In short
Prof G Markets - Episode Summary: Why the U.S. is on the Precipice of a Recession — ft. Mark Zandi
Podcast Overview Hosts: Scott Galloway and Ed Elson Guest: Mark Zandi, Chief Economist of Moody's Analytics Release Frequency: New episodes every weekday Podcast Goal: To break down news impacting capital markets and enhance financial literacy.
Episode Description In this episode, Ed Elson engages with Mark Zandi to discuss the current economic landscape of the United States. Zandi shares his insights on the risk of recession, the impact of tariffs on inflation, potential rate cuts, and concerns about the bond market.
Key Takeaways
Economic Outlook
- Recession Risk: Zandi states that while the U.S. economy is not in a recession yet, it is on the brink. He emphasizes that a minor shock could push the economy over the edge.
- GDP Growth: The GDP growth rate was only around 1% in the first half of the year, indicating a sluggish economy.
- Consumer Spending: There has been no significant increase in consumer spending, which is vital for economic health.
- Job Market: Job growth has stagnated, indicating a potential hiring freeze across the country.
Factors Contributing to Economic Struggles
- Tariffs: Increased tariffs are leading to higher prices and inflation, which negatively impact consumer purchasing power.
- Immigration Policy: Restrictive immigration policies have affected labor force growth, especially in sectors needing immigrant labor.
- Government Cuts: Cuts in government employment and spending may further hinder economic prospects.
Market Dynamics
- Stock Market vs. Economic Reality: Despite economic struggles, the stock market remains high, driven largely by a few technology companies like NVIDIA. However, Zandi argues that the market's current strength may not reflect the broader economy.
- Leading Indicators: Zandi's models suggest a 49% probability of recession within the next year, based on historical data indicating that past predictions above 50% correlated with actual recessions.
Potential Triggers for Economic Downturn
- Stock Market Correction: A significant drop in stock prices could lead high-income consumers to reduce spending, which would further strain the economy.
- Bond Market Concerns: Increased fear about the Federal Reserve's independence and its influence on bond markets could lead to rising interest rates and borrowing costs.
Federal Reserve Policy
- Rate Cuts: Zandi discusses the potential for the Federal Reserve to cut rates in September, emphasizing a shift in focus from inflation to unemployment in the Fed's decision-making.
- Independence of the Fed: The episode also addresses concerns about the Federal Reserve's independence amidst political pressures, particularly with the potential nomination of a new Fed chair.
Optimism in Economic Potential
- Despite near-term concerns, Zandi expresses long-term optimism about the American economy's resilience and capacity for recovery. He believes that through trial and error, the U.S. will ultimately make the right decisions.
Discussion Points
- Impact of Tariffs: Zandi quantifies the economic consequences of tariffs, stating they have significantly hindered GDP growth.
- Inflation Predictions: Zandi's model predicts that tariffs will keep inflation above the target for years.
- Political Influences in Economics: The conversation touches on how economic data and forecasts are increasingly politicized, complicating the role of economists.
Conclusion The episode provides a comprehensive look at the precarious state of the U.S. economy, the factors contributing to recession risks, and the broader implications of political pressures on economic policy. Zandi offers a mixture of caution and optimism, highlighting the complex interplay between market dynamics and economic fundamentals.
Further Engagement
- Subscribe to the Prof G Markets Newsletter for updates and insights.
- Follow Prof G Markets on Social Media for more discussions and analysis.
- Reach out with questions or comments to [markets@profgmedia.com](mailto:markets@profgmedia.com).
Production Credits
- Produced by: Claire Miller and Alison Weiss
- Engineered by: Benjamin Spencer
- Research Team: Miel Saverio, Isabella Kinsel, Dan Chalan
- Executive Producer: Catherine Dillon
For those interested in current economic trends and their potential impact on the markets, this episode provides valuable insights and expert analysis.
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Transcript
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1:58change in the wealth distribution. Cash is trash. Stocks look pretty attractive. Something's going to break. Forget about it. All right. Welcome to Profit New Markets. It is our final day of Scott Free August. We're going to be taking a break on Labor Day, but then we will be back to our regular scheduled programming. Until then, today we are speaking with our friend Mark Zandy, who is the chief economist of Moody's Analytics. We're going to discuss a lot on this episode, including your outlook for America, which you recently published, Mark. We're very happy to have you on the show. Thank you for joining us.
2:34100 ,000 hairs? 100 ,000. I may have 5 ,000 hairs on my head. I shaved all mine off. Yeah. Well, it's good to have you on the show. Thank you. I want to jump right into it because we read your U.S. outlook, which you published recently. There was a lot in there, a lot that I found very interesting and a lot that I found very concerning, to be honest. And I'm just going to start, I've collected a few quotes from your report. I'm going to start with the opening quote, which I think really sums it up. You said, quote, this is actually how you opened the report. This is what you said, quote, the economy is on the precipice of a recession.
3:16While our baseline most likely outlook does not feature a downturn, the economy is struggling, and it wouldn't take much to push the economy over. Really getting right to the point there. Give us the headline. I like that now that I hear it again. I like that first line. Well done, Mark. But not very good news. Let's hear your summary, and then we'll get into some of the more fine details, but your summary of that outlook. Yeah, I mean, the economy is struggling. Pick your statistic. GDP, that's the value of all the things we produce. That grew just over 1 % in the first half of the year. That's pretty punk.
3:57It's consumer spending. If you add up all the spending done by everybody after inflation, it's gone nowhere this year. In fact, it's down a little bit from where it was at the end of last year. Construction spending is falling, and that's despite the boom in construction-related data centers. Everything else is falling. Manufacturing activity would be consistent with recession in manufacturing. And most importantly, obviously, is jobs. The job market has really kind of hit a wall. Job growth in the last few months has come to a standstill. Well, hiring is really, it's almost like we have a hiring freeze across the country.
4:38Layoffs are low, and that's good. And that's the kind of the firewall between the struggling economy and a recession or when businesses aren't lying off. So no recession yet. But when the economy is struggling like this, when it's having a hard time growing, it's when it's vulnerable to anything that might go off script. And goodness knows, there's a lot of things that could go off script. And yet, if you look at the stock market, if you were to look at the NASDAQ or the S &P, we're at record highs. That's telling quite a different story now. Yeah, it's hard to square that circle. I mean, there's a couple of things to keep in mind.
5:15One is the stock market is being driven to a significant degree by the stocks of a few tech companies, Magnificent Seven, AI driven. They run on their own dynamic. They're independent of what's going on with regard to the business cycle. So you got to abstract from that. Of course, the big, beautiful bill has some pretty significant tax cuts for businesses, corporations. So just by definition, it's going to lift stock prices after tax. Earnings are now going to be higher. It's also important to realize that a lot of the companies, the big companies that are publicly traded, that certainly are in the S &P 500, which is the index that most people look at, they get a lot of their revenues from overseas.
5:59It has nothing to do with the U.S. Right. So it's a broader measure of things. But having said that, if you take out all those kind of caveats, I'd say the stock market is basically, here it is, punk, flat. It's not down. That would be consistent with recession. But it's gone nowhere fast. And that's consistent with the economy that we're experiencing, one that's kind of going sideways here. So not great, but not bad. Now, I will say, I mentioned layoffs as being a firewall between the punk economy and the recession. Another is the stock prices. If stock prices were to correct, if we did see, say, the S &P 500 down, let's say, 10 % and it stayed down for a month, two or three, that would be one of those things that would push us into recession because that's off script.
6:54and consumers, particularly high-end consumers, the well-to-do, are very focused on their stock portfolios. And if stocks go down and they feel less wealthy, many of them are older in retirement or close to retirement, they'll pull back on their spending. Consumer spending, instead of going flat here, will go down and that's recession. Yeah, it's striking that, and you point this out in the report that basically all of the gains that we're seeing this year, because the S &P is up, we can't dispute that. We're up 7%. Basically, all of the gains are because of AI. I mean, that is essentially what is juicing the entire market right now.
7:38And we're seeing that both in the increases that we've seen this year, but also just the concentration. I mean, we discussed this on our episode last week, but the fact that NVIDIA is at nearly 10 % of the entire S &P, that's a completely different story from all of those things that you have described. I mean, NVIDIA has only so many employees at the company. Meanwhile, you've got nearly 400 million people living in America. Those are two very different stories. Yet NVIDIA and the tech stocks and the AI stocks, they have this massively outsized impact on the way we perceive how the economy is doing and the extent to which we are dependent on the tech stocks and the AI stocks, I think that is the scary part of this, which is why I think your recession risk model is so important.
8:27I mean, last week, we saw this study out of MIT, which said that basically a lot of companies aren't seeing returns on their Gen AI investments. And suddenly we saw the markets, you know, not freak out, but certainly there was a wobble there, which emphasizes this point that you're also making, which is AI is the story here. But if we were to see something even worse, if we were to see a correction that really took that leg out of the stool when it comes to AI, then we're running into trouble. And I just want to read you your quote from the report here. You said, quote, our machine learning based leading recession indicator puts the probability of a downturn beginning in the next 12 months at 49%.
9:07Since 1960, the indicator has accurately predicted an ensuing recession whenever it has risen to more than 50 % and there have been no false positives when the indicator has breached the 50 % threshold and the recession has not ensued. So what you're basically describing is you have this model. Every time it's hit 50 % or higher, recession has happened. We're at 49%. I'm not making that up. That's the result. And I don't want to overstate confidence. Models are good. They're useful. There are all kinds of problems, issues with models. But it's pretty telling. And if we're not at 49%, we're pretty darn close.
9:56It feels like we're in a pretty precarious position. And I should say, you can go look at all the tried and true leading indicators of recession, and they're all saying the same thing. If you look at, say, the conference Board leading economic indicator, which has been around for decades. That's been falling consistently over the last couple, three years. And in the past six months, it's fallen very sharply consistent with the recession. The yield curve is inverted. Consumer confidence is weak. One kind of esoteric leading indicator that I find useful is that if you go look at the Bureau of Labor Statistics jobs report for businesses, the employment survey, the payroll survey.
10:37There's 400 roughly industries that BLS canvases when they construct the employment estimate. Every time the percent of those 400 industries that are reducing payrolls is more than 50%. So more than 50 % of industries are reducing payrolls. We go into recession and we're over 50 % or 53%. So it's almost like you pick any leading indicator you want. My machine learning recession indicator is a new indicator based on these new statistical techniques. But go take a look at all the kind of tried and true ones that we've been using over the years, over the decades. They're all saying roughly the same thing.
11:18They're saying this economy is really, I use the word precipice, on the precipice of recession. My lazy response to that, when I think about what is the cause of it, why are we in this position? My lazy, but I think probably accurate response is tariffs. I mean, if I were to think about what are the big shocks that we sort of sent into our economy in the past six, seven months, it's that we put up near 20 % tariffs on everyone around the world. Is that it? Is that what's causing this? When you look at what's causing these issues and these heightened recession risks, what do you think is the cause?
11:58I think what else the economy is pretty clear. It's policy, economic policy. You mentioned the tariffs and trade. That's kind of at the top of the list. The effective tariff right now is 10 % up from two at the start of the year. It feels like it's headed to 15 to 20. You said 20, but in that kind of direction, in that ballpark. That's where we're headed. And that's going to pass through. That's starting to pass through in the form of higher prices, higher inflation. And that's going to be very clear of what's happening over the next 6, 12 months. And as that happens, it's going to undermine, going back to the consumer, people's purchasing power and spending.
12:33And that's the fodder for a downturn. Of course, immigration policy, highly restrictive, is having an impact. It's really done a number on the labor force. If you go back a year ago, the foreign-born labor force was growing 4 % or 5 % year over year. Now it's falling. And this began last year when Biden had an executive order constraining or limiting asylum seekers coming into the country. And of course, President Trump has double tripled down on that. But with no labor force growth, labor force growing nowhere, that's putting real significant pressure on the economy as well. in sectors that really need immigrants, agriculture, construction, transportation, distribution, leisure, hospitality, retailing, health care, elder care, child care, all these things, all these industries really depend on those immigrants.
13:23And if you can't find those folks, we see disruptions in higher prices and weaker growth. And so that's also contributing. And obviously the doge cuts, the Department of Government Efficiency, those cuts have had an impact. That'll become even clearer in coming months as many of those government workers who lost their jobs got deferrals or severance packages. And as those things come to an end, they'll show up in the data as a job loss. And so it's the policy writ large that's the issue. But I agree with you. I think tariffs are at the top of the list. You outline this in the report. And I have this other quote I want to read you here in regards to tariffs.
14:02Quote, based on a counterfactual simulation of our global macroeconomic model, assuming that none of these economic policies had been implemented, US real GDP would have been 1.1 percentage points higher by the end of 2025. Our baseline forecast with the policies in place puts real GDP growth at a meager 1.1 % on a year-over-year basis. Without the policies, growth would have been 2.2%, which is consistent with its potential. So again, you put the policies in place, growth gets cut in half. Get rid of the policies, you're back up to more than 2 % GDP growth. Tell us what went into that. I assume tariffs are a big piece of it, perhaps the immigration policy as well.
14:46Perhaps the Doge cuts, though, I'm sort of hesitant about that because I feel like Doge didn't really do that much in the end in terms of the overall economy. But what's going into that model there? Number one is the tariffs. A good rule of thumb is that for every percentage point increase in the effective tariff rate, that reduces real GDP by seven, eight basis points in the subsequent year. So if we went from two, let's say we go to 15, let's just say 15, that's a 13 percentage point increase. You do the arithmetic, that's a percentage point off of growth, GDP growth. That's the bulk of what's going on in that simulation.
15:27The effects of immigration also way, but those become much more significant as we move towards the latter part of 26 going into 27 and 28. And I don't know that I pushed back too hard on your comments about Doge. That's just more about jobs. It has had an impact. If you look across the country and look at which regions of the country are struggling the most, at the top of the list of recessionary economies is the broad D.C. area. D.C., deep recession around Maryland, Virginia, very, very slow economic growth. And that's consistent with the idea that the doge is having an impact. And those job impacts, they're already evident in the data.
16:12It's one reason why job growth has slowed quite sharply so far this year. But that'll become much clearer as all those severance and deferrals wind down and start showing up in the data. And that'll be second half of this year going into next. Just in terms of inflation itself. So we're at, I think our last reading was 2.7%, which isn't, I mean, it's not great. The Fed target is 2%. But it's not horrible. And of course, we just had this Jackson Hole speech from Jerome Powell. It appears that he's probably going to cut rates at the next meeting in September. At least that's what traders are betting on.
16:56But you point out, and I think this is really important, and I'd like to hear again what went into this. You point out that if we had not implemented these policies, these very inflationary policies that are tariffs, you say that we would be at 2 % by Q2 2026. And the prediction in your model is that at that point, we're going to be at 3.4 % inflation. And that to me, I mean, we'll see. And as you say, you never know with these predictions, you never know with these models. But to me, that basically summarizes what I've been saying for the longest time, which is, of course, these tariffs are going to raise prices.
17:42And the reality is, it's going to take a while. They're not going to suddenly flip and go to 3 % overnight. It's going to take months and months and months. And your model is saying, projecting out to Q2 2026, 3.4%. So take us through those predictions as well. Yeah. I mean, there's been a lot of debate about how much of the tariffs will be passed through to consumers because some of it will be eaten by U.S. businesses in the form of lower profitability. They just won't pass it all the way through. They'll just lower their margin. And some of it will be borne by foreign producers. The poster child of that so far has been Japanese automakers.
18:23They have a 15 % tariff, but they haven't passed that through yet. My sense is that by this time next year, when inflation peaks, the bulk of the price increases will have been passed through. The two-thirds, three-quarters of the pack would be passed through to the consumers. It's just taking a little bit of time, in part because the tariffs, the stated tariffs, are all over the map. You know, they're up, they're down, they're all around. So if you're a foreign producer looking at that, you're concerned that if I raise prices now and the tariff goes away, then I'll be wrong-footed. I could lose market share and I don't want to do that.
18:59So I'll just eat a little bit of this for a while, see where their tariffs kind of land. Once they settle down and I know where they are, then I'll pass through the tariff increases. And I think that's kind of in the minds of most CEOs that are trading with the U.S. globally. You know, there's also, you know, this is harder to prove, but I suspect that companies, particularly bigger publicly traded companies, really don't want to get into the political spotlight around price increases. You know, that's a pretty uncomfortable place for a CEO to be. And so I think they're just taking their time.
19:35And, you know, eventually those price increases will happen. It just won't happen. It'll happen more on the radar screen, not publicly so that they don't get called out. The other thing I point I make, that forecast that you just articulated with regard to inflation and growth, that does assume we don't go into recession, right? I mean, that we are on the precipice, but we never actually go over. Because if we actually go over in recession, then we have weaker growth, but also weaker inflation. So there's a lot of different scenarios on how this can all play out. The scenario I just described in the piece that you're quoting from is one that's on my baseline most likely, that we kind of squeak through without an outright economic downturn.
20:20Jerome Powell even acknowledged that point at Jackson Hole. He said, yes, tariffs are raising prices. And, you know, to your point, it's happening slowly and kind of quietly. And a lot of companies and a lot of CEOs don't want to cause a stink about it because they know they're going to get the wrath from the king. But that is exactly what we've seen. We've seen Walmart raising their prices. We've seen Amazon raising their prices, not making an announcement about it. The only way we find out is when a team of researchers goes in and looks at the price and says, yes, we saw a little increase in these products here and these products here.
20:58All of these products that are largely affected by tariffs, i.e. we import them from abroad. Given all of that, and by the way, just to be plainly honest, I completely agree with you. There's no way prices aren't going to keep rising if the tariffs remain as they are. It's 100%, in my view, going to keep rising. Businesses are also strategic when they raise prices. Take the automate. They're going to wait till the changeover in the model year, because in the changeover in the model year, they always raise prices. But this year, they're going to wait there. They're going to raise prices. But they'll raise them more than they typically do, because that's when they'll try to account for the effects of the tariffs.
21:39So that's why, in my view, we haven't seen those price increases coming out of the automakers yet, but they will come. They're just going to come in a more strategic point in time. And also, you're not going to immediately raise your prices by 10 or 15 percent if there's a chance that the tariff's going to be revoked the next week. I mean, you need to wait until you know. It's the same thing that I've been saying about Jerome Powell. He needs to wait until he knows what the story is. No one knows what the story is yet. And yet, at that speech at Jackson Hole, he said that essentially rate cuts are on the table in September.
22:18And he pointed to the employment data. He looked at the labor market. but i just i wonder what your views are on on that speech and on the possibility of a rate cut if it is true as you say and as i would agree with you that prices are set to rise and it's probably going to come end of this year maybe very very beginning of next year in in quite a big way if we're on track for 3.4 % by Q2. And here we have this dovish position coming from Jerome Powell saying, we're probably going to cut rates. What are your thoughts on that? I think it's reasonable for the Fed to cut rates at the September meeting.
23:02Now we got one more jobs number coming out between now and then. So let's just see what that says. That'll have some impact on whether they actually cut rates or not. But I think the way I would frame it is the Fed's so-called reaction function has shifted. They put a weight on inflation above target. They put a weight on unemployment above full employment. Usually those weights are roughly the same, but now they're putting more of the weight on unemployment than inflation. And a couple of reasons. One is they kind of sort of view the inflation as more kind of one-off. They get this price increase related to tariffs, but doesn't cause persistent increases in inflation going forward.
23:41That's a pretty tricky thing to get right, but okay, that's okay. But here's the other thing that matters more. They desperately, they, the Fed, Chair Powell in particular, does not want to go into recession. Think about the political pressure that he will face if we go into recession. He's already, as he should be, very worried about Federal Reserve independence. What's going to happen if we actually do go into recession and the Federal Reserve is blamed? And what does that mean about Federal Reserve independence going forward? So they're kind of – they put it in a much higher weight, and again, I think appropriately so, on growth, on unemployment, where unemployment is relative to full employment than the inflation numbers, at least at this point in time.
24:25And in that context, it makes sense for them to start cutting rates at the September meeting. Go slow because, again, you have to be worried about inflation becoming entrenched and persistent. So maybe you cut a quarter point each quarter until you get back to something that's more consistent with policy neither supporting or restraining economic growth, so-called the neutral rate. But still, you cut rates. We'll be right back after the break. If you're enjoying the show so far, be sure to give Prof G Markets a follow wherever you get your podcasts.
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27:07We're back with Prof G Markets. Just sticking on the Fed here for a second. This week, we've had some pretty shocking news. The president firing the governor of the Federal Reserve, Lisa Cook. You know, the accusation of mortgage fraud. These are all allegations right now. Nothing's been actually brought to the court. We haven't even seen a formal charge yet. I'm not trying to make a prediction on whether or not she's guilty, But the point is, he's firing her for something that has not been proven, which is, you know, notable. Your reactions to the pressure that the Federal Reserve is receiving from the administration right now.
Read the full transcript
27:56And one thing that I've been thinking about, which I'd like to get your reactions to, is, you know, this is a very political issue. And I would imagine it's hard to model these kinds of things out as an economist. Your job is primarily to assess the data and the numbers. And here we have this very kind of, I don't know how to describe it other than political. It's sort of a soft issue. You can't really quantify what the threat to the independence of the Federal Reserve actually is. But if it truly is under threat, as many people are concerned, then how do we quantify that? I mean, what is the hit to the markets?
28:40What is the hit to the dollar? What can we expect, perhaps in the bond markets, perhaps in the stock market itself? I mean, how do we model all of this out and how do we quantify this? What are you thinking about as an economist? Federal Reserve independence is under a lot of pressure. President Trump has made no bones about it. He wants lower interest rates and he wants people at the Fed that have views that are consistent with that. That is an affront to the principle of independence of the Federal Reserve. And I do think that the Fed independence, like the independence of any central bank around the world, is a cornerstone of a well-functioning economy.
29:24If you have a Fed that's been, let's say, captured by the executive branch and is making policy based on political as opposed to economic decisions, historically, and we've got a lot of case studies here, even here in the US, Nixon, Arthur Burns would be the best example, that that always ends up with interest rates being too low, which ultimately leads to uncomfortably high inflation. That's the result. And it never ends well. It always ends with, at some point, much higher interest rates and a much weaker diminished economy. So we really don't want to go down that path. I think we've learned that lesson over the decades across lots of different experiences here and abroad.
30:07So I think this is a major concern, a very significant issue. Now, I have not changed my forecast for what the Fed will do as a result of this, at least not yet. And maybe that's why markets really haven't reacted yet. And I think the key here will be, who does the president nominate to be the next Fed chair? As you know, Fed Chair Jay Powell's term is up in May of 26. President Trump is going to put forward a nominee here sometime before the end of the year, and a lot rides on that choice. If the choice is, and I don't have any insight here, but I'm just going from press accounts. If it's Scott Besant, the Treasury Secretary, Kevin Hassett, the head of the National Economic Council, even Kevin Warsh, who was on the Fed under Bernanke many years ago during the crisis, You know, they would be viewed as solid individuals with an appreciation of the need for an independent federal reserve.
31:11And I think we can feel reasonably confident, trust but verify, kind of confident that they're going to maintain that independence sufficiently that my forecast won't change. Now, if it's somebody else, we'll have to see who that is and what that implies. But that probably is kind of the inflection point for when everyone kind of wakes up and says, hey, we've got a problem here. Forecasts are going to change. It means higher inflation. It means higher long-term interest rates, probably, because long-term bond investors don't like inflation. That's something that's kryptonite to a bond investor.
31:51They're going to ask for a higher interest rate. It's going to mean a weaker dollar. because foreign investors are going to have some real reasonable questions about the saving haven status of the U.S. and its management, how things are being managed. There are already some questions about that. But I think that's the key here. We'll see how this plays out. But at this point, I've not changed my forecast. When you look at the inflation of pretty much any third world country in the world. And I'm saying this because, you know, this idea of central bank independence and capture of the central bank, this isn't like a fairy tale that we're imagining.
32:32This is a thing that regularly happens in societies, hence why people are so worried about it. And when you look at the charts of inflation in basically any third world country where you've had rampant inflation, When you look at Turkey, for example. Yeah, that's a poster child. What you found is, you know, there is a larger-than-life president, bordering on dictator, who installs a loyalist into the Federal Reserve, captures the central bank, installs the loyalist in there. And then as soon as that happens, the inflation literally skyrockets. It goes up like this. and you know this is this has happened so many times and it's such a tried and true playbook we see it so often in politics that it feels as though i i always try to check myself and make sure that i'm not being alarmist and make sure that we're not you know getting too worked up over something that isn't really likely but it feels as though this is one of those things that is actually quite likely or actually quite probable, maybe likely is too strong.
33:47But the idea that Trump would put a loyalist in the Federal Reserve and they just do exactly what he wants in terms of interest rates, cut rates, cut rates, cut rates, and then we have rampant inflation, which is already being pushed by the tariffs. I mean, we're increasingly going away from a fairytale scenario to something that could actually happen in the very near future. And to your point, markets haven't reacted that much. As of this recording, my belief is basically you can't fire her. I mean, you have to have a cause. It's not going to go through. It's going to be litigated in court. But how probable is it that we could have that sort of third world inflationary outcome?
34:31How is that us being alarmist? Is that us being, you know, biased and just having some level of Trump derangement syndrome? Or is it like an actual possibility or how probable do you think this could be? I think low probability, that kind of scenario, I don't think this is a cliff event. I wouldn't articulate it as such. It's not like the Fed's captured, we know what that means exactly, and it affects policy, and immediately you get inflation. Okay. There's a long lag here. A lot of – it's more of a corrosive, I would think. It plays out over a period of years. And inflation expectations have been well anchored.
35:17So that can change quickly, but so far so good. So I think that's not a likely – it's a scenario, a likely – but I don't think it's a likely scenario. I think a more likely scenario is that, you know, you get into next year and the economic data would say, oh, okay, the funds rate should be, the federal funds rate, that's the rate the Fed controls, should be 3%. That's that equilibrium rate I was talking about earlier, that rate where policy is neither supporting or restraining growth. But the Fed chair and the Fed at the time decided to push the rate even lower, say, to 2 % to try to keep the economy strong going into next year's election.
35:55that's not going to generate runaway inflation right it's not going to be turkey but it will mean higher inflation going into 2027 and 2028 and you can see how it can become a it's a corrosive it becomes more of a problem as you as you move forward and it's you know maybe the case study for us would be president nixon and arthur burns who was chair of the fed back in the 70s Arthur Burns was, and this is all based on the Nixon tape. So we have firsthand knowledge of kind of how this all played out. The president Nixon wanted lower rates, Arthur Burns to blige leading into the 1972 election. And of course, go look at what happened in the seventies and eighties.
36:37You know, we saw very significant run up in inflation. Of course, other things were going on, oil price embargo, the Orion hostage crisis, higher oil prices, that kind of stuff. And the Fed really didn't understand the role of inflation expectations like they do today. So there's a lot of differences between now and then, but that's kind of more like what would happen. It would play out over a long-running period of time, years, not months, certainly not weeks. So what you've articulated as a scenario, certainly prudent to consider, but I think probably a low-probability scenario. I want to shift us to your what keeps me up at night chart, which I love.
37:20I love this chart. You basically— Yeah, don't you like it? I call it the risk matrix. I should trademark it. The risk matrix, right. It's great. You basically have on one side, on the y-axis, you've got likelihood of risk. On the x-axis, you've got economic severity of risk. And then it's just this dot plot of all these concerning things that could happen based on how likely they are to occur. um you i don't describe necessarily exactly the whole chart but if you could rank sort of your top three or four concerns for america right now based on their likelihood and also the severity uh of of each risk what would they be rank your top three well and i'm you said y and x that's interesting so people know what y and x are it's the horizontal and vertical axes right So that's great.
38:14They have a very sophisticated listenership. Very sophisticated audience, yeah. Yeah, very sophisticated. I mean, obviously, you want to look at the part of the matrix where high severity, if the thing goes off the rails, it's going to do a lot of damage to the economy and high probability. And that's kind of in the northeast part of the matrix, if you can kind of visualize that. And obviously, trade war is up there as a real threat. Who knows how that's going to play out? We think we know we're doing forecasts based on what we expect, but who the heck knows how that's going to play out and whether there's at some point going to be more retaliation from U.S.
38:51trading partners. Fed independence is up there. I call it Fed capture in the matrix, but that's what I mean by Fed – what I'm using as a term for Fed independence. I talk about institutional erosion more broadly in that there's a whole slew of things that go into that. You know, the recent decision by the government to take a stake in Intel would, in my view, could be in that bucket of institutional erosion that raises all kinds of questions about the efficacy of that. But the one thing I would call out is a meltdown in the bond market. So while the Fed's lowering rates, obviously, the Fed doesn't control long-term rates directly.
39:36And it could be the case that investors get spooked by the lack of Fed independence and the prospect for higher inflation. Then you throw into the mix there are large budget deficits, which are gigantic. Our deficit is 6 % of GDP. Our primary deficit, excluding interest payments, is 3 % of GDP. That's massive, particularly in the context of an economy that's at full employment. Debt to GDP is 100 % and rising very quickly. And given the big, beautiful bill, there's nothing that's going to stop that. Interest payments on the debt as a share of GDP or revenue is at or just about breaching the record high.
40:13We're spending more on our interest than we are in defense at this point. Also, who's owning treasury? The bonds is shifting. We're going from the Fed owning the bonds because they QE'd and bought all the bonds. They're now QTing and letting the bonds roll off. institutional investors and banks that are less price sensitive. They don't care as much about the rate that there's parking their money there for as a safe haven. They're exiting the market and in the void are hedge funds. Hedge funds are coming in. They're becoming very large players in the market. And these guys, they're very price sensitive.
40:48I mean, they're there when times are good. They are completely out of there en masse. They all run for the door at the same time when times are bad. So I can go on, but you've got this dark brew of stuff coming together that could suggest that at some point, and I don't know when, but it could be my sense is the risk is, and that's why it's where it is in the matrix. In the next 6, 12, 18 months, we see a sell-up in the barn, which means much higher long-term interest rates. I mean, 10-year treasury yields, not four and a quarter, it's five and a quarter, it's 6%, something like that. And think about what that means for mortgage rates, what it means for borrowing costs for businesses and consumers.
41:26That's a pretty bad situation. So that's not my baseline. This is a risk matrix. What could keep going wrong that's less than likely, but still a possibility that we should consider? That would be kind of at the top of the list of my concerns. Stay with us.
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43:13We're back with Prof G Markets. I found it very interesting that the bond market meltdown, I mean, it's high up there in terms of severity of risk, but it's also pretty high up there in terms of likelihood of risk compared to all of your other scenarios. I know you said you can't predict when, and of course, no one can. But do you have any thoughts on what might trigger that some sort of bond market meltdown? I mean, this is kind of the ultimate question that everyone's trying to wrap their head around. And, you know, we see what happens when this big, beautiful bill is passed and we already have these insane debt to GDP levels, this insane deficit to GDP level that we're going to explode even further.
44:02And yet people say they're worried. I hear people talking about it. I look around. Everyone says, yeah, we're really worried about this. But then you look at the markets, and the markets, you know, they're not unfazed by it, but they're certainly not scrambling right now. And I'm just wondering if you have any thoughts on what it might take to cause a bond market meltdown, and especially for investors to actually get legitimately concerned about our national deficit and our debt problems in America, such that they start actually selling. Yeah, I go back to Fed independence and who the president is going to nominate for the next Fed chair.
44:48It feels like a pretty good stress point when bond investors all over the world are going to be looking at that and saying, who's that person? And how should we think about that person in the context of an independent Federal Reserve? So if I had to pick a catalyst for that sell-off, that would be a pretty good inflection point. Right. You know, there's also, you know, I think it would be good at governance issues with regard to the budget itself. We get into the next fiscal year. There's another reconciliation package. You know, what does that look like exactly? Will that add to the deficits and debt?
45:26And if it does, to what degree? And could that be the catalyst? Or, you know, maybe we get to a place where government comes to a standstill. There's a government shutdown. The Democrats don't go along with whatever. And the Republicans can't get enough votes to keep the government open. Or there's a, you know, I don't think the Treasury debt limit is not going to be an issue for a few years because they extended that out until 27 or 28. but uh you know could be some kind of governance issues where global investors say hey you know i'm really not sure i'm gonna get paid on it in a timely way not that the u.s can't pay me the u.s is a you know can pay that's not the issue but will they pay me and will they and will they pay me on time that's the real issue but i think the catalyst probably has to come from global investors saying, no mas, I can't take this anymore.
46:18You're going to have to pay me. You, the US government, is going to have to pay me more to compensate for the risk that I'm not going to get paid on them. By the way, there's evidence that it's already affecting 10-year treasury yields. I mean, you could make, I don't want to stretch this too far, but you can look at other corners of the financial system and they're signaling saying, hey, there is a risk premium in the 10-year treasury. Go look at credit default swaps on US treasuries and where they're trading, or look at the the swap market prices in general. And they're saying, look, the investors are already nervous about the safe haven status of the United States.
46:54So I don't know that it would take a whole lot to trigger that bond market meltdown that we've been talking about. I want to slightly shift gears here and hear about how you work, because what I've found is that everything is getting politicized in a way that we haven't really seen before. And it's been true of, we've seen it with the Federal Reserve this week, where basically, if you want to maintain rates, then that is a political position. You are against the president. If you want to cut rates, then you are pro-MAGA, you're pro-Trump. I mean, I'm simplifying it a lot, but basically what we are seeing is that the governorship of the Federal Reserve is being split into factions.
47:43And that is certainly what Trump is trying to do. He wants to fire someone, get her out of there, and then install someone who's on his side. And we're seeing this in lots of different areas of the economy. I mean, we're seeing it even with the Bureau of Labor Statistics, where the data has become politicized. You put out a bad report, or you adjust the previous numbers, and that is a political action, or at least it is perceived to be a political action. And I find this in my own work too. I try to balance politics as much as possible on this podcast without being distracted by it. But what I find is that whenever we discuss the data, whenever we discuss economics, it oftentimes is perceived to be a political conversation and that it is biased in some way.
48:39And when I look at your report and the things that you highlight that are problems in the economy right now, one, I agree with them. But two, all I can think about is some guy on the Republican side of the aisle who would say, this guy's biased. He just wants Trump to lose. And I'm wondering how you think about that today. Do you find that your work is increasingly viewed as political? do you find that it is increasingly difficult to put work out there and to teach about economics and to talk about economics in a way that isn't politically swayed or politically influenced? And if so, how are you dealing with that?
49:22I do my best to be apolitical. I think it's important to acknowledge that we all have a political prism that we look at the world through, whether it's explicit or implicit. it. So I think I'm self-aware of that prism and the biases that I potentially have. But, and I apologize if I come across as being political, but it's very difficult, as you say, not to, because we're talking about economic policy as the kind of the driving force behind what's going on in the economy. So how can you not talk about policy? And once you talk about policy, it's difficult not to be perceived as political. And I apologize to everyone if I come across that way.
50:06I try not to. I try to be apolitical. And by the way, when we talk about trade and tariffs, that's the one issue where really we're debating that. I mean, economists debate everything, reasonably so, every issue, because they look at first order, second order, third order, fourth order effects, depending on whether you're an academic or a guy like me. and it's all reasonable. But on trade and tariffs, broad-based tariffs, there isn't a debate. I mean, that's like, if we're going to debate anything, that's a great one to debate because there's no question that that's a pretty bad idea. It's a pretty bad idea.
50:46We know this. We know this. This is tested over the years, over the decades, over the centuries. We know that this is corrosive on the economy. And so, if we're going to pick one issue that we're going to get, that we will focus on, I'm fortunate it's trade because there's no debate here. My views are entirely consistent with the broad consensus of views of economists on either side of the aisle. So, okay, if you think I'm political, then you think there's no way to talk about this in any sense whatsoever. Now, it hasn't changed the way I approach things or the way I forecast. And you've got to give Moody's credit for that, that I have independence.
51:28I can think about, write about, speak about what I want. Now, I have to be careful in the context of the current environment. There's no doubt about that. But I have not said anything that I do not believe. And my forecast has not changed as a result of any kind of pressure or anything else. So I find that very fortunate. I think that's critical to the work that I'm doing and that we do. Our clients are all over the world, major financial institutions, governments, if non-financial corps that use our information in lots of different ways. They rely on that, and they are dependent on our being as unbiased and as true to our thinking as we possibly can.
52:14Now, we are fortunately very quantitative. We're not qualitative. We're very quantitative. We've got very sophisticated, and I don't mean to oversell, but we've spent a lot of time and energy on the models that we were using to produce these forecasts. And so that provides a very significant discipline to what we're doing. At the end of the day, we have to make some assumptions. But the way I handle assumptions is I say, okay, here's my baseline assumption, and here are the risks. And that goes to the risk matrix. Let's go do different scenarios so we can think about, and it's prudent to think about, What if the world is different than the assumptions are different than the ones that I've articulated that are on my baseline?
52:53But because we are a quantitative shop, I also think that imposes a discipline on what we're doing that makes it less likely we'll be political and more likely we'll be apolitical. But this is all new. I've been a professional economist for 35 years. I've never been in this kind of situation. Never, never. Wasn't even close to what we're going through. It's a real, what I call stress tests on, you know, everything, including economic analysis and forecasting. It's a huge stress test on just numbers in a way. I mean, the idea that a number could be a political statement. Right. That's sort of a new world.
53:36And I felt that way certainly after the chief of the Bureau of Labor Statistics was fired. Because that, to me, sort of blasted us through the door of a new situation where, you know, if we can't agree that the data is real, if we can't agree that the fundamental economic data that has come from the U.S. government is true, or at least the truest thing we have, then what are we doing? You know, what am I doing with this podcast? What are you doing over at Moody's? Right. And I wonder what the implications of that are for the study of economics itself. I mean, how are economists supposed to move forward?
54:25How do you move forward? I mean, another question might be like, do you trust the data? Will you trust the data when it comes out in the next six months? Say he hires someone that is perhaps another loyalist. Will you believe that the data that's coming out of the Bureau of Labor Statistics? I mean, where does this leave you if America cannot agree on whether or not the data is even real? Right now, it's trust but verify. So working really hard to come up with approaches, techniques, methodologies, other data sources to test, to make sure that we are confident in the data, the quality, the comprehensiveness, timelessness of the data that we're receiving.
55:10So we're not going to simply, well, this has always been the case, but obviously we're now on hyperdrive trying to figure out how to do this in a kind of consistent, rigorous way. And we're thinking about and actually working on producing alternative data sources so that, for example, on consumer prices, CPI, here's what I worry about, really worry because of the BLS cuts, the funding and staffing cuts. They are unable to canvas as many products and services for calculating the CPI, the Consumer Price Index. I don't think I'm making this up. 35 % of the prices of goods and services in the CPI are now so-called imputed.
55:51That's up from 10 % at the start of the year. 35 % is a lot in my mind. And so there we're starting to think about how do we scrape websites, produce our own estimates of CPI. There's some researchers that have already gone down this path to follow at Harvard, the Billions Pieces Project. So we're piggybacking off of some of that work. So we're hopeful that we get alternative data sources just so that we can make sure that we feel confident in the information that we're getting and that we're providing. But having said all that, it's a pretty tough spot to be in because the government is critical.
56:24It's, there's, you know, the Congress called a public good. It's a public good. There's no better example of a public good. We need government to collect this data because we're getting, we need, because of privacy issues and security issues, we need the federal government to be fully engaged here. So we're not going to be able to fill the, completely fill the void, you know, but so hopefully the integrity of the data is maintained, you know, going forward as best as possible. But we're, you know, we're, we're not going to stand still. We're doing the best we can to, again, verify and also construct new data sources.
56:58And there are, by the way, there are a lot of data sources out there that kind of haven't really thought about as carefully, starting to think about them more carefully because they are valuable sources of information. Like we have relationships with companies tracking the credit performance of consumer credit cards or mortgage loans, that kind of thing. Another partnership with a company to try to calculate house prices and commercial real estate values. There's a payroll processing company that does a really good ADP, which does a really good job of figuring out what's going on in the private sector in terms of jobs by industry and by region.
57:34So there are, and I can go on and on, there are a lot of data sources out there. We just now have to think about this more with greater urgency and in a more systematic way. Just to wrap up here, we've had a lot of kind of grim predictions and we opened this show with your point that we are on the precipice of a recession, or at least that is what the model is telling you. Is there anything that you are feeling optimistic about in the economy? Is there anything you're bullish on? Is there anything that we could end this show on more of a positive note? I mean, you know, the American economy is a marvel.
58:15I mean, it's just, you know, if you just let it have at it, you have a problem, you may allow people to make money, they figure out the problem. If we just get out of the way, government just gets out of the way, you know, regulate, but, you know, just let the let the economy go. It will be just fine. And I keep going back to, I think Churchill said this, or maybe I've got this wrong, but something to the effect, you know, Americans try everything and then ultimately do the right thing. And I just, I fundamentally believe that we are going to, we're trying everything, but we will ultimately find the right way.
58:52And, you know, we'll land in a pretty good spot. So I'm near-term nervous about what's going on, obviously, but I'm long-term bullish. I think the American economy is just a marvelous thing, and it's going to be pretty hard to upset it in a systematic and long-term way. Mark Zandi is the chief economist of Moody's, a leading provider of economic research, data, and analytical tools. He also hosts the Inside Economics podcast, and he serves on the board of directors of MGIC, the nation's largest private mortgage insurance company. Mark, this was great. It was great to have you on the show again.
59:27We really appreciate your time. Thanks. I appreciate the great questions. I'll have a lot to think about there. Awesome. Take care now. Thanks, Mark. This episode was produced by Claire Miller and Alison Weiss and engineered by Benjamin Spencer. Miel Saverio is our research lead. Our research associates are Isabella Kinsel and Dan Chalan. Drew Burrows is our technical director. Catherine Dillon is our executive producer. Thank you for listening to Profity Markets from the Vox Media Podcast Network. If you liked what you heard, give us a follow. Enjoy your Labor Day. And we will be back with a fresh take on markets, not on Monday, but on Tuesday.
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From the publisher
Ed Elson is joined by Mark Zandi, Chief Economist of Moody's Analytics, who returns to the show to discuss his U.S. outlook and how he thinks the economy is actually doing. He shares his insights on what is causing heightened recession risk, how tariffs will impact inflation, and a potential September rate cut. Plus, he gives his main concerns for America right now and shares what he thinks might trigger a bond market meltdown.
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