The Federal Reserve has hiked rates in rapid fashion, yet the evidence of their impact is scarce. Inflation is still hot (though it has come down quite a bit.) The unemployment rate remains very low. And economic growth appears to be robust. So does this mean that higher rates aren't significant? Or could it be that their impact has simply yet to be felt, and that it's still coming. On this episode, our guest argues the latter case that due to lags, we really haven't felt the pain from rate hikes yet. Julia Coronado, is the founder, CEO and president of Macro Policy Perspectives, as well as a Clinical Associate Professor of Finance at the University of Texas McCombs School of Business. She argues that we really haven't felt the credit effects yet from higher rates, but that they're on the way. In particular, we discuss the delayed impact on commercial real estate and other areas of the economy where debt may have been termed out, but will eventually need refinancing. This transcript has been lightly edited for clarity
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Key insights from the pod
:
What is the state of Austin, TX commercial real estate? — 5:44
What would a CRE crash mean for the broader economy? — 9:59
How long are the monetary policy lags? — 12:36
Why has inflation fallen so much over the last year? — 14:56
Why aren’t lags instantaneous? — 23:46
What is the state of household balance sheets? — 27:17
Can we achieve a soft landing? — 31:13
What are the macro implications of large deficits? — 36:36
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Joe Weisenthal: (00:09)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:15)
And I'm Tracy Alloway.
Joe: (00:16)
We've been on the road a lot lately.
Tracy: (00:18)
I know, it's been nonstop trips. Let's see. We did Jackson Hole and then we went to California at Huntington Beach, and now we're in Austin, Texas. Your hometown.
Joe: (00:28)
Have you enjoyed Austin so far?
Tracy: (00:30)
Oh, I love it. Okay. I mean, I'm not gonna lie, large parts of it do remind me of Dallas — controversial opinion. But it has its own thing. Going to like amazing bars, restaurants, shops. We went cowboy boot shopping at Allen Boots. We've had some amazing Tex-Mex, really excellent barbecue at Terry Black's. It's been good.
Joe: (00:53)
We were in Jackson Hole. We did a lot of episodes in Jackson Hole, but a lot of them were sort of like these sort of like longer running like academic questions. We didn't really do too much there on like, what's happening right now in the economy with monetary policy, the impact of the Fed rate hikes, things like that, even though that's sort of on a lot of people's minds.
Tracy: (01:16)
Yeah. Funnily enough, at a macroeconomic conference, the real economy wasn't the first topic of conversation, although that's a little bit unfair because they did talk about supply chains and things like that. But you're right, we haven't done a ‘current state of the economy’ episode for a while, although we've touched on it in various ways.
One of the more recent ones was when we spoke to Wayne Dahl from Oaktree about the credit market, and a big topic of conversation in there was, why haven't we seen more of an impact from this historic pace of rate hikes on the real economy?
Joe: (01:50)
Yeah. It feels like this is still this looming question and until we have a sort of better idea of what's going on here, I think there's like a sense of unease.
And even at Jackson Hole, at Powell's speech, even with the improvement in inflation from last year, there is this still underlying sense of unease, which is partly driven by the fact that we've seen improvement, but we can't quite explain why because drawing that line between the rate hikes to the improvement in inflation is hard to draw. You would expect that, okay, if unemployment had been rising significantly, it's like, okay, well we could tell the traditional monetary policy story.
Tracy: (02:31)
We can’t say the Philips Curve is alive and well...
Joe: (02:34)
We can't quite tell that story. And then maybe it has something to do with the terming out of the debt that we talked about with Wayne Dahl. And then if that's the case, well what does that mean then? Like, are we still going to feel the impact? So it's like there's improvement, but it's like, there's this sense of unease underneath.
Tracy: (02:49)
Absolutely. But the most simple explanation for what's been going on is yes, we had a massive terming out of debt on the corporate side and arguably on some individuals as well — homeowners, for instance. And that's provided a cushion between 2021/2022 and where we are now. But it can only last for so long and you're sort of getting back to the traditional long and variable lags argument. Like, maybe this is just the longest lag that we've seen in many, many years.
Joe: (03:23)
So we did actually have this conversation at Jackson Hole. We just didn't get it on the record.
Tracy: (03:28)
Oh, yeah, you're right.
Joe: (03:29)
We did actually talk about all this at Jackson Hole. We just never recorded an episode, but the person who we spoke to in Jackson Hole in Wyoming last month happens to be based here in Austin, Texas. So we are like, in a way, we're going to pick up the Jackson Hole series with someone who happens to be here in Texas.
Tracy: (03:48)
I like how we've gone to Austin to record an episode with someone we talked to in Wyoming.
Joe: (03:54)
So I'm very excited we're going to explore these topics and more further, I'm very excited about our guest. A second time appearance on Odd Lots. We're going to be speaking with Julia Coronado. She is the founder, CEO and President of Macro Policy Perspectives. She's also a clinical assistant professor at the University of Texas on Business and Economics. So Julia, thank you so much for joining us.
Julia: (04:18)
It is my absolute pleasure to be here with you.
Joe: (04:21)
Really simple question to actually to start.
Tracy: (04:23)
Oh wait, can I just say, Julia is the first Odd Lots guest who has ever brought us breakfast tacos.
Joe: (04:28)
Which now if you're listening and you wanna come on the Odd Lots, this is now the expectation.
Tracy: (04:33)
Please bring us food.
Joe: (04:34)
Bring breakfast tacos. But Julia, so great to chat with you. Actually, just real quick, what do you do at Macro Policy Perspectives?
Julia Coronado: (04:42)
So, Macro Policy Perspectives is a macro forecasting firm. So we work mostly with money managers, people that are managing portfolios, and we provide them a perspective on the US economy. We're US-focused, but globally-oriented and very markets-oriented. So we work with money managers to help them understand this crazy world.
Joe: (05:05)
Speaking of crazy world, and we'll get to all the debt stuff, Tracy and I, the other night, we actually spoke to a group of students here at the business school at McCombs, and we were chatting about various things. And one of the students said something interesting.
They were talking about CMBS. And they’re like ‘oh it’s hard to know what's in some of them’. They're very smart kids. They said it’s hard to know what are some in some of these assets that people are buying and what if you're buying, stuff that's like Austin, downtown Austin real estate and there's huge vacancies.
Is that true? It seems like this town is booming. Is it actually, underneath the facade here in Austin, is there some problem brewing?
Julia: (05:44)
It depends. There's a debate. The commercial real estate crowd is inherently optimistic, glass half full type type of people. I think you have to be to take that kind of risk. And they've been printing money for a decade, right? Austin has been booming. All of their developments exceed expectations. And so it's been a great run.
But yes, there is an overhang. So you see the cranes all around you, but a lot of these buildings are empty. So we have very high vacancy rates. Very high rates of subleasing, which is another indication that, you know, Google or Meta builds a building, but then they don't need it. And so they sublease a lot of the space.
And depending on how you look at it the estimates of the pipeline under construction as a percent of the existing inventory is by far the highest in the nation and at record highs by many measures.
So we've got a lot of supply both in offices and in multifamily that are coming to market in the next 12 to 18 months. And rates are high, vacancies are high. Probably the assumptions that went into these projects at the beginning are not going to materialize. So the question is, does that mean just reduced profits or does that mean outright defaults, delinquencies and some distress?
Tracy: (07:04)
Right. This was going to be my next question, which is, how does distress in commercial real estate actually feed through into the wider economy? Because you see different types of arguments. You know, you see a more optimistic scenario, which is, well, yes, there are pockets of stress, but not everything is dire at the moment. Yes, downtown offices are probably the most affected, but, you know, maybe a multi-use building in the suburbs with doctor's offices and little shops — probably not as huge a deal.
And then the dire scenario that you see every once in a while is that we are going to get a bunch of defaults eventually, and that will impact the banks, presumably, and they're going to have to cut back on lending. So how are you viewing the actual impact of CRE destruction?
Julia: (07:52)
That is extraordinarily difficult to get a clear idea or put good parameters around, because CRE is inherently idiosyncratic. Every project is different. The financing of each of these projects come in layers and are, you know, sourced differently. So it's really hard to get kind of a macro framing of how much potential distress, you know, I would categorize the banking channel as one that could go non-linear in the sense that, you know, it could, we could see more bank failures, or it could be just a macroeconomic channel of a headwind, right?
Right now the unemployment rate in Texas is underperforming. It's risen more than the national average. That's unusual for Texas. Some of that is the tech layoffs, which are part of what's behind some of the vacancies. So as these projects roll off, you're going to see less jobs. You know, people in the real estate industry and the construction industry are seeing layoffs here. Maybe not everywhere, but certainly here. So you'll just see some regular old garden variety economic headwinds, even if it's not, you know, some sort of crisis. It's yet to be felt and therein are the lags and monetary policy.
Joe: (09:10)
I want to get into obviously this whole debate, but before we do, you know, you mentioned the developers of various sorts in Austin have been printing money, and you mentioned all the cranes. We don't really see many cranes in New York, because I guess as a city, we forgot how to build for various reasons.
Tracy: (09:27)
Also even if they were there, they’re up pretty high. They're really high. You kind of gotta look for them.
Joe: (09:31)
Right. Because the one thing they do build out those like super tall buildings...
Julia: (09:36)
Tall, skinny cigarette buildings.
Joe: (09:38)
Tall, skinny, yeah. But Austin is not alone. I mean, is this a broader Sunbelt story? And can you talk about like how much of these developments are built on spec? We're building this for Google, or we're building this for Meta or whatever versus we're building this and it's the Sunbelt and someone is eventually going to rent it, but we'll build it without even knowing who.
Julia: (09:59)
There is a lot more build it and they will come activity in the Sunbelt. That doesn't exist in New York.
In New York, before you build a Hudson Yards, you've got several anchor tenants lined up. That is not the case here. You can actually, a lot of these developments, you know, the Google and the meta buildings are an exception. But there are a lot of developments around town that are built on spec. And is it broader than Austin? Yes, there's a number of cities.
Austin has by far got the biggest overhang, but Dallas has a pretty big overhang. Denver, Boise. There are a number of the sunbelt boom towns, the Covid boom towns in the west where you can build, where it's relatively more straightforward to get from concept to groundbreaking. And I would say it is a Sunbelt slash Covid boom town phenomenon. Mostly in the west and the South and the southeast.
Tracy: (11:13)
Can we get Jackson Hole-ish for a a moment?
You know, going back to the way monetary policy is supposed to work, when you hike interest rates, you are supposed to be deterring some speculative frothy activity. So in a sense, how expected is this development for policymakers? I mean, you were in Wyoming. You were talking to loads of people. When you talked to them about what's going on in the Sunbelt, construction maybe slowing in places like Austin. What do they say and what do they think?
Julia: (11:47)
That's a great framing. There's a range of views, obviously. And yes, this is an intended channel to the extent that people took risks that turn out not to be, you know, viable or have a lower rate of return than they anticipated. That's just, you know, that's life in the big city.
It’s just part of taking risk is you realize sometimes some losses as well as some gains. So this is an intended channel of policy. The debate is more around, have we seen all that we've seen and therefore we need to do more to slow the economy. Or are a lot of the effects of this still do they still lie ahead of us? And I think that's where there's a range of views.
I really respect and like to hear the views of Chris Waller, Governor Waller. But he tends to be of the view that, you know, the lags are shorter because of forward guidance, because the Fed is very transparent that markets react almost instantaneously, well before they actually raise rates. And therefore it's all priced in. I think if we think about a credit channel, and it's something we didn't really have last time, right? The credit channel was crisis. We didn't have this elongated kind of tighter credit.
And because of the refunding that you touched on with your other episode, the lags are probably longer. And this is something that if you talk to European central bankers, they think of the lags as being longer because of fixed rate financing and more of that. And that it's going to take some time for financing to roll over and to feel the effects and employment and activity. And so you have to know that what you've done already is going to keep being a restraining force going forward. So I'm more in the lags are longer camp because of this than the lags are all behind us camp.
Tracy: (13:40)
Joe, this kind of reminds me of some of the discussion around inflation. Just the idea that it's been decades since anyone has really had to deal with higher inflation and we're not sure how to deal with it. This idea that like, well, maybe it's been decades since we've had a sharp change in monetary policy propagated out into the economy and we don't really get how it works. And the last example was so extreme in 2008.
Joe: (14:05)
I love the way you put that, which is that we think of 2008 as a credit crisis. But the actual mechanism by which the economy slowed down was not per se the contraction of credit, but “Oh my God, the world is falling apart.” And everyone just slams the break at once.
They slam the break on hiring, they slam the break on new development, etc., which is not really what people have in mind. This idea that we're just going to pull back on credit and slow things down. This is the key dynamic we want to talk about.
But you know, the realized disinflation that we've seen so far. So at one point I think we were like in around 9%, maybe we're like closer to three something percent now. But as I said in the intro, no one really knows why. And unemployment didn't rise like the way many economists would expect. What's your story basically for the last 12 months of fairly nice disinflation?
Julia: (14:56)
So we are big believers in sectoral analysis, micro to macro, right? So what's going on sector by sector, what's going on in the dynamics of, you know, how concentrated is a sector, how are the profits pan panning out? How is consumer price sensitivity in that sector? And then building, you know, running the top down macro models, but also building that outlook from the bottom up.
And the bottom up is, you know, on the one hand, it led us to be falsely in the transitory camp early, but then we pivoted because the reason it failed was we had more supply chain frictions. We had more waves of Covid, we had Malaysian chip factory shutdowns, we had all kinds of these frictions and challenges sand in the gears that kept inflation. Meanwhile also like very strong demand support, very price insensitive demand.
When we look out at the dynamics so far, I mean, some of it, yes, when, when you look at cars, for example, which has been such a key part of the inflation, and now it's been a key part of the disinflation. It's both a macro story, higher rates, lower demand for cars, more price sensitive demand for cars, but also improving supply chains, improving inventories, available chips. So it's both, you know, a supply and a policy story tangled up together. Hard to disentangle, but you know, it's definitely a key part of the disinflation.
And if you don't think in those terms, if you're just thinking, okay, economic growth equals inflation, which is kind of what Powell did at the press conference, then you're going to be untrusting, you're going to be skeptical. Part of which is perfectly healthy, but also maybe too skeptical. They're extreme. They have very pessimistic inflation assumptions for the remainder of the year and their forecast definitely seem to be leaning on ‘we maybe need to do more.’
And we see a lot of good things happening in inflation dynamics. One of the things we look at, for example, is the diffusion. How many prices are increasing versus decreasing? If you look at the ‘70s, that was a hundred percent, every single price was going up every single month, quarter, year, all wages were going up. That's not what's happening now. Some prices are falling, airfares go up and down depending on consumer demand capacity, there has totally normalized, auto sales similarly up and down. So I think we're seeing a much more dynamic, healthy pricing dynamic, which gives us more optimism that this lower regime can have some staying power. And you don't need to hammer the economy. I mean, we had several cycles over the last 30 years where we had growth and no inflation.
But because of the PTSD from the pandemic, there's this equating of growth with inflation. And what was surprising about the meeting, the September FOMC meeting to me was how unanimous it seems to be — everybody's forecasts kind of showed a higher funds rate and everybody raised their 2024 inflation forecast, or a lot of people did. There isn't a lot of sectoral inflation in the FOMC. And I think that gives them a very rigid view of how things are playing out.
Tracy: (18:39)
This was going to be exactly my next question, actually. You mentioned Powell’s speech, which was very macro and sort of traditional FOMC speech but Christine Lagarde of the ECB gave basically the opposite speech talking about like, we are in this weird period where it feels like the real economy, supply chain constraints, fiscal, is more in control than monetary policy and it poses new challenges to economists. How well equipped do you think economists are to start looking at, you know, individual industries or looking at specific sectors as you just pointed out, versus the sort of macroeconomic theory that many of them have been trained on?
Julia: (19:21)
There's a lot of good economists, ourselves included, I would say, that are doing this kind of work. So Alan Detmeister at UBS, Skanda Amarnath at Employee America, Omair Sharif, Mike Konczal at Roosevelt.
Tracy: (19:35)
I love that most of these are Odd Lots guests.
Joe: (19:38)
We've never had Alan Detmeister on.
Tracy: (19:39)
We should.
Julia: (19:41)
Definitely should. This is the who's who Odd Lots macro. But there's, and you know, we engage in this conversation and this debate, you know, in social media and there's lots of great exchanges and analysis the seller's inflation. Your point about the ECB is a great one. Sellers’ inflation. Let's set aside the loaded term ‘greedflation’ but the idea of profit margin.
Tracy: (20:05)
We have purposely avoided saying ‘greedflation.’ We tried to coin the term ‘excuseflation,’ which some people have been using it, but I think sellers’ or profit-led inflation...
Julia: (20:14)
Yeah. Profit-led inflation. And if you look at, say, Lagarde’ss press conference, she breaks down what's been happening in inflation in terms of what's driven by the labor market and what's driven by profits like as a matter of accounting. You know, there's plenty of ECB officials that are sort of well versed in yes, there's the labor market and then there's the product side, there's the profit side, the industry side.
It has to do with concentration and common shocks, etc. So it's not like it's a radical theory. It's not like there's no work out there. It's just like there's nobody on the FOM C that embraces this overtly. And so again, I just think there's a common framework at the Fed that is, you know, it's an important framework. It's a useful framework, but it's not the only framework.
And you need to have, I would say it's better to have as many possible perspectives and points of view to understand these dynamics. You know, inflation went up more than even the macro models suggested, and at a timing that does not align with the macro models. So when you have an error in your model as a forecaster, you look forward and think, “Hmm, that error might reverse at some point. I might get downside surprises.” Standard forecasting. I'm not saying anything radical.
Now, of course, it's not the central bank's job to err on the side of optimism when they're above their target. But, you know, you can, you can talk, I don't understand, like Powell had several opportunities at the press conference.
There was three or four questions actually. Craig Torres of Bloomberg asked an excellent question about the nuances of higher rates and supply side-led inflation in real estate. And Powell just won't go there. He just doesn't want to go to the supply side and talk about those. I mean, he did, to be fair, he did say we understood that fading pandemic frictions are part of the story. But again, I think they just are very shell-shocked by what they've been through in the last couple of years and are still erring on the pessimistic side.
Joe: (22:29)
You know, one other thing in that Lagarde speech specifically that you mentioned, this idea of the price insensitive demand and the big source of that is the investment that's happening in like green transition and energy infrastructure — and that's going to happen regardless. If we could have a recession, yes, we could have a boom, but we know governments are going to spend a lot on this.
They're going to subsidize a lot. And of course we talk about that all the time on Odd Lots. And yeah, this is an interesting dynamic and there's a lot of spending that's going to happen regardless of where we are in the cycle. But I want to get deeper into the lags debate. Because I have this like sort of weird sympathy for the priced-in view. Everything's always priced in.
Julia: (23:06)
Everything's always priced in. Yeah, it's all priced in. That's what we saw after the FOMC meeting, right? It was all priced in.
Joe: (23:12)
And so, okay, that's the Waller view as you characterize it. Like, why isn't it all priced in? What is the case for why, like, all right, even if we know that rate hikes are coming, they telegraph it. We're in an age of very aggressively clear forward guidance. The dots didn't use to exist. That's a modern innovation in central banking. So like, let's talk theoretically and then let's get more concrete.
Like, what is the case for why it wouldn't all just be priced in and why people don't adjust their behavior the moment the central banks give their indication of where rates are going.
Julia: (23:46)
The way I think about it is I break it into two channels. There's the capital markets, and then there's the credit channel. And the capital markets channel, exactly as you describe, the Fed telegraphs its intentions, its perspective on the balance of risks and capital markets price it in.
But there's the credit channel side where you've got this, you know, fixed rate financing for a couple of years, and you've got time and there's legitimate uncertainty about where we're going to be in a year in two years. And if you are, you know, again, commercial real estate is a perfect example because they are, you know, glass half full kind of people.
And there's been a real conversation. And you know, I talk to a lot of people in the real estate industry, there's a real sense that, you know, if we hold on long enough, rates are going to go back down. And so I'm not going to mark my losses. I'm not going to scale back my project. I'm going to maybe slow walk that project and not be in a hurry. Because I think, and if, if I come to market in a year or two years and I need to roll over my financing, I'll get better terms then. And that's not irrational.
But it does mean that, you know, if they're wrong, which, you know, the market has moved. One of the things that's happened since the last FOMC meeting in July is that markets did move to higher for longer pricing. Real rates are up 50 basis points. And so we have yet to feel the effect of that last leg of increase in real rates. It just happened.
And that was a change in psychology in the market. The market realizing maybe higher for longer is where we're going, in which case we need to reprice things, in which case, and then you look at the impact of that. We've seen mortgage applications roll over, we've seen car analysts lower their forecasts for the remainder of the year because there's less pent-up demand at these interest rates. So all these leading indicators are saying, yeah, there's going to be an effect from that last leg up in interest rates. And the Fed raised its 2024 forecast, not lowered it. So the conviction they have on extrapolating the recent good performance into 2024 was surprising to me.
Joe: (26:11)
I’ve got to say it's not lost on me, when you think about commercial real estate developers, just this sort of like sheer belief that it'll be fine, that the two most famous developers, and I think I may have stolen this observation from someone, the two most famous commercial real estate developers that everyone knows are Donald Trump and Adam Neumann, which sort of gives you a sense of maybe the sort of mindset of a lot of the people dealing with.
Tracy: (26:33)
Those are the poster children for commercial real estate optimism.
Joe: (26:37)
The sheer belief in winning.
Tracy: (26:39)
I realize we've been talking a lot about corporates. Can we talk maybe a little bit more about household balance sheets? Because this is the other area of uncertainty and there is a lot of debate at the moment, over how healthy the consumer actually is. And you see these charts of outstanding credit card debt, you know, going up to records and people panicking that people are going to struggle to pay some of this back as interest rates go higher. But on the other hand, there's plenty of discourse that says individual balance sheets are basically in the best shape they've been in a very long time. so how are you viewing that particular debate?
Julia: (27:17)
Yeah. So first of all, the credit card debt at record highs, you never look at nominal debt. You always scale it by income. The flow of funds for Q2 just came out. Debt to income is right back down. So if you look at including credit card debt as a percent of income came down. So I don't look at households and see a picture of, ‘oh, they're binging on debt or they're leaning on debt because they can't finance their spending with income.’
I do think household balance sheets are in fantastic shape. We came into this tightening cycle in the best shape ever, both in terms of net worth, but also in terms of delinquencies on, on all categories of consumer loans. It was the first recession where we actually lowered delinquencies through the recession, through all of that fiscal support.
People used it to pay their auto loans. They used it to pay their credit card. So we didn't have the delinquencies we typically have with job losses. That was part of the idea. And so I think there's a bit of a haves and have-nots in the consumer world. If you look at delinquencies, they're coming up off the lows across categories, auto delinquencies, credit card delinquencies. Mortgage delinquencies are still very low, you've got, you know, lower income consumers who have been hit by the rental inflation versus homeowners who got to refinance to record low mortgage rates.
Tracy: (28:47)
I feel like this is really the linchpin.
Julia: (28:49)
There's a real bifurcation. And who's feeling the effects of the higher rates? Most people that have to buy, you know, or the higher used car prices, these are going to be more moderate income consumers. So I think, and that's the other thing that we've been seeing too is the labor market is still level-wise very healthy, but the slowing in job growth is quite pronounced.
And so, you know, we've been in the soft landing camp all along. We never have been forecasting a recession. I actually see the recession odds as just as high or even maybe a little bit higher because the labor market looks like it's closer to, it's not just going great guns.
The sectors that are hiring have narrowed, the pace of hiring has slowed. Wage growth is slowing. So the, the nominal income growth being generated by the labor market has slowed quite a bit. Delinquencies looks more like a cyclical shift, but it's only amongst a certain segment of consumers.
Joe: (30:08)
Well, so this gets to the question. So the Fed, we don't know if they're done raising rates, but what they are doing, or what they are indicating is they're telling the market that cuts are not forthcoming. And that is a de facto tightening — a form of maybe second derivative tightening or something.
And so if you look at their 2024 dots, they're coming up and basically telling the market, if you think there are cuts, they're probably not. And so let's set this, you say the recession odds are ticking up a little bit because that nominal income, the labor market, it's slowing. We're not saying mass layoffs or anything like that. But there's some slowing wage growth is probably slowing a little bit.
The inflation dynamics you think are improving meaningfully in a way that can be sustained. The Fed doesn't appreciate perhaps that they can be sustained. The dots are coming up. So talk to us about that risk that the Fed is still sort of pessimistic about inflation dynamics. It's sort of engaged in a modest tightening still by raising those out dots and in a backdrop of a time when the recession risk is ticking up,
Julia: (31:13)
It's still is a very healthy economy. I mean, the fact that the corporate side of the world has gotten more optimistic probably helps labor market resiliency in terms of preventing further layoffs. But I think, you know, if you're extrapolating off of the Q3 GDP tracking than you're probably gonna see some disappointments down the road.
The growth has ebbed and flowed. You know, what I see is, if I look at the consumer, consumer spending sort of dropped to trend early last year, and then the quarterly numbers bounce up and down just depending on where that spending falls and kind of ebbs and flows. So you know, whatever Q3 is tracking, that's not the run rate right now we're in for some slower patches of data and that could be more worrisome sort of, but there's two things that keep us in the resiliency camp.
One is we do believe that inflation is coming down more sustainably. That is a tailwind for consumers that gives them more purchasing power. The energy shock is a complicating story to that that could, that's going to hurt purchasing power in the next few months. But the Fed also has ammo.
If things get really rocky, they can cut rates. And we are in a world where there's a credit channel, so you might get a response in housing, look at housing, housing rolled right over rates went down because of the recession call expectations early in the year. Then they've come back up and you've seen housing demand ebb and flow with that. So there is a lever at their disposal, which is effective that they can go to.
Of course, the bar's much higher when you're coming at the inflation target from above. They're very skeptical. But, you know, if we could hit a soft patch and then they could respond, and that could keep us back on track.
Tracy: (33:04)
This might be an unfair question to ask an economist, but you are also a clinical associate professor of finance, I believe. So maybe you can answer this, but one of the puzzling things in markets recently has been the very low spreads or risk premiums on corporate bonds. Even as you see, you know, all the concern about everything we've been talking about in this discussion. One way I can think of justifying it is that maybe markets still think, you know, if rates continue to go up, eventually something might break and then the Fed comes in and cuts. And so the interest rate problem kind of goes away again for a lot of companies.
Julia: (33:42)
Right.
Tracy: (33:43)
Is that a reasonable explanation or how would you explain persistently low spreads in the credit market?
Julia: (33:50)
You know that's a great question. I think one of your prior guests talked about how a lot of the weak hands got squeezed out during the trade wars.
Tracy: (33:58)
Yes, this is true.
Julia: (34:00)
And I thought that was a very interesting point because a lot of the sort of riskiest businesses were in the energy sector, and a lot of those already felt their recession before the recession. And so we have sort of a higher credit quality landscape. The other area of pronounced weakness is in the tech sector and they're just not that debt-exposed.
They’re valuation-exposed, their valuations are much more volatile. That's where all the speculation goes when people are optimistic or pessimistic, but it's doesn't necessarily translate into credit spreads. So it is perplexing that it's still so solid in terms of a global capital flows perspective. One question I've been asking sort of more globally-oriented people, is we know that less money is going into China. Where does that money go?
Tracy: (34:58)
That’s a good point.
Julia: (34:59)
Is it possible that developed markets are experiencing a little bit more of a tailwind from money that has to be reallocated to the US or other countries? And I think the answer is possibly yes. You know, you think about what does it mean, this sort of structural shift in China, one of the things we think, well, China's been the source of the excess savings glut, maybe that, you know, takes away the subsidy to Treasury yields to some extent.
But it might mean more asset allocation from global investors into the US in other asset classes. So I'm not an expert on that, but I am, you know, that's something I'm trying to learn more about and think more about.
Joe: (35:43)
Back to that Lagarde speech and the price insensitive demand, I mean, the other thing that's going on now and is we’re in the era of big fiscal. And it's like the opposite of the 2010s. In the 2010s, we got this pretty, in retrospect, modest stimulus right off the bat, like 2009. Then it died pretty quickly after the Republicans won the house in 2010. That sort of took further fiscal expansion off the table.
Now we’re in an area where people are talking about high structural deficits for a long time to come for various reasons, including the Inflation Reduction Act, which is, I suspect a lot of like high multiplier spending because it's construction and factories and all this stuff that goes into a lot of pocketbooks of sort of construction workers, etc. How are you thinking about the persistent macro impact of the era of high deficit?
Julia: (36:36)
Yeah. So I'm really glad we got here because that's another area where I think the narrative is skewed. So the narrative tends to be, we just equate deficits with inflation. And there’s a lot of the fiscal shaming coming back out. But if you look at what we're spending money on, you know, during the pandemic, yes, it was all just giving money to consumers to spend. This is all giving money to builders to build. Right?
And Texas is, we've had this conversation, I believe Joe, in Jackson Hole, which was, if you look at what's happening in Texas, we are in the middle of a renewables boom. And that is arguably disinflationary because we've had the hottest summer on record. And let me tell you, anybody that has lived in Texas for the last two summers knows that we are in an existential change and we're going to need more capacity.
And we, thank goodness, have that capacity. So I was, somewhere in July, I'm like, why are we not like experiencing a crisis like we did, you know, during the winter of 2021? And I looked at some of the data from ERCOT and the generation capacity and well, we've just been growing, you know, hand over fist in terms of wind, solar, all the new capacity is in the renewables, thank goodness.
And let's do the counterfactual. I kind of tried to ask this question at Jackson Hole. I'm not sure it came through. When we think about fiscal, we need to think about why we're doing it. Why are we doing it? It's not just random ‘Oh, let's just spend a lot of money and let's just run big deficits.’ Why are we doing it? Well, first we did it because we were in a global pandemic and we successfully achieved a much stronger recovery.
Secondly, now we're doing it, and Christine Lagarde explicitly talked about this in her speech. You're going to have to expect the government to play a bigger role when we're in an energy transition because nobody else can engineer that. The private sector won't do it by itself. So the government steps in and provides these incentives, and it's working. I mean, it's a story that's hopeful to me that we are getting the capacity we need. It's in renewables. And what would've happened, like if you look back to 2021, the grid failure in Texas was another friction that brought chip supply shortage, made it worse, right? We had chip factories here that were affected.
What would've happened if we would've didn't have this capacity this summer? You know, what would've gone down? What kind of capacity? What kind of production would've gone down? We have surge pricing in Texas. Prices for sure would've gone up more than they did because of the presence of renewables. So, you know, arguably that's been disinflationary already for Texas consumers. And I think we need to think more expansively about what are we doing? What are we getting for this money? It's not all just, you know, going straight into demand. It's going into capacity.
Tracy: (39:47)
This was also Biden's argument in the very early innings of the IRA, his whole, you know, spiel for it was that, well, we have these supply constraints and we have these choke points in the economy. And so we spend now to solve those. And ultimately that becomes a disinflationary impulse and the solution to our inflationary problems.
I want to ask just one last question. Going back to the long and variable lags idea, what are you watching out for for signs of interest rates really beginning to bite in potentially problematic or systemic ways? I know we talked about commercial real estate, but what are specific things people should be looking out for?
Julia: (40:27)
It's kind of hard to pinpoint. I mean, the SVB example is a perfect example of, you know, you just don't always see it coming. That's still a possible shock. If you look at the FDIC's latest quarterly report, those securities and loan losses are just as big if not bigger because real rates would have gone up.
So their portfolios are even further underwater. So there's still, it's a tough road for particularly midsize and smaller banks that are making money on bread and butter economic financing, not, you know, the capital markets, businesses that the big banks have to offset. So I think still watching the credit channel and the credit flows. Credit flows have slowed and are tighter. The financing terms are tighter.
And so, you know, I think that that can affect the economy, not necessarily in a crisis-like way, but definitely slow, continue to slow things down. Big picture, we've had a generational interest rate shock after, you know, years at the zero lower bound, where is all the leverage in our economy to zero rates?
Tech has been a surprising area of sensitivity to monetary policy. They're not indebted, but their valuations sure are sensitive to QE versus QT versus, you know, Fed hawkish, Fed dovish. It could be that there's a wave of, you know, there's been some relief lately. Maybe we get further correction there because it turns out that that was when you, when you don't have just good old plain safe yields, you start speculating more on things like software and, crypto and crypto's another one that can keep going. There's some leverage in that system that could spill over to the broader financing system. So there's a number of areas that we could see tighten in ways that aren't just a gradual linear march. It sort of happens all of a sudden when people just can't roll over their funding anymore.
Joe: (42:36)
Julia Coronado, Macro Policy Perspectives. I'm so glad we had this conversation. We were able to make it happen after we didn't get the chance to.
Julia: (42:44)
Now we can have some more breakfast tacos.
Tracy: (42:47)
Breakfast taco time.
Joe: (42:48)
Thank you so much for coming back on.
Julia: (42:50)
My pleasure.
Tracy: (42:50)
Thank you for the tacos too.
Joe: (42:52)
Yeah. Thank you for the tacos.
Julia: (42:53)
Great.
Joe: (43:01)
That was such a good conversation. So much in there. I just want to say before I forget, not all tech speculation is, like some of it amounts to something. And I know this because I took my first self-driving car drive home last night. Some tech investment actually becomes real. It is so amazing.
Tracy: (43:18)
You've gone to Austin, you've ridden around in self-driving cars, and then you went to like the fund manager who is the ultimate espouser of the efficient market hypothesis theory, and now you're just feeling really good about everything. You're like, ‘it's all priced in. Tech is great. The future is bright. Let's eat more tacos.’
Joe: (43:39)
Yeah. You know what I really liked though, that I thought was extremely helpful, is Julia's demarcation of the credit channel versus the asset channel. Or the capital markets channel. And that was so helpful for me in terms of thinking about like, yeah, stocks do price in the dots for 2024 come up and then stocks go down or whatever.
And then this idea that like credit is just never going to work automatically like that. And there's lengths of credit and there's different opinions and people can hold out and restructure, etc. And so the idea that credit markets will respond automatically in the same way [as] asset valuations is like a really helpful way to sort of, at least in my mind, resolve some of these tension.
Tracy: (44:25)
Absolutely. So two things stood out to me. One was the point that fiscal stimulus or fiscal spending doesn't always have to be inflationary. And I know this was actually a big talking point. Again, I pointed it out, at the beginning of the IRA, this was the selling point from Biden, but I think it got lost in the ether with all the discussion and drama around the debt ceiling and things like that. But we have seen some glimmers of that. You know, there, there were fiscal attempts to solve the backlogs at the ports, for instance, which seemed to have helped a little bit.
And then the other thing that stood out to me was the contrast between the 2008 monetary policy changes versus now. And I think this is really key and maybe one of the reasons why policymakers are struggling at this moment in time. We have not had a huge dramatic shift in monetary policy, you know, for a long time, but not in the shape that we have at currently where it's a series of hikes. In 2008, as Julia pointed out, it was ‘crisis!’
Joe: (45:29)
That was a really good point. Like the idea of, well, a credit channel constraint is something that we haven't really experienced in a while and we're seeing glimmers of it. We saw it actually play out in housing at the end of 2022, maybe again now with mortgage rates roughly 7.5%, I think the home builders have come down. Home builder optimism has declined. So we're seeing that dynamic again.
Also, you know, it is sort of an underappreciated point. As Julia pointed out, monetary policy can now work in the other direction. When we were at Zirp, there was not really much that the Fed could do to stimulate. I mean, they could like do more QE, but I think always the efficacy of that was always sort of debatable. They can cut rates now, which is a really interesting dynamic and probably get some juice out of those rate cuts in the way that we haven't experienced in a long time.
Tracy: (46:20)
Absolutely. Shall we leave it there?
Joe: (46:22)
Let’s leave it there.
You can follow Julia Coronado at
@jc_econ
.