Why America’s Inflation Problem Isn’t Going Away

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1:56Mark Zandi:welcome to prof g markets i'm ed elson it is july 15th let's check in on yesterday's market vitals The major indices climbed on a better-than-expected inflation report. More on that in a minute. The inflation reading also sent Treasury yields lower. Meanwhile, Brent crude declined after President Trump scrapped his idea for a 20 % fee on cargo in the Strait of Hormuz. And finally, IBM plunged 25 % after pre-announcing earnings that missed expectations. It was its worst day of all time. okay what else is happening inflation cooled to an annual rate of three and a half percent in june which was lower than economists had predicted consumer prices fell 0.4 percent between may and june that was the largest one-month decrease since april 2020 much of that drop was driven by lower energy prices after the u.s iran ceasefire eased fears of supply disruptions, but that relief may be short-lived.

3:01Mark Zandi:Last week, of course, President Trump declared the ceasefire over. And yesterday, the U.S. launched a new round of strikes on Iranian targets. Brent crude has since climbed back to around$85 a barrel, raising the prospect that energy prices and inflation could move higher again. So joining us to discuss this inflation report. We are speaking with Mark Zandy, chief economist at Moody's Analytics. Mark, great to see you. Thank you for joining us on the show. Inflation's come down. We were at 4.2, which was really high. We're now down to 3.5, still pretty high, but lower than expected. I think the bigger question, though, is how much of that was because oil prices went lower in June.

3:47Mark Zandi:And I ask that because oil prices are, of course, rising again, which makes me think maybe this is not here to stay. Yeah. It's odd when you said the inflation is easing to 3.5%. It is easing. It's down, but it's still awfully high, uncomfortably high. As everyone knows, the Fed's target is 2 % inflation. That's kind of what we take as being a comfortable rate of inflation. And I think what I'll call underlying inflation, kind of abstracting from all the vagaries of the data. And by the way, in this report, there was a lot of noise. I don't know if you noticed, but it's a very noisy report. And, you know, a lot of anomalies in the data, and I'm not sure how much to read into it.

4:31But, you know, abstracting from that, I think underlying inflation is kind of three to three and a half percent, somewhere in there, again, uncomfortably high. And that's abstracting from the swings in energy prices related to the war, which obviously, you know, added a lot to inflation, you know, coming into the war back in the spring, early summer and is now detracting from inflation. But abstracting from that, we're at a very high, uncomfortable level of inflation. And this is after a number of years of very high inflation. In fact, inflation has been above the Fed's target for five years. And so the cost of living is extraordinarily high.

5:12It reflects the cumulative effect of those high rates of inflation. And I people just are feeling very uncomfortable with that. And hopefully the Iran work moves in the right direction here and begins to abate. But as you point out, that's now a new risk.

5:26Mark Zandi:I think the big question is, is this going to be the trend? Will we keep seeing the number go down? And that's what I'm trying to understand from this report. Does this tell us that inflation is now headed in the right direction, specifically down? Or is this a blip? Because what we know about last month is that, you know, specifically when we look at the energy markets, people seem to think the war was over. Now here we are in July, prices are going back up, and people seem to think, no, it's not, because the president told us as much. I mean, obviously a lot depends on what the president does or doesn't do and whether the strait reopens and we get oil flowing through or not.

6:10I mean, I think there's no way to know for sure, obviously, given the ups and downs and all around here. You know, I think the most likely scenario is that the incentives here for the president and the Iranian regime to figure this out and open up the strait, you know, over time and get oil flowing, get oil prices down are pretty high and that they will figure that out. But obviously, I say that with no confidence. This can go in a boatload of directions. And if we just assume I'm right, oil prices come down and inflation continues to come in, it'll take time. It's not going to come in fast. It's going to be sticky.

6:45You know, I think that there's a lot of other things going on here. You know, artificial intelligence is juicing up inflation. The immigration policy is juicing up inflation. There's just a lot of slew of things going on that suggest that while inflation will come in, assuming the wrong word sticks roughly to script, it's not going to come in fast. is going to come in slow and sticky, and it might not be a couple, three years before we get back to anything we all feel comfortable with.

7:11Mark Zandi:Do you expect that three and a half will, it'll go up from three and a half over the next few months? It'll go down. I mean, what directionally, where do you think we're headed? I think we're directionally lower. Again, assuming that, you know, the Ron War doesn't go off the rails here and oil prices stay where they, roughly where they are, let's say, or 80, 85 bucks a barrel, then I do think we will see it come in. Because the other thing to consider on inflation that's really fundamental is the job market. You know, that goes to wages and cost of labor, and that is the single most important driving force of inflation.

7:49And right now the labor market is soft. You know, we saw that in the last jobs report. We're not creating a whole lot of jobs, and there's slack in the labor market that's continuing to increase. That's putting downward pressure on wages. Wage growth is below the rate of inflation and slowing across all different wage groups. And that should ultimately drive the rate of inflation lower. But again, that's a process. That takes time. That doesn't happen in a month or two or three. That happens in a year two or three.

8:18Mark Zandi:Just looking at the U.S. inflation rate compared to other nations, we currently have the highest inflation rate in the G7, which is quite interesting because it seemed as though we were kind of the most sheltered from what was happening to oil prices as a result of the Iran war. But now I guess that's not really the case. I mean, what do you make of the fact that we're actually in a worse spot now than many of our peers? Yeah, I think that goes to the fact that most other countries provide subsidies or regulate the price of energy. They don't let it pass through. The Europeans don't let it pass through.

9:02Some countries do, some Asian countries, but most don't. The U.S. is very different in that as soon as oil prices go up, our cost of gasoline, diesel, jet fuel goes immediately up. Now, there's problems with that, and that is we're all struggling with lower purchasing power. Our real incomes are declining and it's hurting the economy. But the benefit of that is we adjust a lot more quickly. We pull back on our driving. We fly less. We become more efficient in the use of trucks that deliver packages to our door. The rest of the world, there will ultimately be a pass-through, but it just takes a much longer period of time for that to occur.

9:43The other thing that might be going on to help explain, and this is a little more problematic, is lack of competition. You know, competition in different industries has eroded over time. Increasing number of industries are dominated by a few companies that can set prices more significantly or are able to hold their pricing for longer in the face of weakening demand or slower costs of doing business. And so that lack of competition, which is, I think, occurred over the years and become more pronounced now, may be also playing a role in the higher rates of inflation that we're seeing here. And the fact that maybe why inflation, the reason why inflation might be more sticky here, because businesses are under less pressure to cut prices because of the lack of competition or the lessening of competition.

10:36Mark Zandi:Kevin Walsh, new Fed chair, spoke to Congress. he said the CPI drop does not mean, quote, mission accomplished on inflation. He seems to be a lot more hawkish than people expected. I mean, what do you make of his statements? What do you think this means for interest rates going forward? Yeah, I've been surprised at how, as you say, hawkish he has been. You know, going back to the FOMC meeting, the policy making committee meeting, he used the words price stability several times, you know, and he convinced investors that he's serious about that. If you look at inflation expectations and what bond investors think inflation will be in the future, they came back down and back to where they were prior to the Iran war.

11:23And so they're convinced that he's going to work hard to keep inflation down. That's his primary focus. And I take a great deal of solace in that because I, you know, Six months ago, when we were having these conversations, I was much worried about the Fed's independence and that whoever the Fed chair was going to be could buckle under the weight of the pressure from the president who says he wants lower interest rates. But I feel less worried about that. We'll have to see. Obviously, we'll have to see how this plays out, and there's a lot to be learned. But so far, so good, and I think that feels very good.

11:55Now, it does mean the potential for higher rates. I mean, markets are now anticipating, last I looked, might come in today with these better inflation numbers, but last I looked, two rate increases, quarter point each time. And so the investors are expecting that that hawkish rhetoric will translate into higher interest rates. And, you know, one of the side effects of more hawkish Fed chair is you're going to have higher rates for longer. But I think ultimately, you know, the key thing here is Fed independence. And I feel much better about that in the wake of all the things that Kevin Warsh has done since he's been appointed.

12:32Mark Zandi:Do you have a view on the path for interest rates for the year ahead? I mean, this seems to be like the biggest question for investors. Will rates go up or down or will they stay flat? And people have been debating this since the beginning of the year. Everyone seemed to agree they were going to come down heading into the year. That's changed now. Do you have a view on that debate? Yeah, of course, Ed, I've got lots of views. Even on the World Cup, I've got a view. Or will the Phillies win the World Series? Yeah, I've got a view. It's a bit outside of consensus. I don't think the Fed's going to raise or lower rates.

13:13I think policy will remain unchanged because I do think, you know, they have two mandates. One is low and stable inflation, and that's what we've been focused on. That would call for higher rates. But the other mandate is full employment. And there the job market, in my humble opinion, is soft. It's weak. I mean, we're not creating any jobs. All the jobs we're creating is in the healthcare sector. It's very narrow. If you lose your job, you're in big trouble because you can't get hired back. Hiring rates are very low. The share of the unemployed that are unemployed for long periods of time is now rising and very high.

13:47Wage growth is very weak. And so I worry that there's slack in the labor market. You don't see it in the unemployment rate because labor force is collapsing. People are leaving the labor force. And, you know, if the labor force participation rate had just remained unchanged over the past year, the unemployment rate would be 5%. And we'd all be talking very differently if it was 5%. And so I think the job market is very soft. And I think ultimately that will convince the committee not to raise rates. But, you know, like many things, like which way is this war going to go? I say this with low levels of confidence because, you know, obviously there's a lot of uncertainty here.

14:23Mark Zandi:Right. It seems like the question is, as usual, which one is more of a problem? I think I tend to err on the side of the inflation problem is more of a problem because I'm personally very worried about what we're seeing in terms of the Iran situation. But I take your point. And you said this recently in your social media. You said that the commentary on the employment report for June was, quote, much too dismissive of how weak the numbers looked. And so I guess we find ourselves in the same position that the Fed always finds itself in, which is you got to choose. Well, although they're pushed into this really bad place, right?

15:05I mean, because of policy, I mean, because of the tariffs, because of immigration, because of the war, that leads to weaker growth and higher inflation. That's stagflation. This is a stagflation environment. And what do you do with that at the Fed? Do you focus on inflation or do you focus on growth? And it's a very tough spot to be in. And that's the situation they're in. My sense is they punt and they say, I can't figure out which one to focus on. I'm not changing rates, but I hear you. I mean, you know, at the end of the day, push comes to shove. They've got to focus on inflation. Now, I think the deciding factor ultimately on that will be inflation expectations.

15:43If inflation expectations stay down, then they may be able to get away without raising rates because inflation should come in. If inflation expectations start to rise, say, you know, right now inflation expectations are based on the expectation the Fed's going to actually raise rates. Now, let's say they say, okay, they're not raising rates. So inflation expectations start to rise. Therefore, they got to raise rates. I mean, so I know that's mind-numbing, but that's the way this all works.

16:08Mark Zandi:It does make your head spin. Yeah, it's like a hall of mirrors. Yeah. All right. Mark Zandi, Chief Economist at Moody's Analytics. Mark, appreciate your time. Thank you. Thank you. After the break, Wall Street banks make a killing again. And for even more markets insights, you can subscribe to my weekly newsletter, Simply Put, at simplyput.profgmedia.com.

16:52We'll see you next time.

17:04for three months,$90 for six months, or$180 for 12-month plan required. $15 per month equivalent. Taxes and fees extra. Initial plan term only greater than 50 gigabytes. May slow when network is busy. See terms. Is Kamala Harris running for president again?

17:15Mark Zandi:Listen, I might. I might. I'm thinking about it. But does anybody want that? Yeah. Yeah. Yeah. Well, I don't see why not. Absolutely. I think Kamala Harris should run for president again. I don't think there'll never be a woman president in the United States. Now, wait, wait, wait. You can't just walk away on that. Tell us why. I know it's still early to talk about 2028, but as we build to our post-Trump future, it seems to be a big question about the Democratic Party. Kamala Harris leads all of the presidential polling. So does this mean that the person who led the ticket in 2024 is going to lead the party again in 2028?

17:55The campaign needs to be called Bye-Bye, Biden. It's just a tainted brand. Do you think from a donor community largely that there's any appetite for a Harris return? I don't. I'm Estet Herndon, and this is America Actually. Catch us every Saturday on YouTube or wherever you get your podcasts. It all started with Call Me Maybe. Over 10 years ago, we created Switched On Pop to Listen Closer, uncovering the song craft behind even the glossiest of pop hits. Since then, we've released almost 500 episodes. We've defined the sounds of our modern soundtrack and interviewed hundreds of musicians and music insiders, including the singer of Call Me Maybe herself, Carly Rae Jepsen.

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19:25Mark Zandi:We're back with Prof G Markets. Five of America's biggest banks just reported earnings and they all delivered the same message. Wall Street is booming. JP Morgan beat on the top and bottom lines with CEO Jamie Dimon announcing record revenues across every major business. Goldman Sachs posted one of its strongest quarters in history with profits up nearly 80 % year over year. And Bank of America, Wells Fargo and Citigroup all topped expectations as well. Driving those results was a revival in dealmaking, including$500 million in fees from the largest IPO of all time, SpaceX. But investors didn't reward the banks equally.

20:06Mark Zandi:Goldman popped nearly 9 % on the news. JP Morgan and Bank of America both rose about 2%, while Wells Fargo and Citigroup fell 2 and 5 % respectively. So here to tell us what Wall Street's blowout quarter means for the markets and for the economy. We are speaking with Saul Martinez, head of U.S. financials research at HSBC. Saul, thanks for joining us on ProfG Markets. Blowout earnings across the board. According to Jamie Dimon, it's, quote, getting close to as good as it gets for JP Morgan and for basically everyone. Why is it such a good time to be a bank right now? Right now, you have almost a perfect storm of a good economic backdrop, a resilient economy, high real rates, which is positive for the net interest margins of banks.

21:02And you're seeing a resurgence of dealmaking activity. Asset prices are going higher. So you have a backdrop that is supportive of a wide, wide range of businesses, everything from traditional banking, which is benefiting from good loan growth, good net interest income growth, good net interest margins. But what was exceptional, I guess, was most exceptional, I think, about the results this quarter were the capital markets businesses. Dealmaking is back in spades. So this quarter, investment banking fees for the five companies you highlighted grew anywhere from 30 % to 55 % year-on-year, and it's a cross-product.

21:44IPO activity, which has been historically low, has rebounded. And at the same time, M &A activity has been strong. Debt issuance is historically elevated. And then on top of that, what may have surprised more than that is on the trading side. So banks intermediate trades. They finance institutional investors. And those businesses are also booming, especially equities, which was up for those banks anywhere from 45 to 90 percent year on year. And so it's almost the perfect storm where traditional banking capital markets businesses are doing well. And it's reflective of a good economic backdrop with higher rates than we've had in the past and a lot of dealmaking activity going on.

22:30Mark Zandi:So just to go through some of these things that are going right, you've got the loan growth, you've got the phenomenal equities trading, which, I mean, it basically sounds like clients, investors are trading stocks more than double than they were in some cases, or sorry, close to double what they were trading from a year ago. So that's booming. And I assume a lot of that is the volatility that's happening in the markets that often increases trading M &A, the dealmaking, and then, of course, the IPOs, the most significant of which was SpaceX, which all five of these banks were underwriters of. my question, how important was that SpaceX IPO to these earnings?

23:15Mark Zandi:And how important will these future IPOs, namely OpenAI and Anthropic be, to these earnings as well? Or are they less important? Well, I mean, if you look at them in isolation, they're not huge numbers relative to the total revenue numbers. So even, you know, we don't know the exact, you know, fees collected by each individual bank, but it helps the equity capital markets business. But that's a pretty small proportion of the overall revenue stream. Now, no, don't get me wrong. You've seen IPO activity more broadly, you know, rebound, and that is helping investment banking fees generally. And you do have additional IPOs, large IPOs that could be coming, which provide an additional tailwind possibly later this year and into early next year.

24:03So it's helpful. It's not the biggest driver. That said, there are, you know, there are other, there's a sort of a multiplier effect also from some of these transactions. You know, you mint a lot of billionaires, for example, with something like SpaceX, and that provides opportunities for your wealth management business. There are trading opportunities around that. There's going to be index rebalances around SpaceX, which forces investors to reposition their portfolio. So your market making activity increases. So looking at the IPO fees and the investment banking fees in isolation on these deals probably tells you only part of the story.