess saving, the saving they built up during the pandemic that they wouldn't have done otherwise. I don't think that's nearly the case in Europe. Consumers have been much more cautious in spending that excess savings.

Gaurav Ganguly:              That's right. I was looking at UK household savings looking across all deposit types from equity investments to cash, to site deposits. And clearly that went up massively during the pandemic because of the UK government's furlough scheme, which gave people 80% of their wages and households accumulated all of that. But they've spent very little of that since. And in fact, my intuition tells me looking at other data that when they are spending it, they're actually spending it to pay off debt. So they're paying off their mortgages rather than using that cash to go out and buy goods and services. So they're very, very cautious.

                                                And if I look across the Eurozone, I can see that savings rates went up during the pandemic just in line with the same stories in the UK. They then came down, but actually savings rates have started to tick up again. I think economic uncertainty is weighing on households.

Mark Zandi:                       Going back to inflation though, you do bring up a really important point about the supply side, shocks created by climate, the heat stress, and now the transition to a green economy. And that is those things are going to add to inflation as we move forward. So I think we need to make a distinction between the dynamics, inflation dynamics, here in the very near term and there I think we're on solid ground in my view, thinking that inflation is going to moderate, get back to something central banks and everyone feels comfortable with as the supply shocks from the pandemic and Russian war fade.

                                                But we are still left with these other supply issues, some of it related to climate risk that you mentioned, that will continue to play a role and that is a reasonable concern about underlying inflation going forward. What do you think about that? Would you concur with that?

Gaurav Ganguly:              Absolutely. And you're right about that degree of certainty. We've got a fair handle. We've got a good handle on inflation dynamics right now. We've lived through the pandemic and the Russian invasion, we've studied the data, we've seen changes day by day, month on month, and we have a pretty good view of how this is going to work out. There's much greater uncertainty in the medium term over the progress of prices. So if you look at agriculture, the example I picked, all those factors will weigh on agricultural prices going forward, and I don't know exactly how that will all crystallize.

                                                So Europeans eat a fair bit of pork, it's the biggest exporter of pig products, but there's a lot of pressure on herd sizes, there's a lot of pressure through heat stress. That's caused a huge problem with herd sizes. And then agricultural policy creates other issues, behavioral change comes along and Europeans start consuming less prosciutto and palmer ham. I don't know exactly how that's going to play out, but certainly it's pointing more towards upside risk on prices than to downside risk. And then we've got broader geopolitical issues that could cause structural shifts in prices. And I don't know, again, we'll have to navigate those waters and see how that plays out.

Mark Zandi:                       Right. Good. Okay, let's move on. Let's play the statistics game. You guys playing? Gaurav, you playing? Matt?

Gaurav Ganguly:              Yeah, I can play.

Mark Zandi:                       Okay, very good. Marisa, you're up for this?

Marisa DiNatale:              Oh yeah.

Mark Zandi:                       I know you were on vacation and not thinking about this stuff, but you got a good stat.

Marisa DiNatale:              I have a reputation to defend, so I'm back.

Mark Zandi:                       Yes, you do. In fact, I was-

Marisa DiNatale:              You guys have had it easy the past couple of weeks.

Mark Zandi:                       I was singing your praises when you're away for sure. Just to remind everyone, the stat game is we all come forward with a stat, the statistic, the rest of us, the rest of the group tries to figure that out with questions, clues, deductive reasoning. The best stat is one that is not so easy. We get it immediately not one that's not so hard, we never get it. And if it's apropos to the topic at hand, which I guess is inflation, then all of the better, but doesn't necessarily need to be the case.

                                                So let's go with Matt. Let's go with you first because you're the stats guy, you're deep into the data. Oh no wait, that's a mistake. We always start with Marisa. I'm losing my mind. You were gone for so long, I [inaudible 00:43:15].

Marisa DiNatale:              You got used to me being gone.

Mark Zandi:                       Yeah. Sorry, Matt.

Matt Colyar:                      That's okay.

Mark Zandi:                       Stand down, slow down. I know you're ready to go.

Matt Colyar:                      If Marisa takes mine, that won't seem fair, but go ahead.

Mark Zandi:                       That's true. That's a good point, which happens regularly.

Marisa DiNatale:              But I'm sure, Matt, you have plenty up your sleeve. So I think you'll be okay.

Mark Zandi:                       I think he'll be fine.

Marisa DiNatale:              Yeah.

Mark Zandi:                       He's a big boy. He'll be fine.

Marisa DiNatale:              Okay, ready?

Mark Zandi:                       Yeah, go ahead. Fire away.

Marisa DiNatale:              60.7.

Mark Zandi:                       60.7. Is it an inflation statistic in CPI?

Marisa DiNatale:              No.

Matt Colyar:                      Is it an ISM measure?

Marisa DiNatale:              No.

Mark Zandi:                       That didn't come out. That came out last week, I think. Is it a stat that came out this week?

Marisa DiNatale:              Yes.

Mark Zandi:                       Is it a government statistic?

Marisa DiNatale:              No.

Mark Zandi:                       Is it NFIB from the-

Marisa DiNatale:              No.

Mark Zandi:                       It's not from the NFIB, the National Federation of Independent Business. Okay. Is it labor market related?

Marisa DiNatale:              No.

Mark Zandi:                       Oh my gosh. Okay, we're toast, guys. What's the units?

Matt Colyar:                      Is it a sentiment measure?

Marisa DiNatale:              It is a sentiment measure.

Mark Zandi:                       Hey, something came out today. I haven't had a chance to look. University of Michigan came out today?

Marisa DiNatale:              Yeah.

Mark Zandi:                       Is it from that survey?

Marisa DiNatale:              It is.

Mark Zandi:                       Oh, is it the actual survey number?

Marisa DiNatale:              It's not the top line number.

Mark Zandi:                       It's not the top line. It's present conditions or expectations? I don't know.

Marisa DiNatale:              Right, it's expectations. Yes.

Mark Zandi:                       It's expectations. Okay.

Marisa DiNatale:              Now that you guessed all three possible numbers.

Mark Zandi:                       That's my strategy, overwhelm you with just everything. So 60.7. Okay, so that's the University of Michigan survey.

Marisa DiNatale:              It just came out this morning at 10 o'clock.

Mark Zandi:                       Guys, does that seem fair to you? That seems like a little [inaudible 00:44:59].

Marisa DiNatale:              It was before the podcast started.

Mark Zandi:                       Really? It all came out at 10:00.

Matt Colyar:                      30 minutes before.

Marisa DiNatale:              Yeah.

Mark Zandi:                       Okay, fair enough.

Marisa DiNatale:              So University Of Michigan Consumer Sentiment Index for the month of October, this had been improving. And then in the month of October it fell quite a bit, which is consistent with this index being extremely sensitive to measures of inflation and in particular to energy prices and gas prices. So we know that gas prices, they didn't increase as much over the month of October as they did in September, but they're still obviously very, very elevated. Inflation is still, it's going in the right direction as we talked about, but it's still above the Fed's target.

                                                I picked the expectation measure, so there's two measures within the overall measure. There's consumers assessment of current economic conditions and then there is their assessment of future economic conditions, six months, hence it fell from 66. This is a diffusion index. It fell from 66 in September to 60.7 in October, so it was quite a big decline and it's the first decline in the index in a few months and it was quite a big one. This puts the index now back to where it was or lower than where it was. You have to go back to a few months to May of this year to get the expectations index this low. It's only the second time it's fallen since May too, so we'd seen this steady improvement.

                                                Inflation expectations, they also ask consumers, "What's your expectation of inflation going forward?" That jumped also. And again, this survey, there's a couple of expectations surveys. There's this one, University of Michigan, there's the conference board. The conference board tends to be much more sensitive to conditions in the labor market, which explains why it's been a lot better than Michigan over the past few years because the job market's been strong, inflation's been uncomfortably high. They ask consumers what their expectations of inflation are, their long-term expectations of inflation. So five years hence climb to 3% after dropping to 2.8% in September. So year ahead expectations rose even more. They rose to 3.8% in October from 3.2% in September.

                                                So again, just on the topic of inflation, consumers are very, very sensitive to changes in inflation. That's how they assess their own financial position. And in particular, they're very sensitive to gas prices and energy prices.

Mark Zandi:                       So the University of Michigan survey for the month of September, one year ahead inflation expectations, what was that? Do you know?

Marisa DiNatale:              Let's see. I think I just said it, right?

Matt Colyar:                      3.2%, I think.

Mark Zandi:                       What is it?

Matt Colyar:                      It was 3.2%, now it's 3.8% for the preliminary reading of October.

Mark Zandi:                       For the month. Oh, I'm sorry, it was 3.2%.

Marisa DiNatale:              That's right. It went from 3.2% to 3.8%. Yeah.

Mark Zandi:                       Okay. And that's obviously very closely tied to the cost of a gallon of regular unleaded. If that goes up, then inflation expectations go up. Okay. So I tend not to look at the University of Michigan survey just because it feels so, I mean out of bounds. I mean, if you take a step back, look at what the index is, it's saying, "I'm as pessimistic now as I was in the teeth of the pandemic. I'm as pessimistic now as I was in the teeth of the great financial crisis." Does that make sense? Does that even smell test, right?

Marisa DiNatale:              No. And generally I agree with you that I've discounted measures of consumer sentiment quite a bit just simply for the reason that the way consumers have been answering these surveys has been very inconsistent with their actual observed behavior in terms of consumer spending. If people are this pessimistic about the economy, they should be pulling way, way back on what they're doing. They should be saving more, they should not be spending. But I still think it's important because sentiment has a way of becoming this pervasive thing and there's a lot of psychological components to the way consumers behave. And if sentiment sort of continues to snowball and people start to feel like things are getting worse or will get worse [inaudible 00:50:04].

Mark Zandi:                       Don't get me wrong. I agree with all of that.

Marisa DiNatale:              Yeah. And the reason [inaudible 00:50:08].

Mark Zandi:                       The University Michigan Survey doesn't seem like it's useful because it doesn't square with anything.

Marisa DiNatale:              Yeah. I mean, the reason I picked it is because of [inaudible 00:50:18].

Mark Zandi:                       I'm not trying to be critical of why you picked it. It was a good statistic to pick, so I didn't mean it that way. I mean, the conference board survey just feels, it passes the smell test. If you look at it, the level of the index, the conference board survey, the one you mentioned, is consistent with its long run average. And that kind of sort of makes sense. I mean, even though unemployment's very low, inflation's very high. Okay. So they wash out and you're kind stuck in the middle here. And that's consistent with what consumers are doing in terms of their spending, as you point out, that it's pedestrian. It's 2% real, that's not too strong, that's not too weak. It just feels right. The University of Michigan survey feels like it's just off the mark, right? No? I don't know. Matt, do you have a view? Let's settle this.

Matt Colyar:                      Sentiment measures in general I find have just been so confounding. I was... Yeah.

Mark Zandi:                       He's not going to do that, Marisa. He's not going to say, "Mark, you're right." Or, "Marisa, you're right."

Marisa DiNatale:              No. I mean, clearly.

Matt Colyar:                      Yeah.

Mark Zandi:                       Good move. They are confounding. But I think, Marisa, I totally agree with you. I think almost anything that's survey-based has a problem because response rates, the way people respond. I never responded to a survey, my wife who used to respond all the time doesn't now respond at all because for lots of different reasons.

Chris Lafakis:                     Also, the political climate could influence survey-based measures.

Mark Zandi:                       Oh, yeah. Go look at the-

Marisa DiNatale:              We know it has. When you look at the difference between the way self-identified Republicans respond versus Democrats, it just depends on who's in the White House. So regardless of actual conditions, economic conditions, if you have a Republican in the White House, Democrats think the economy's terrible. And if you have a Democrat in the White House, Republicans overwhelmingly think the economy's terrible regardless of what it actually is. So that's become an observed major issue in these sentiment responses over the past 10 years. It's not new, but it certainly wasn't to this extent, 20, 30 years ago in these surveys.

Mark Zandi:                       Hey Gaurav, and I know we need to move on, but this is fascinating. In Europe, there's a lot of these kind of sentiment surveys as well. Would you have the same kind of issues there as we have here?

Gaurav Ganguly:              Same issues, exactly the same issues. Can't really rely on surveys right now. Consumer confidence surveys give you the impression that consumers are retrenching like crazy. Well, they are retrenching, but not to that extent. Same sort of thing, they're the gloomiest ever or the gloomiest since the global financial crisis, but that doesn't really square up with what we see in hard data. The same sort of thing.

Mark Zandi:                       Yeah. Okay. All right. Hey Matt, you're up. What's your number?

Matt Colyar:                      Well, if you saw my eyes darting around, I was going to go with the University of Michigan inflation expectations, discounted or not, but we'll go with 7.7%.

Mark Zandi:                       Is that in the inflation report? The CPI report? No, it is not. Is it a stat that came out this week?

Matt Colyar:                      Yes.

Mark Zandi:                       Is it a government stat?

Matt Colyar:                      No.

Marisa DiNatale:              Is it in the University of Michigan?

Matt Colyar:                      No.

Mark Zandi:                       Is it in the National Federation of Independent Business?

Matt Colyar:                      No.

Mark Zandi:                       No. And you said, I'm sorry, you said it was not a government statistic. Okay.

Marisa DiNatale:              Is it in the PPI report?

Mark Zandi:                       He said not government though, didn't he?

Marisa DiNatale:              Oh yeah.

Matt Colyar:                      Not government.

Mark Zandi:                       Non-government.

Chris Lafakis:                     Is it mortgage apps related?

Matt Colyar:                      You're the closest thus far.

Mark Zandi:                       Housing related then. Is it house price series?

Matt Colyar:                      No.

Mark Zandi:                       I can't think of what. Did it come out this week or... It did come out this week.

Matt Colyar:                      Yes.

Mark Zandi:                       7.7%.

Matt Colyar:                      Pardon, Marisa?

Marisa DiNatale:              It's housing related?

Matt Colyar:                      It is. And it's not particularly obscure, but I'm starting to second-guess myself.

Mark Zandi:                       It's not particularly obscure. Well, because you know the data so well, nothing's obscure. So can you give us a hint without giving it away?

Matt Colyar:                      Comes out every week.

Marisa DiNatale:              Oh, it is it the mortgage rate?

Matt Colyar:                      It is, the 30-year fixed rate mortgage.

Mark Zandi:                       In plain sight. Yeah.

Matt Colyar:                      Yeah, it's not obscure. One, my wife and I bought a house a few months ago, so it's top of mind. We got a little bit less than that so we feel sharp even though we're not. And two, it speaks to the tightening and financial conditions. That's a pretty steep rise over the past eight weeks. And my thinking about, "Okay, yesterday's report. What would this report have to say for the Fed to change course?" I think that threshold changes course and raise rates again in November, I think that threshold lifted significantly given how tight financial conditions, bond yields have risen, mortgage rates alongside have gone up higher and are doing a lot of the Fed's work for it.

                                                So I think some of the communication you're hearing, which I agree with, is that that tightening is equivalent to a rate hike. So again, raise the threshold for what they would need. Yesterday would've needed to be a blowout surprise to the upside for what I would expect would kick off a rate hike in November. It wasn't, so I think we should be increasingly confident that they're going to pause when they meet in a few weeks.

Mark Zandi:                       That was a good one, Matt. And a good one, Marisa. You're right, that was right there.

Chris Lafakis:                     Isn't it reported in that MBA report?

Matt Colyar:                      Yeah, and I know there's different measures, but that's the one on EV, so that's what I'll go with.

Chris Lafakis:                     Yeah. You led me a straight, man. I asked about that report.

Marisa DiNatale:              Well, it's a different source.

Matt Colyar:                      Oh, you said applications. Oh, you're right. I was thinking volume, like the index volume that we report. I thought that's what you were referring to.

Chris Lafakis:                     Mortgage app survey, MBA mortgage app survey.

Matt Colyar:                      Yeah.

Gaurav Ganguly:              Do I go next?

Mark Zandi:                       Sorry, I think I froze.

Marisa DiNatale:              You froze for a minute.

Gaurav Ganguly:              You froze. Yeah.

Mark Zandi:                       Am I back?

Marisa DiNatale:              You're back, yeah.

Mark Zandi:                       I'm back. Okay.

Marisa DiNatale:              Just in time.

Mark Zandi:                       Just in time. Okay. I don't know what you guys said, but I'm sure it was [inaudible 00:56:48].

Gaurav Ganguly:              I was going to offer to go next.

Mark Zandi:                       Okay. Fire away, Gaurav. You're up.

Gaurav Ganguly:              Okay. So I've got a number, and I'll give you a hint. It's not that recent a number, but it does relate to what we were talking about earlier, i.e., Inflation. It's -3.2%.

Matt Colyar:                      Is it a growth rate?

Marisa DiNatale:              It's not that recent.

Gaurav Ganguly:              You guys have been talking about data that came out this week. This didn't come out this week, but it did come out in August. Big hint.

Marisa DiNatale:              Okay. It's an inflation number.

Gaurav Ganguly:              It's an inflation number. Came out in August. So it's a UK inflation number because you'll recall, I said to you earlier that I don't have the September UK inflation number yet.

Marisa DiNatale:              -3.2%.

Gaurav Ganguly:              -3.2%.

Marisa DiNatale:              Was it energy prices in the UK?

Gaurav Ganguly:              Yes, it's energy inflation in the UK. Exactly. And this is kind of interesting because you could see what energy dynamics are doing. So you've got an increase in petrol prices because of the recent increase in Brent, but the big fall in electricity price if because of the come down in gas prices have meant that energy inflation continues in year-on-year terms to be negative, even though I guess the rate of decline has slowed down by the recent increase in oil prices, but nonetheless it remains negative.

Marisa DiNatale:              So what's your forecast for September?

Gaurav Ganguly:              Actually, in the UK it's going to step down even more because in October we are going to see a reset in retail electricity and gas prices. So it sort of happens every six months, so we had a reset earlier in the year. Now we're going to get another reset in October, so it's going to become an even bigger drag on headline inflation before it fades away.

Mark Zandi:                       Hey guys, I got thrown out. I missed the stat. What was it? What was the number?

Gaurav Ganguly:              So it's energy inflation in the UK in the August inflation release. Yes.

Mark Zandi:                       I see.

Marisa DiNatale:              And guess who got it right?

Mark Zandi:                       No. Really? Wow. That is masterful. I've never gotten it right. I'm glad I tuned out. Mr. Lafakis, what's your number?

Chris Lafakis:                     So I woke up thinking of a number and then I thought it was too easy. And then I found a Goldilocks number and then our discussion inspired me to pick a different number entirely.

Mark Zandi:                       Oh my gosh.

Chris Lafakis:                     Which might be a little bit difficult for you guys to get, but I'm going to give it to you anyways and I'll preface it by saying it is a price because otherwise it would be very hard for you to get, it's $9,034.

Marisa DiNatale:              Dollars?

Mark Zandi:                       Is it an energy price?

Chris Lafakis:                     It is not an energy price and the unit is dollars per metric ton.

Mark Zandi:                       Geez. Dollars per metric ton. $9,000.

Marisa DiNatale:              Is this some sort of carbon price?

Chris Lafakis:                     No, but it has been impacted by climate and it goes to Gaurav was speaking to earlier.

Gaurav Ganguly:              Is that a food price?

Chris Lafakis:                     Yes.

Gaurav Ganguly:              Is it some kind of meat price?

Chris Lafakis:                     No.

Marisa DiNatale:              Grain price.

Chris Lafakis:                     No.

Matt Colyar:                      Fertilizer?

Chris Lafakis:                     It's not fertilizer.

Marisa DiNatale:              No meat, no grain, no fertilizer.

Matt Colyar:                      What did Mark guess?

Mark Zandi:                       I'm still impaired by my Zoom. I'm going to tune out. I'm going to-

Marisa DiNatale:              Why don't you turn your camera off.

Mark Zandi:                       Okay, let's try that. Yeah.

Marisa DiNatale:              And just try the audio.

Mark Zandi:                       Okay. All right. I didn't guess. The last thing I heard was a food price, but that's where I got-

Marisa DiNatale:              We guessed meat, grain, and fertilizer. And those are all incorrect.

Mark Zandi:                       But you said $9,000 per metric ton.

Marisa DiNatale:              $9,034 per metric ton.

Chris Lafakis:                     Yes.

Mark Zandi:                       Is it like a palm oil or something?

Chris Lafakis:                     Very close. You're very close, Mark.

Mark Zandi:                       Soybean oil.

Chris Lafakis:                     I'm sorry, you're very close though.

Mark Zandi:                       Oh gosh.

Gaurav Ganguly:              Is it an oil?

Chris Lafakis:                     Yes.

Gaurav Ganguly:              Okay. Sunflower.

Chris Lafakis:                     No, keep going.

Marisa DiNatale:              Olive.

Gaurav Ganguly:              Not even [inaudible 01:01:18] keep going.

Chris Lafakis:                     Yes, Marisa.

Gaurav Ganguly:              Olive. Very good.

Chris Lafakis:                     Thank you, Marisa. It's olive oil prices. $9,034 per metric ton.

Mark Zandi:                       What other oils are there?

Marisa DiNatale:              There's lots.

Chris Lafakis:                     There's sunflower, there's soybean.

Mark Zandi:                       Okay, so explain-

Chris Lafakis:                     There's palm. So the reason why I picked this is because olive oil prices have more than doubled in the last year. They have literally more than doubled in the last year, and it's because of extreme droughts in major producing regions, especially in the Mediterranean region. Very little rainfall and very high temperatures. So it goes back to the impact of climate change on inflation and making it more difficult to grow these commodities and thus shrinking the supply and putting prices through the roof. And it causes me to be a little bit less optimistic in terms of the long-term trajectory of inflation when it comes to production of raw commodities, but I just couldn't resist, guys. It was on point and too good of a number.

Gaurav Ganguly:              I think it's a great number. It's a great statistic.

Chris Lafakis:                     Thank you.

Marisa DiNatale:              But, Chris, does olive oil, is that mostly a final good or is it also an input to other things like these other oils are?

Gaurav Ganguly:              It's also an input to other goods, but it's mostly a final good. Yes, it does get into various food products. It's mostly a final good. But to Chris's point about the upward trajectory of food prices from this kind of shock, there's a huge amount of uncertainty about how all this plays out and the time it takes to play out. And I'll give you the example of England, because I'm here in the UK, English wine I think is the next big wine. Who would've believed that? Who would've believed that?

                                                But with climate change occurring, actually South of England is becoming quite a good place, a good wine producing region, and English wine is starting to pick up just as wines in Bordeaux start to go down. There've been terrible harvest in Bordeaux because of the heat. Olives might face a similar shift in production rate, so it's really a lot of uncertainty around how all this plays out. But certainly last couple of years have been horrendous for olive oil prices in Europe. Well, around the world, but Europe being such a big producing region around the Mediterranean.

Mark Zandi:                       Obviously, a big part of the inflation story is around energy and oil and natural gas, not only directly but indirectly through food prices and goods prices. And even more importantly than that, what we were talking about it, oil prices, what we pay at the pump affects inflation expectations, therefore wage dynamics which feeds into inflation. So it's really, oils despite the fact that the US now has energy, oil independence has been in decades maybe since the combustible engine, because we're producing as much oil as we're consuming. Despite all that, we're still very, very dependent on oil. It really drives the train here.

                                                And I've been, Chris, I'm going to turn to you. I've been hoping, praying that oil stays between $80 and $90 a barrel, and at this point in time last time I looked, we're sitting at 85 bucks a barrel on WTI, West Texas Intermediate. And given events, what happened recently in Israel and what's happening now in Israel and Gaza, although that doesn't have a direct impact on oil energy markets, obviously it's in a very sensitive part of the world when it comes to oil and other fossil fuels. Is $85 kind of where you think we should be? I mean, should we be really worried about prices going higher here or can we get lucky and they go meaningfully lower or how are you thinking about oil prices?

Chris Lafakis:                     Yeah, absolutely. So our forecast is for prices to be at $87 per barrel. That's on Brent in 2024. And I think that there are risks both to the upside and the downside of that. I would kind of want to broaden the conversation to not just oil, however, but to also refining because I think that that has been, and that was going to be my statistic, but it has contributed to the consumer price inflation that we felt. So in terms of what's happening in the oil market, we have an elevated amount of excess supply because countries, particularly Saudi Arabia, have withheld production in order to keep prices where their break even is fiscally.

                                                At the same time, we've had the US having a little bit of a less restrictive policy against Iran that has allowed Iran to export more barrels to the global market. Iranian production has increased by over a million barrels per day since President Biden was elected in 2020. So those two have kind of offset each other to some extent. Now with the conflict between Israel and Hamas in Gaza, that dynamic of increased Iranian production and withheld Saudi Arabian production might be unwound to some extent, and the screws might get tightened on Iran a little bit. And Saudi Arabia, we would expect to loosen the taps, produce, fill some of that void. So we expect oil prices to stay roughly where they are now in 2024. In terms of what could go wrong, if this-

Mark Zandi:                       So obviously oil prices will go up and down and all around, but you're saying on average through the end of next year, prices should remain roughly where they are literally today, is what you're saying?

Chris Lafakis:                     Yes, they should.

Mark Zandi:                       It's a delicate balance between global supply and demand and obviously things happen, but right now that kind of dynamic suggests stable pricing here going forward?

Chris Lafakis:                     That's correct. That's our baseline forecast. The most likely scenario is that this conflict in Gaza does not engulf other major oil producers in the region. Iraq doesn't meaningfully change its production levels, neither does Saudi Arabia. The screws might get tightened on Iranian production a little bit, but we can handle that because we have a lot of Saudi production in the bank and that this all plays out and we get range bound oil price over the next six to 12 months.

Mark Zandi:                       Okay. Just to put a few numbers on it, and I may have the numbers wrong, but I think with the Saudi production cuts, there's probably what, 4 million barrels a day of excess capacity to produce in Saudi? A little bit in UAE, couple of other countries? Is that about right, 4 million? And just for context, we consume, produce about 100 million, roughly speaking, 100 million barrels of oil a day globally. So about 4 million in excess capacity. Is that roughly right?

Chris Lafakis:                     It's 5.1 million.

Mark Zandi:                       Is it five? Okay.

Chris Lafakis:                     Yes. And that is a historically elevated number. In a normal, well-functioning market, you'll have between three and three and a half million barrels of excess supply. And it has been difficult historically for OPEC to sustain for long periods of time, such high levels of excess capacity. It becomes too tempting to pump at higher prices. So we are expecting some of the voluntary Saudi Arabian 1 million barrel per day production cut to be unwound gradually in 2024.

Mark Zandi:                       Okay. And the other key assumption here is that if other global supplies are impaired, Iran will be a good case in point. And I think just again to put a number on it, I think the Iranians are what, exporting 3 million barrels a day of oil?

Chris Lafakis:                     Well, that's closer to their actual level of production.

Mark Zandi:                       Oh, I'm sorry. Their production is 3 million barrels a day.

Chris Lafakis:                     Yes.

Mark Zandi:                       Okay. And that's up from two, if you go back to the beginning of the Biden Administration, it was about 2 million. Now we're up to about three.

Chris Lafakis:                     Yes.

Mark Zandi:                       Okay. And you're saying, "Look, if in a darker scenario, if the events in the Middle East kind of broaden out and it seems most likely that the Iranian oil would be impaired because of their links to Hamas and the conflict and the war," then your expectation is Saudi would open up the spigots a bit and fill the void. If say a million barrels of Iranian oil go away, we go back from three to two. Saudi would use some of that excess capacity to build up here to kind of fill the void and no harm, no foul. We still get mid 80s on oil prices. That's what you're saying?

Chris Lafakis:                     That's what I'm saying. We have a buffer.

Mark Zandi:                       Okay. And that feels like a pretty tenuous, I mean, we're making a lot of assumptions there that are pretty risky, that the Saudis would actually step in and help out here, but you feel pretty confident in that.

Chris Lafakis:                     Well, I mean, you have a point. I mean, the Saudi Arabian government has not been too friendly with the Biden Administration and maybe they want to put the screws on the Biden Administration heading into a presidential election year and maybe they withhold production and let prices go above 100 in order to achieve that. So there are certainly assumptions that we're making that could ultimately not come to fruition, but demand is also very sensitive to price, and we've seen this in the immediate response to the Russian invasion and subsequent spike in oil prices.

                                                And consumer prices have been more affected than just the raw oil price, and that's because of challenges in the refining market. Coming into the invasion, 2021, the year prior to the invasion, the invasion was in February of 2022, was the first year in the prior 30 years that there had been a global decline in refining capacity, and that was led in part by the US where we had a fire at Philadelphia Energy Solutions Refinery and rather than put forth the capital to refurbish the refinery, the refinery is ultimately closed. That was a massive refinery, one of the biggest on the East Coast.

                                                And so we came into the Russian invasion with a squeeze on our ability to refine petroleum. And fast-forward through the invasion, countries, including the United States, the UK, Australia, Canada, and the European Union have banned not only crude oil imports from Russia, but also product imports, diesel and gasoline, and that has put a squeeze on the global refinery capacity and has increased the so-called crack spread, the difference between wholesale prices and the price of oil, wholesale petroleum product prices like diesel and gasoline and the price of oil.

                                                If you look actually at where petroleum crack spreads were prior to the invasion, look at the 10 years prior to the invasion, the gasoline crack was $11. Since the invasion, it's been $29. That's a difference of $18 per barrel, which boosts pump prices by 45 cents per gallon. That's just on refining. And for diesel, it's even worse, 70 cents per gallon just on refining again. So we're still feeling the aftershocks of the Russian invasion of Ukraine, and we're feeling it more in the refined petroleum markets than we are in the oil market itself.

Mark Zandi:                       Okay. So let me ask you two questions. First, and I'll come back to the crack spreads in the cost of gasoline in a second. But going back to oil, we're sitting in the mid 80s, do you think the risks that we go consistently above 90, closer to 100 or greater or less than or equal to the risk that we go below $80 and closer to $70 on a consistent basis over this period through the end of '24? Are the risks symmetric here or are they asymmetric in any way?

Chris Lafakis:                     They might be asymmetric 60/40 to the upside.

Mark Zandi:                       Okay.

Chris Lafakis:                     The principle worry on the downside is that the Fed is impatient and pushes too hard and it undermines demand, and then we have a weaker macroeconomic environment.

Mark Zandi:                       Yeah, but no, don't bring in any of that other stuff, but the global supply... Oh, I guess it is demand. Okay, fair enough. Everything affects demand, but looking at the supply side of the market and what's going on there, you think it's more 60% probability that we get higher prices and 40% would get meaningfully lower prices than what we're expecting?

Chris Lafakis:                     Yes. And that goes to Saudi Arabia withholding production.

Mark Zandi:                       Yeah. Okay. A lot that depends on that. Everything depends on that. Okay. Then let's go back to the crack spread in gas prices. And that's actually something that is a bit fortuitous. Even though oil prices are up, gasoline prices have kind of come in a little bit here, certainly over the last month. And those crack spreads, while they're still wide, while those margins are still wide for refineries, they've come in a little bit. So are you saying that you think there's more room for those margins to come in and keep gasoline prices down or something else? They're historically wide for lots of reasons. Do you think they might come in some more and we might get lower gasoline prices for a given level of oil price?

Chris Lafakis:                     Yeah, I think that there are some reasons for optimism here. Number one, what you're observing is a seasonal decline in the gasoline crack spread. This happens every year. The margins peak in May, June, and July. The seasonal factors are roughly neutral for gasoline prices for the crack spread in October. They decline a little bit in November. They decline more meaningfully in December, January, and February. So we will experience a seasonal decline, and that's about 10 cents per gallon in November, and it goes up to 20, 25 cents per gallon in December, January, February. We're going to get that, and that's partly why top line gasoline prices have fallen a little bit of late.

                                                Now, going back to crack spreads being elevated since Russia invaded and the squeeze on the refining margin, we talk about this frequently in commodity markets, Mark, the cure for high prices is high prices. And so these wider crack spreads provide producers, the supply side of the economy, with the incentive to make investments so that they can earn more on refining. And we did get the first ever, well, not first ever, but the first new refinery in the United States since the 1970s that was built quite recently. It wasn't a big one. It's a Texas International Terminals in Channelview, Texas.

                                                Refining capacity is just 45,000 barrels per day. That's about 12 times smaller than the Philadelphia Energy Solutions Refinery that closed in 2021, but just to the point of you will get more investment over time as these crack spreads remain wide, that will compete away, will arbitrage away the elevated crack spreads that have happened since the Russian invasion. It's going to take some time though. The supply side of the economy does not move quickly, but within the next six to 18 months, I would certainly expect that precisely happen.

Mark Zandi:                       Okay. I think we're going to end it on that optimistic note. I guess I would comment that, again, we forecast many things, some things we feel confident in, some not so much. I kind of feel confident in the outlook for the growth and the cost of housing services. I feel good about that. Oil prices, gasoline prices, not so much. That's a pretty tough thing to get right because there is so many crosscurrents here and it's all global, and it's geopolitical, and it's just really difficult to nail down. But I'll take the optimism here, I'll take the optimism.

                                                Okay. I think we should call this a podcast. We've covered a lot of ground and taken up a lot of time. Anything else anybody wants to bring up before we call it quits? Marisa, good to have you back again. Gaurav, good to see you. Matt, anything? Chris? No? Okay.

Chris Lafakis:                     All good.

Mark Zandi:                       Okay. Hearing none, we're going to call this a podcast. Take care, everyone. See you next week.