We’re not living in a world of stagflation, economist says

Matthew Luzzetti, Deutsche Bank Chief U.S. Economist, joins Yahoo Finance Live to discuss how markets are moving after September's CPI data came out and weigh in on why investors shouldn't be concerned about stagflation just yet.

Video transcript

BRIAN SOZZI: Today's CPI report came in a little bit better than-- a little worse than expected here, a little hot. Let's dive in here. Matthew Luzzetti is Deutsche Bank's Chief US Economist and joins us now. Matt, top takeaway here?

MATTHEW LUZZETTI: Sure. Thanks for having me. I think the top takeaway is, you know, inflation is still running hot. It's well above the Fed's target. I think within the details the most important point was rental inflation was the highest that we've seen since 2001, so in about two decades. And so while the print itself was not all that much stronger than expectations, I think from a forward-looking perspective it is actually telling you that inflation is going to be higher than people anticipated heading into 2022.

JULIE HYMAN: And Matt, it's Julie here. You talked about one component. I was also looking at the hourly wages, which actually ticked down. Although if you look at total compensation, including things like how many hours worked, you saw an uptick there. So how are you looking at that particular input as we head into the final months of the year?

MATTHEW LUZZETTI: Sure. It's been a difficult tug of war, I think, here between nominal wages going higher, and we saw that on Friday with average hourly earnings printing above expectations, but inflation, for the most part, eating away at that and stripping away a lot of those nominal wage gains that we've seen. So if you focus on wage gains minus inflation, they've been negative for a period of time here, given that we've seen inflation picking up, particularly on a headline basis, and energy prices driving a lot of that.

I think from the Fed's perspective, that is one reason why they've said that they don't think that this is going to be as persistent, because they would want to see wages running above productivity growth and real wages running above productivity growth. And we haven't seen that as of yet. But I think today's data, at least on the rental front, does tell you that the rise in inflation is probably going to be a bit more persistent than what the Fed had anticipated previously.

BRIAN SOZZI: Matt, maybe you could poke a hole in this. There's this thinking, at least from the folks that I talk to, so when the Fed starts tapering, that will bring inflation down. But it doesn't work that way.

MATTHEW LUZZETTI: No. So I think even from the Fed's perspective, it wouldn't work that way. What tapering is, is it's reducing their pace of asset purchases. So they will still be adding to their portfolio, we think likely through the middle of next year. They'll still be actually providing accommodation to the economy. And so we don't think that they're actually going to be removing accommodation by raising interest rates until late next year.

Our forecast, which we just changed recently, is that the Fed will raise rates in December of next year and then three times in 2023. And I think the data that we've received over the past several days really just supports that, the inflation data this morning. Yesterday, we got information from the New York Fed.

Their consumer survey for inflation expectations continue to move higher. And so I think what you've seen from a market response to this data is really bringing forward expectations for the Fed raising rates with, at one point this morning, the market pricing in September of next year for the first rate increase.

JULIE HYMAN: Hey, Matt. Here's the thing though. Even if the Fed was going to raise rates tomorrow rather than just tapering-- or at its next meeting, would that do anything to inflation? I mean, if the source of inflation in this case is mostly hot demand and supply bottlenecks, the Fed raising rates is not going to help the port delays, right, or manufacturing delays. Or maybe I'm wrong here. I mean, maybe it would have an effect.

MATTHEW LUZZETTI: No, I think you're absolutely right. I mean, from a typical monetary policy perspective, you don't usually respond to something that is explicitly a supply shock, because, as you mentioned, the Fed can't help with port delays. They can't help with chip production. Essentially they're raising interest rates to try to tamp down on demand.

What I think you have at this moment is fiscal policy has been obviously very accommodative over the past year. It led to a surge in demand. That surge in demand has meant supply constraints. And so [AUDIO OUT] is to try to disentangle these two effects, supply versus demand.

On certain areas and categories, you know, new vehicles, used cars, that's been a very clear area where I think supply constraints have been binding. On other areas such as airfares, lodging away at hotels, we've seen a lot of price pressures there as well. That, I think, has been more demand-driven. And so depending on what you're looking at, it's a relative support for supply versus demand.

I think from the Fed's perspective, they're worried about two things. One, demand is hot in a number of areas. And two, inflation expectations are moving higher. And so the Fed, by responding to an economy that does look hot, can help to bring back down inflation expectations, and hopefully lead to lower inflation over the medium term.

BRIAN SOZZI: Matt, how many rate hikes are in your expectations for next year? And then off of that, do you think the economy-- I mean, how do you think that will impact the economy?

MATTHEW LUZZETTI: Yeah, we have one rate increase next year in December, three the following year in 2023, and then three more in 2024, so getting up to almost 2% on the Fed funds rate at that time. We do think that it will slow the economy. But I think it's important to keep in mind two things.

One, we have estimates of what neutral monetary policy is. And that's kind of the threshold that really begins to impact demand. And in our mind, it's not really until you get closer to 2% on the Fed funds rate. The other thing to keep in mind is that this economy, I think in many ways, is less sensitive to interest rate increases at the moment. It's mostly being driven by the services sector.

And it will be mostly driven by these supply constraints easing and production and inventory rebuilds coming back. So I think it is not as much a story about housing, consumer durables, those things that are typically very sensitive to interest rates. So I think you have an economy that will be just less sensitive to interest rates. So we will see the economy slowing as the Fed tightens policy but perhaps not as much as you would have expected given history.

JULIE HYMAN: Matt, finally, I feel like recently I've been contractually obligated to ask all of our economist guests this-- stagflation. You know, and I don't think we found anyone who thinks it's happening yet. But what's your view on that word that's been bandied about a lot more lately?

MATTHEW LUZZETTI: Sure. I think it's certainly out there a lot. And I think what it's referring to in the moment is growth forecasts coming down, supply constraints clearly hitting production and growth expectations, but at the same time, those supply constraints are lifting inflation. And so it's a clear negative supply shock, as we typically think of it. I would not think of it as stagflation at the moment.

You know, our forecast for growth next year is still above 3%, which from a pre-COVID perspective is actually really good. You know, trend growth or potential growth in the US economy is around 2%. So we still expect growth to be enough to see the labor market tighten over next year. So I think it's being spoken of in a word where growth is coming down and forecasts are being downwardly revised and inflation is being revised upward. But I don't think we're in a stagflation world from the perspective of growth actually being negative and the labor market reversing course and actually deteriorating.

BRIAN SOZZI: Real helpful insight. Matthew Luzzetti, Deutsche Bank Chief US Economist, thanks for coming on. We'll talk to you soon.