'COVID still is in the driver’s seat here,': Deutsche Bank Chief US Economist

Matthew Luzzetti, Deutsche Bank Chief US Economist, joined Yahoo Finance Live to discuss the market's decline and what it means for the U.S. market.

Video transcript

- A little more than 15 minutes to the closing bell. And we got some data today from the Federal Reserve, their 2020 Survey of Household Economics and Decision Making, which essentially-- a lot of us know that lots of people in the country suffered economically because of the pandemic. But what this survey also found out is that people would have been worse off without the trillions of dollars we've been spending in taxpayer-supported stimulus to help people get through that.

Let's discuss this with Matthew Luzzetti-- he's Deutsche Bank's chief US economist-- because we're watching a tightening labor market, but we're not there yet. Do we know why?

MATTHEW LUZZETTI: Sure. Thanks so much for having me. It's something that we've been looking into a lot after the April jobs report, which was, in some sense, kind of shockingly weak. We only added about 200,000 jobs, after almost adding a million in the prior month.

And there's a key question about what is driving this. Are there some constraints on labor supply that are there?

I think what our analysis has shown is COVID still is in the driver's seat here. Those states with either greater restrictions or where individuals are concerned about going out to work or going out and doing economic activity, continue to under-perform, from a labor-market perspective. So, that remains the most important factor. We didn't find much evidence that unemployment insurance benefits and the federal boost to those is an important factor.

But finally, and I think specifically to your question about stimulus checks and wealth gains, it is interesting that you are seeing older-age groups, their labor-force participation continues to decline as retirements pick up. This is very different than post-global financial crisis, with households in that age group now looking like they're in better financial shape, perhaps being able to retire now versus after the global financial crisis, where we actually saw labor-force participation rising for those age groups, given their wealth losses.

- If jobs continue to go unfilled at this rate, what's the cost to the economy? I mean, how big of a worry is this?

MATTHEW LUZZETTI: Sure. I think there was no concern at all before the latest jobs report. Everybody was expecting very strong growth, very strong labor-market gains. I think what we are seeing is various supply constraints.

In that April jobs report, we saw goods-employment decline. That I don't think was a labor-force story, or labor supply-constraint story. That was a supply-chain story. So, autos, manufacturing industrial production has declined due to chip shortages and other shortages.

On the other side, I think the leisure and hospitality sector, it's been really fascinating what's been going on there. You still have 2.8 million jobs below pre-COVID levels, 10% unemployment, but we're seeing very rapid wage gains. In the latest month, the highest month-the-month that we've seen on record for some of these workers.

And I think that really is just telling you how much demand there is out there. Job openings in leisure and hospitality hit record-high levels. Job openings for the entire economy hit record-high levels. And so, these are, I think, the constraints that we are hitting as we reopen in an economy, a $20 trillion-plus economy, that is trying to reopen over a couple of months. There is going to be some hurdles in that taking place, and we're seeing them in the monthly data.

- Matthew, it's one thing when we hear wage inflation, which I think the Fed has actually wanted for a decade, and hadn't been able to get until now. But when an investor hears inflation, they may have some caution. So which is it? Is the expectation for inflation, at this point, the kind of inflation we experienced when I was a kid, that seemed to start to get out of control?

MATTHEW LUZZETTI: You know, I think we're having this very big and real macro debate about this question at this moment. People like Larry Summers talking about 30% or so probability of getting to these higher inflation outcomes that we've seen in the past. Our baseline expectation is, you will see very strong inflation rates over these next several months. There's uncertainty about how long it will last. But we anticipate by the end of the year, as the supply-demand imbalances get worked out, inflation will come off and actually be lower next year.

But there's very real risks to this. We are seeing, obviously, a lot of fiscal stimulus. We're seeing a Federal Reserve that is no longer preemptive but is reacting to inflation data. And it's unprecedented re-opening the economy. We've seen used car prices, lodging rates at hotels, airfares all jumping record amounts just in the latest data.

So, I think it's-- we have to be very humble in interpreting this data, in terms of how confident we can be going forward. I would highlight one data point that I think is really important, and it's inflation expectations. And those latest data points from consumers last week, professional forecasters in the market, have been moving higher.

The Fed is focused on them as a way to think about, will this be a transitory story that becomes persistent. And, at least on our measures, those have, to use the Fed's words, re-anchored around the levels that we saw pre-2014, which I think is an important development.

- Matt, you mentioned the fact that the expectations for consumers has been trending higher. Has it started to-- or when do you expect it to-- start to weigh on consumers' purchasing decisions?

MATTHEW LUZZETTI: Sure. So, in the latest University of Michigan survey, there was a lot of commentary around this-- inflation expectations rising, possibly pulling forward households' demand for, whether it's durable items or other goods.

I think, ultimately, the fact that this is a very unusual recovery means that the services side of the economy and consumer spending will be in the driver's seat. Reopening is in the driver's seat. And we anticipate that there is some pent-up demand for those services going forward.

I think that will lift consumer spending and growth over these next two quarters. We expect growth to peak in Q2, still be very strong in Q3. And we don't expect that those price expectations really start to weigh just yet.

But we are seeing high gasoline prices that will divert some spending away from, whether it's services or these other items, to energy. So that, on the margin, is a drag from these other items.

- Hey, Matthew. Very quickly, we've laid out the reasons for inflation through the supply-chain bottleneck and wage inflation. What about people who say we just have too much money from the Fed and from the federal government, and that's causing inflation? Which is it?

MATTHEW LUZZETTI: Look, I think these may be two of the same coin. Certainly there are supply-demand imbalances. We've had very strong consumer-spending growth, certainly boosted by stimulus checks. The scale of the fiscal stimulus, the $1.9 trillion recently, was very strong, robust, and we're anticipating more going forward.

At the same time, you have these supply constraints that are out there. From a money-supply perspective, if you look back over the past 30 or 40 years, the link between money-supply growth and inflation really has not been there. So you have to go back to the pre-1980s to look at an environment where money-supply growth was a trigger for higher inflation.

So, that's why we are not building it in as a base case at this point. But if you look back at the 1960s, very strong fiscal spending, a Fed that was very easy, very rapid money-supply growth, that was an environment that did eventually lead to higher inflation. So, it bears watching

- Matthew Luzzetti, Deutsche Bank's chief US economist. Thank you for joining us. We'll be right back.