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Economist on pessimistic consumer sentiment: ‘I’ve never really seen anything like it’

Moody’s Analytics Chief Economist Mark Zandi joins Yahoo Finance Live to discuss the June CPI data, inflation, the housing market, and the Fed's interest rate hike cycles.

Video transcript

[MUSIC PLAYING]

SEANA SMITH: Inflation is soaring, surging to a new 40-year peak, with rising rents, higher gas, and food prices making everyday life even more expensive. For more on this, we want to bring in Moody's Analytics chief economist Mark Zandi. Mark, it's great to have you. That 9.1% print that we got this morning, I have to, I guess, think that this might have been a little bit hotter than what you were expecting. What's your takeaway from that report that we got?

MARK ZANDI: Ug. It was pretty ugly. For the typical American family, they're now having to shell out almost $500 more a month to buy the same goods and services that they were purchasing a year ago because of the higher inflation. And just for context, the typical American family makes about 60k a year. So if you do the arithmetic, you get a pretty clear sense of the financial pain and suffering that's resulting. So, yeah, a pretty ugly report.

RACHELLE AKUFFO: And obviously, a lot of that bringing up concerns about recession. You can usually consider those two consecutive quarters of falling GDP growth, but you said that this isn't-- it doesn't actually work for this current trend that we're in. Why is that?

MARK ZANDI: Well, the two quarters of negative GDP, that's a rule of thumb, which has roughly worked historically. But the arbiter of recessions, at least here in the United States, is, the business cycle dating committee, which is a group of academic economists of the National Bureau of Economic Research. And they look at a plethora of data. And GDP's on the list of things they look at, but it's probably down on the list. I think the thing that is most important is employment, jobs.

And we saw last week that the economy created 400,000 jobs in the month of June and close to a half million jobs on a monthly basis over the past year. Unemployment is low. Layoffs are incredibly low. They may be record low. That's not consistent with a recession. The thing I'd just quickly say-- and I won't go into any detail because probably, everybody's eyes will glaze over. But I think there's all kinds of measurement issues, data problems. And ultimately, if you ask me back five years from now, when we look at this data, I wouldn't be surprised if these declines got revised away.

DAVE BRIGGS: Our eyes are not glazed over, sir. Do you think we're headed into a recession? Can the consumer stave it off?

MARK ZANDI: Well, you know, obviously, recession risks are very high. At this-- with this kind of inflation and the Fed on the warpath and jacking up interest rates, recession risks are very, very uncomfortably high. Sentiment is very weak. I've never really seen anything like it. Consumers, business, investors all very pessimistic. It seems like everyone's forecasting for a recession, which is just unprecedented. You can see, by my hairline, I've seen a lot of recessions over the years. I've never seen anything like it.

So, you know, obviously, risks are high. I will say, though, with a little bit of luck on the pandemic, let's just hope it continues to fade away. And a little luck on the Russian invasion-- let's just hope that the economic fallout is-- the worst of the fallout is behind us. Then I think we should be able to navigate through. I think the Fed should be able to thread the needle and land-- I'm going to mix all kinds of metaphors here, but land that economic play on the tarmac without crashing it.

And I think the American consumer, as you point out, is key to all this. There's a firewall between a economy that's growing and one that's in recession. And the firewall, it's definitely on fire. I mean, the high inflation is cutting into purchasing power. But if you look at excess saving and debt service and net worth, the only things you might look at to gauge the health of the American consumer, they look pretty good.

SEANA SMITH: Mark, what about housing? Because we know that that's a very important sector when we talk about a recession, where exactly that falls. We've seen some cooling at least in the latest data when it comes to housing, but what are you expecting to see play out over the next couple of months there?

MARK ZANDI: Well, that's going to weaken. That is the-- housing is the most interest rate sensitive sector of the economy. So the Fed is raising interest rates to slow growth. And that's going to work first and foremost through a weaker housing market. And it's already pretty clear that's happening. The higher mortgage rates were now just south of 6% on the 30-year fixed. That's twice what it was just a year ago, when rates were at their record lows.

You take that higher mortgage rate, you multiply by these high house prices, and people can't afford these homes. The monthly payment for typical first-time homebuyers jumped by $500, $600 a month. That's just prohibitive. So first-time buyers are locked out. Trade-up buyers, they're locked in, right? Because they have a mortgage sitting at 3 and 1/2, 4, because they've refinanced down into those lower rates.

Now, if they sell that home, buy another, need another mortgage at 6, their mortgage payment is going to jump, so they're not going to do that. So home sales are already falling very rapidly. And the number of homes in inventory, they're starting to rise. So that means we will start to see some house price weakness. My sense is, if we don't go into recession, nationwide house prices will effectively go flat here for the next couple three years.

But that means big parts of the country are going to experience meaningful price declines, particularly it's going to be in those parts of the country that have seen the most significant increase in price because-- like Southeast, Florida, and Atlanta, Charlotte, and in the Mountain West, you know, Boise-- just learned how to pronounce Boise-- Boise, down to Phoenix. Those prices have jumped a lot. And again, you mix in those higher rates, affordability becomes a real problem. And that's where we're going to see the most significant weakness. If we go into recession, then nationwide, I expect to see some price declines.

RACHELLE AKUFFO: So then in terms of signals ahead, keeping an eye on what's been happening with the Treasury yield curve there, what is that signaling to you right now?

MARK ZANDI: Yeah, that makes me nervous. You know, I had been hanging on the yield curve, 10-year, two-years, as evidence that the economy can navigate through. Now, it's only been, I think, four or five trading days that that curve is inverted, meaning two-year Treasury yields have risen above 10. And today, obviously, it inverted meaningfully. I think the difference today is about 20 basis points, or 2/10 of a percentage point. That's consequential.

So if the yield curve stays inverted like that for another two, three, four weeks, then I may have to give up my optimism about the economy navigating through. It's going to-- the shape of the yield curve, at the very least, is strongly arguing that growth is going to slow very dramatically here. And if it stays as inverted as it is, it will start, in my view, signal a recession. So hopefully that doesn't continue in the trading days ahead.

DAVE BRIGGS: Mark, the president called the numbers, the CPI number, unacceptably high, but also out of date, based on the fact that gas prices have begun to come down for several straight weeks. Are you willing to proclaim that inflation has finally peaked? And apologies for the double. Are we headed for a 100-point basis point hike?

MARK ZANDI: Yeah, well, you know, I say it with great trepidation, but I think the president is right. You know, gasoline-- oil prices are way down from where they were last month. Gas, diesel, jet fuel prices are coming in. That's really critical. That's the first step in getting inflation down. And it feels like we just-- we are now taking that first step. And if you ask me back a month from now, and we have this conversation around the July CPI report, it's going to look a lot better than the June report.

So I think that's right. I mean, obviously, I'm hesitating because there's so many uncertainties, unknowns around what's going to happen with Russia and Ukraine and EU sanctions, and what are the Saudis going to do. And it's not even just oil. It's refining capacity, right? We have no refining capacity, so if a Cat 5 hurricane blows through the Gulf, hits the Gulf, hits the Texas coast and takes out a refinery for a few weeks, we've got a problem. So we're really on an edge here. But I think it's fair to say that we've seen the peak, and we're moving in the right direction.

On the 100 basis point hike, in my view, I think the Fed should do whatever the market says they should do. So, if the market says, hey, I think you're going to raise rates 100 basis points, I would take that opportunity to raise 100 bips because markets should then not react to that, right? I mean, it's already embedded in equity prices and credit spreads and the value of the dollar and the mortgage rate, so. And we all know that they have to get rates up as fast as possible.

But if the market is saying 75 basis points, 3/4 of a point, I'd go with that. I mean, that's good enough. You know, you're getting rates up fast enough. So it's really about what market expectations are at this point. And that, I think, will determine whether it's 100 basis points or 75.

SEANA SMITH: Mark, if we do get that 100 basis point hike at the end of the month, what does that mean then for the fall in September? Will we see the Fed quickly start to scale back?

MARK ZANDI: Yeah, I mean, I think with these rate hikes, we're going to see much slower growth. Job growth is going to slow meaningfully here. And other indicators are going to show the economy is really starting to throttle back. And hopefully, I'm right about inflation. And we'll see inflation moving in the right direction here. And the combination of those things-- two things will allow the Fed-- they'll continue to raise rates, but at a much slower pace.

And so instead of 75, 100 basis points, it'll be 25 basis points, maybe 50. And then they'll get the funds rate target up to-- they're now targeting something between 3 and 1/2% and 4%. And that sounds about right to me. I think that feels like where they're headed. It's just a question of when we get there. At the very latest, it will be this time next year. But I do think growth will slow, inflation will moderate. And that will allow the Fed to keep stepping on the brakes, but maybe not quite as hard as they're doing right now.

DAVE BRIGGS: All right, got to leave it there. Moody's Analytics chief economist, Mark Zandi. Good to see you, sir. Thanks.