Hello, and welcome to What Goes Up, a weekly markets podcast. My name is Mike Regan. I'm a senior editor at Bloomberg.
And I'm Aldona hired across asset reporter with Bloomberg.
And this week on the show, Well, the magic number is one point one percent. That's how much the US economy grew in the first quarter, according to the government's first estimate. That's down from growth of two point six percent at the end of last year, and quite a bit lower than the one point nine percent that economists had estimated in a Bloomberg survey. So is this it is that looming recession we've been hearing about more or less since the last recession. Is it finally upon us?
And if so, how bad could it get? We're going to pick the brain of a senior economist at a major US bank, but Bildana. First, I have a very important question for you.
Always have an important question.
This is a divisive question this time of year. Okay, it's playoff time, but the question is hockey.
Obviously, the sabers are out right, they're out. I don't actually watch that much of it, what my husband tells me.
Okay, the wait, wait, wait, wait wait, you just do what your husband tells you.
No, no, just when it comes. That's not.
I mean, the only knowledge I have of the NHL is what he tells what what? What he relates back to me? You have me flustered.
Now.
I know that the Sabers are out, which is sad for our household. But the devils are are they still in the play?
Devils indeed are still live.
Oh my gosh. Then that's who I'm rooting for.
Just beat the Ranges, the Ranges, but Florida Beat. You're exhausting my hockey knowledge. I'm an NBA guy. I uh, this is so you don't for me.
I see, okay, but.
I wish the hockey would just end earlier, like I could get into it if they weren't competing at the same time. Yeah, mba.
Anyway, I don't know if there's a hockey team where our guests this week is based.
She's in Charlotte. Is sarah hockey team?
Oh yeah, yeah, I believe.
So I don't know. Well, let me bring her, let me let me bring her in.
It's Sarah House, senior economists at Wells Fargo. Welcome to the show.
Thank you. So I'm a journey from Charlotte. So our closest NHL team is in Raleigh, and the Hurricanes, I'm happy to say, are still in the playoffs.
Oh my gosh, she knows more than me and you.
It's amazing that they play hockey in Carolina during basketball season at all.
It's amazing that they play hockey in Florida at all. True, I'm always amazed by that.
Well, Sarah, hockey or basketball the important question?
First, hockey, for sure?
Really, there you go.
We beat we beat you out.
Okay, But Sarah, maybe you can just start by telling us about your role at Wells Fargo.
Sure. So, I'm one of our teams senior economists. So I focus on the US economy, specifically inflation and labor markets. Look a lot at FED policy just given the importance of those two sectors there, but really just that broader focus on the overall US outlook.
So, Sarah, that print for the first quarter GDP surprising to you, more or less what you expected. How walk us through how you're thinking about what we know about the economy after that report?
Yeah, so we're actually below consensus, in part because you did get some pretty significant revisions to consumer spending in the days before the release, so we had taken down our consumer spending numbers, but I think in some ways it was surprising and just the degree of the slowdown, so sort of bigger drag from from inventories. But you know, overall final demand from domestic purchasers was holding up, and so that's really kind of the better bell weather for
underlying pace of economic activity. But we did see momentum slow over the quarter, and so we're a little less optimistic that we can maintain the pace that we saw in Key one as we look out further into the year.
Okay, so let's look up into the year, because I believe you and your team are anticipating a modest recession for later this year, starting later this year, So can you tell us what's behind that.
Yeah, so we are in the recession camp. We don't think it's going to be quite the douzy of the past few recessions. But when we look at just the degree of tightening that we've seen coming from the FED and really just the severity of inflation, we think that if the Fed's going to be really set on getting inflation anywhere close back to its two percent target, it's likely that we're going to see demand need to pull back, and so we are expecting a contraction later this year
and spending. We're already starting to see some weakness coming out of the business investment side, and this is really a FED engineered recession aimed at curtailing demand to send
that inflation pressure. Before the mess of March, we already see credit conditions tightened just as the outlook was deteriorating, So we think that's going to be important part of this slowdown, and not just the availability of credit, but just also the cost leading to businesses and households just getting a little bit more conservative.
And you see it starting later this year and then continuing on into the first half of twenty twenty four. Or how long can we expect it to actually be playing out?
That's a good question. Yeah, So in our baseline forecast, so we have the economy tipping into recession around the third quarter and really things getting worse around Q four. So Q four is kind of where we see the worst of it, but still spilling over a little bit
into Q one. So we think it's likely to be kind of more of a slow drag in terms of economic activity, just given that, we also don't think the Fed's going to be writing to the rescue as soon as you do see that weakness, the nature of the inflation that we're seeing right now, I think that the FED is actually going to be pretty reluctant to ease policy even as the economy is entering a recession. So we do think it's likely to last a few.
Quarters, you know, sir, there seems to be this sort of discrepancy right now between the manufacturing side of the economy and the services side of the economy. Manufacturing is very weak, you know, according to most of the purchasing manager indexes, they're all coming in below fifty, you know, that sort of dividing line between growth and contraction for manufacturing. Services have been better, but they're still holding above that fifty,
signaling growth in the service industries. I mean, obviously the service side of the economy is way way bigger than the manufacturing side. But I'm wondering how you think about that discrepancy? Is there, you know, the possibility that that manufacturing side is sort of a canary in the coal mine for the entire economy, or how do you think about it? Sort of you know, one's growing, one's shrinking, and what it means going forward.
Yeah, So I think one important aspect of that manufacturing services divide in this cycle, in particular, is the nature of the crisis that we just came out of, and really what areas of the economy have done fairly well over the past few years and which ones have struggled a little bit more to get back on their feet. So, you know, what's so interesting about the COVID recession is
that it was a boon for manufacturing. So typically when you see a downturn, that tends to be some of the more cyclical items, you know, big ticket costs, and so consumers retrench more. But just given the nature of the shock that we saw and the demand that resulted in physical things over experiences, that was a huge benefit
to the manufacturing sector. So we think some of this pullback is cyclical, so it's in response to the higher rate environment that we're seeing businesses cutting back on capital goods expenditures. But we also think it's a little bit of payback from some of that demand being pulled forward and just really unsustainable levels of activity and demand for goods that again just benefited so much from the nature
of the crisis. So I think there's a little bit of both in there that I think the downturn that we've seen, and not just the isms, but some of the hard data on manufacturing from the Industrial Production Report is indicative of the conditions are getting harder. It's harder for businesses to plan, they're cutting back on spending. But we think some of this is also just payback from what we saw in the pandemic years.
And you mentioned the turmoil that we saw in the banking sector, and obviously that continues to play out. But I'm wondering how you're thinking about it, is the worst behind us? And then how can we start to see credit tightening or a crunch, whichever way you refer to it. How can we see it starting to manifest in the economy.
Yeah, so our baseline assumption is the worst is over. You know, we saw obviously the Treasury, the FED, the FDIC come out pretty strongly and swiftly to try and stem the issues surrounding the banking sector. So, for example, we have a new facility aimed at helping helping banks with some of the securities that have lost value. And so our working assumption is that we're not in for an outright credit crisis, but we do think that on
net credit is going to be tighter ahead. So we had already seen credit tight and pretty substantially leading into March. So if you look at the Senior Loan Office or survey for example that only went through the fourth quarter, we were seeing recessionary degrees of tightening across business loans, consumer loans, commercial real estate already. Now we don't have the next out quite yet, so we don't know exactly
what the March events did to that. But you do have some data, for example, from the Dallas FED that does a by quarterly version of this, and it showed marginally more more tightening, and so we think that it's it's that additional restraint on credit flow. So we think maybe there's not a significant degree of additional tightening. I think that's consistent with what a number of Financial Conditions index, including the Bloomberg one, is showing. But I think overall
we're looking at probably marginal more tightening. As banks are just a little bit more conservative, there's probably more anks around some of their funding costs and what's happening with the deposits, and so we think that that's going to lead to just slower credit growth across the economy, and
that's going to weigh on activity. It's going to weigh on business's ability to expand, to hire, and so we think it's it's going to be a slow kind of a slow burn as we move through the rest of this year.
And you do point out in a recent note that credit spreads haven't exactly blown out. They did widen quite a bit after the March bank turmoil, they've closed up a little bit, you know, and for listeners who are unaware, that's basically the interest rate on corporate bonds, the spread above the interest rate on treasuries is what we're talking about. Should we expect some more widening if the economy is
headed for a recession? And how bad would you expect that to get if so, And really, to complicate the question even further, how do you explain why credit spreads have remained fairly tame in this environment?
Yeah, so I think it's possible that we'll see those credit spreads widen a little bit as you think you do see market participants get a little bit more concerned about the path for the economy. So, you know, we're a little bit more downbeat in our assessments of what we think is going to happen to the US economy. There still is this the softly camp floating around, so we think it's if we were to see that happen,
I think you would see those credit spreads widen. But I think in some ways that the fact that they haven't widened all already it speaks to, you know, this
is a pretty uncertain environment. So while we're in the recession camp, you know, there's a lot of unique factors about this cycle, which I think makes it very difficult to kind of pin down the timing of when activity is likely to just low more meaningfully and when you actually might get some of that more pressure on corporations and their profits and just pricing therefore being reflected in that worsening outlook for the business sector.
And then how are you thinking about what's going on with the jobs market, Because we do have some more chatter of people saying the jobless claims have ticked up a little bit in recent weeks. The jolts number was a bit more surprising than people had thought. So how are you starting to think about what's going on in the jobs market.
Yeah, So our view of the jobs market is that overall the market remains very strong, but the direction here is very important. So if you look across a whole host of labor market indicators, the direction is deteriorating. So you can see that certainly from the demand side, with those job openings down twenty percent from their peak. You can see it in terms of the jobless claim so still at exceptionally low levels, but we have seen them trend higher over the past few months after being more
or less stable through twenty twenty two. Same thing with hiring plans, so we've seen weakening across the pmis whether you're looking at the ISM versions or some of the regional FED employment components in their surveys, but also just the small business hiring plans. So that's been an area where small businesses have been the ones that have had the hardest time getting labor in this economy over the
past few years. But we're seeing those hiring plans dial back pretty markedly here, and in fact they're lower than at any point of barring just the throes of the pandemic since about twenty seventeens. You're seeing the demand indicators come down supplies coming back a little bit, and that's helping prop up the overall level of nonfarm employment in
the pace of hiring. But even then, we've seen it decelerate over the past year, and we think we're going to see a further downturn here in the coming months.
So I think when we hear the word recession, you know, dunk, dund dun, people tend to think of, you know, double digit unemployment, something really nasty. I don't get the impression that's what you're bracing for, though, how bad do you think that unemployment rate could get from here.
We're not bracing for a huge spike in the unemployment rate, and part of that has to do with the fact that we're not thinking this is going to be a downturn like we saw in two thousand and eight, two thousand and nine, or the acute downturn that we saw in twenty twenty. So our GDP contraction we're looking for basically a peak to traff decline of roughly one percent. But even when we look at the increase in the unemployment rate, so we're only expecting that to go up
to about five point one percent. So if realized, that would actually be the smallest increase in the unemployment rate over recession, and I think part of that reflects the fact that it's not a super severe downturn. But also there are still industries like leisure and hospitality that are catching up on hiring, and so that's going to have an impact in terms of perhaps the degree of output cuts. But those are less lower productivity jobs, and so that's
going to help there. But then there's also a supply consideration here, So just the fact that one, employers are already pretty desperate to hire, they might be a little bit more conservative in terms of laying off workers, just given how hard it's been to get workers in the first place, not just over the past two years, but in the years preceding the COVID recession. And then also just the inflows into the labor force are much much slower than what we've had in prior decade, just given
population trends. So I think just the normal inflows that we'd be seen into the labor market in the coming years that's going to limit how high you see that unemployment rate rise.
So would that level of unemployment a little over five percent, would that change the calculus for the Federal Reserve. Do you think make them actually throw in the towel and start cutting rates.
We're no, So we do think probably once the unemployment rate rises a percentage point or so, we think at that point, when it's very clear that the economy is in a recession, we do think that the FED will will start cutting. So this would still be a market departure from the reaction function of prior cycle. So for example, if you go look at the two thousand and seven cutting cycle, so they began to cut rates when the unemployment rate had only ticked up about a tenth or two.
So the fact that the FED is likely to wait until unemployment has risen a full percentage point, which is pretty well known that it usually only takes about half a percentage point and you're definitely in a recession, I think that's a big change in the Fed's reaction. So we don't think that they'll, you know, completely look through the rise in unemployment, but we think that they will drag their feet because they want to make sure that you are seeing slack in the labor market come back,
but also weakening demand. That's going to be enough to put down put enough downward pressure on inflation where you're going to get back somewhere at least close to two percent.
What about before we see any potential cuts, Like, what are you expecting from the Fed for the remainder of the year, Because I was speaking with a bunch of money managers earlier this week, and a bunch of them are expecting the FED to also raise rates at their June meeting, even though it's not something that the market is exactly pricing in right now. What is your team projecting in terms of what we're getting from the Fed before any potential cuts.
Yeah, So our or basicline expectation is that they hold in June and they remain on hold for the following few meetings, and that may is likely the end of the hiking cycle. And with that, I think that comes from the fact that you do see a number of FED officials, I think, getting increasingly nervous about how much they've done, lack of certainty over what the impact of the increases are on the banking sector, what it means
for for credit growth and therefore the economy ahead. So I think just given the rapid degree of tightening that we've seen and the fact that FED officials they know that policy acts with the lag they want to see how that affects. So I think it's likely that we'll see the FED on hold for an extended period and
then our baseline assumption is that then they cut. But I think if we continue to see the spending continue to grow, if we see the jobs market remain very strong, resilient, you don't really see that meaningful increase in unemployment and inflation remains sticky, you might hear a lot more conversations about, well, maybe the next move is actually another hike rather than the next move beating a cut.
So the one thing that we really haven't touched on so far is your outlook on inflation. I think the one thing everybody can agree on is it's just not coming down fast enough. So what are you expecting in terms of the inflation rate coming down and to what level?
Yeah, so our expectations are that we are going to see some meaningful improvement here over the coming month. So I think some of the increases we saw in the first quarter might have to do with a little bit of a residual seasonality, So you tend to see more price increases at the start of the year, and maybe
just the seasonals not quite catching up with that. And I think also some of the momentum we've seen in inflation, you have to remember a lot of that came through revisions to those seasonal factors, so showing that Q four was actually a lot stronger than it was. So as we think ahead, I think there's some technical reasons why we might get a little bit more of a clear improvement on the inflation side over the next few months.
Is those seasonals will actually lend a little bit more of a depressing effect to some of the readings coming up. But then I think also just where we are in the economy and the growth cycle, so our expectations are that you're starting to see the impact of the weaker housing market start to show up in these official inflation measures. I think we got a little bit of a taste of that in March. Maybe it overstated the pace of decline, but I think that's set to gather momentum. Thus far,
the improvement in inflation has been pretty narrow. It's been largely energy and vehicles, but I think that there's certainly more room for that vehicle this inflation to pick up, but also broader goods as we have seen supply chains correct, and also just consumers are getting more choosy and their finances are squeezed, and so they just don't have that same degree of purchasing power. Just they're not able to just accept the same degree of higher prices that we've seen.
So we think that that's going to be an important part in other goods, but also even some services, including some of the more discretionary services like travel that can also reprice pretty quickly as compared to other parts of the service sector like medical care for example. So we have core inflation coming down but still looking pretty high when we get to the end of the year. So core PC probably somewhere close to three three and a half percent on a year over year basis, I think progress,
but still unacceptably high. And I think what we'll put the FED in a pretty tough spot is they're seeing that labor market deteriorate, but inflation is still running uncomfortably high.
So what does the FED do?
So you guys are projecting cuts obviously towards the end of the year, but if inflation is still at three and a half, you know it does put them in a bund, as you say, So what do they do in that instance, like maybe you can put yourself in their mindset and think about how they might be thinking about it.
Yeah. So I think given what we've seen in terms of the discussions and how frequently you're seeing officials including share Pal harken back to the nineteen seventies, I think that they're going to lean towards giving inflation a little bit more weight in this environment, that they're going to accept somewhat weaker labor market conditions and an unemployment rate in part because the labor market is contributing to this
inflation environment. It is just not all the supply chains for physical goods, the lack of chips for auto's production, but it comes down in large parts to the fact that you're still seeing exceptionally strong labor cost growth. So we had a very strong Key one employment costs index showing labor costs still running it close to five percent annualize, and that has the FED pretty nervous about what's happening
to some of the services components of the core. And so I think that given that the labor market is contributing to these inflation air pressures in the significant way, I think that the FED looks through some of that labor market weakness if it means getting inflation at least back on track towards two percent. They don't need to hit two percent on the nose, but I think they want to see that conditions are in place for it to slow further, you.
Know, Sarah. One of the biggest headlines that we saw this week that I think caught a lot of people off guard was Treasury Secretary Janet Yellen came out and said the quote unquote x state for the debt ceiling is in her estimation now June one. In other words, the US government, if the debt ceiling is not by then basically has the potential to run out of money in early June. Then the Congressional Budget Office came out
and kind of confirmed the timing more or less. I don't think to the day, but said early June was kind of the target. So many people that we've talked to have kind of, I think, ignored this issue and hope it goes away to some degree, which makes sense given how many times issues come up and the brinkmanship goes down to the eleventh hour and then there's a deal struck to avert the worst case scenario. I do
wonder though, if this time is different. I mean, politics are so toxic and so combative in the US right now. I'm assuming, you know, if you're forecasting a shallow recession, that your base case is that this won't be an issue, that this will get resolved before disaster strikes. But I'm wondering how you're thinking about it. How big of a risk is this the US doesn't get to a deal to increase the debt ceiling before that date. How big
of a threat to the economy is that. I mean, my guess is it's a massive threat to the economy. But I'm just curious how you're thinking about it. All.
Yeah, so I think this is a significant threat. And we think, despite you know, it seems we go through this exercise, you know, at least every couple of years, and it eventually gets worked out and we've all become a bit numb to the debate. We think that this particular instance has the potential to be quite contentious, and it's reaching that X state and surpassing it with It's a tail risk in our view, but it's a significant one, just given the catastrophic implications that it would that it
would likely have. So we think about just the split in Congress and even just the some of the divisions within the GOP and how thin their margins are. You know,
this could very likely come down to the wire. And I'd also point out that it doesn't even we don't even have to actually reach that X date without a deal, But if it looks like it's coming down very close to the end of that period, you could still see a lot of collateral damage in the economy, I think, particularly given the toxic political environment and perhaps you know, some not a lot of optimism that it might actually
get done. So if you go back to twenty eleven, for example, consumer confidence over the summer, when we were having a very similar split in terms of Congress and the White House, you saw confidence plunge that summer. You saw the stock market decline essentially seventeen percent in just
a matter of weeks. So you don't even need to actually default on the debt for I think there to be real damage in the economy, and particularly given that that the overall picture is already getting increasingly fragile, So it wouldn't take a lot to kind of accelerate that downward momentum if you did see another contentious debt ceiling.
Debate, but then even in actual default and it just seems like, well, the wheels really come off the bus at that point.
Game over.
Yeah, it's not funny, that's not I laugh because a nervous laughter of course at the apocalypse.
Yeah, the apocalyp We can cry after the podcast is over.
Well, Sarah House, senior economist at Wells Fargo. Really great to be able to pick your brain on all things about the economy this week. Can't let you go just yet. We have to talk about the craziest things we saw in markets this week, which is our tradition.
We have a lame one and a good one. Should I go with the lame one?
Okay, it's actually from my sister, who's our new craziest things.
We don't have to put her on the payroll here.
Yeah we will, because she keeps texting me all the time like crazy stuff she saw. But it's a little bit lame anyway. She said, this was the craziest thing she saw. Wendy's is putting their chili with beans into grocery stores at four ninety nine.
A canoe for a can of chili from Wendy's with beans.
With beans and beef, And apparently they started making the chili because they had a lot of leftover hamburger meat and they didn't want to waste it.
Really.
Yeah, anyway, it's a little lame. I'll admit I like it.
I like it. H Okay, I tell you commend to your sister for me. She's doing good work.
Yeah, she is. She usually says to be some really good ones.
Five bucks for canna chilli.
I don't know, I know, maybe it's a super large camp.
I feel like it's probably cheaper than that at Wendy's. Well, have to do some research on that.
We can go to Wendy's. Oh my gosh. Yeah, good, Frosty's all.
Right, Sorry, how about you. You see anything crazy this week?
Well, one thing that stuck out to me was a comment from the Ism Manufacturing Index we got earlier this week, and I think it just did a really good job summing up just how much uncertainty that we are seeing in this economy and how in some ways we're seeing things weakend but in other ways hold up better. And she just speaks to I think the degree of uncertainty about where exactly. The economy even is right now, let alone where it's it's going. So the comment was, we
seem to be in a season of contradictions. Business is slowing, but in some ways it isn't. Prices for some commodities are stabilizing, but not for others. Some product shortages are over, others aren't. Trucking is more plentiful, except when it isn't. There's uncertainty one day but not the next. The next couple of months should provide answers or not. It's hard to make projections at.
The That's almost like a poem.
All It's like the shruggy man emoji at the end.
Of the day, Yes, the one, Yeah, they should have the little shruggy.
The pandemic I feel like broke everything. It broke every chart. It really just created this environment where no one can predict anything. Is that your sort of vibe these days, Sarah, That it's just forecasting is infinitely harder than it used to be before the pandemic.
It's certainly gotten a lot harder, and I think there's tremendous more uncertainty. And I think you see that, you know, even in our own forecast discussion. But amongst other economists. If you look at just the dispersion of estimates, if you look at the FED and how they rank a certainty around their own forecast, it's at record highs. So I thought that summed up. I think where the overall state of the economy and economists are right now?
All right, well, my crazy thing is back in the crypto markets. I'm just going to read the lead of the Bloomberg story because it sums it up so well. Well, this is an Ohio man photographed lounging in a bathtub full of dollar bills must serve four years in prison for stealing seven hundred and thirteen bitcoin from a computer device seesed by the government in a case against his brothers. So the brother got arrested for laundering money in the
darknet in of various crypto transactions. The irs actually seized the brother's hard drive, which had what he thought were his bitcoin wallet. But I guess the way this works is you really just store your private keys on the wallet. So the brother was able to using the actual private keys, basically replicate the wallet on the hard drive and steal seven hundred and thirteen bitcoins right off of a hard drive. When was it possession by the irs? Twenty twenty? So April twenty twenty.
Bitcoin was like eight or nine thousand dollars back then.
He was twenty twenty. Wasn't that low, wasn't it?
Because we were coming out of March twenty twenty when it hit.
Up seven hundred and thirteen bitcoin value then at about four point nine million. So I'll let you do the math there. But there were a bunch of other four hundred and eighty seven Okay, what is it again? Four hundred and seventy seven digital token valued what four point nine million million? Divided by Shoot, we're doing math live on the cast here.
Because divided by seven hundred.
Thirteen thirteen, what was the price of VICLINI hundred? You got that love on twenty four?
Yes, it was March twenty twenty, She's.
What and I buy? The best part is they seize the guy's phone and they find this picture of him lounging in a bathtub full of dollar bills. I thought that was pretty good. And uh, one of the things they said he did he used sixty eight bitcoin as collateral for a one point two million dollar loan and spent that loan to buy a luxury condo in Miami. Cleveland.
Wow, yeah, I guess.
Cleveland, which you know, I didn't even know they had luxury condos in Cleveland. I mean, I Lebron had to live somewhere, so I guess maybe it's that building. But had they released the picture of the guy in the bathtub full of dollar bills, he looks very happy, I would be two. But you know, if you're a real player dollar like at least tens or twenties, what he.
Did, he did just one dollar bill. That's good.
So anyway, that's a good story. Sara House, so great to hear your perspective on everything. We really appreciate your time.
Thank you, Thank you, Sarah.
What Goes Up.
We'll be back next week. Until then, you can find us on the Bloomberg Terminal, website and app or wherever you get your podcasts. We'd love it if you took the time to rate and review the show so more listeners can find us. You can find us on Twitter, follow me at Bildana Hirich. Mike Reagan is at Reaganonymous. You can also follow Bloomberg Podcasts at podcasts. What Goes Up is produced by Stacey Wong and our head of Podcasts is Sage Bauman. Thanks for listening. We'll see you next week.