INSIDE ECONOMICS

Mark Zandi:                       Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by a bevy of my colleagues. Of course, there's Chris deRitis. Chris, hey, Chris. How are you?

Cristian deRitis:                Doing well, doing well.

Mark Zandi:                       That's good. We are missing Ms. Dina Talley again? I guess she-

Cristian deRitis:                Yes, we are.

Mark Zandi:                       Yeah, COVID I heard.

Cristian deRitis:                She'll be back soon. She'll be back soon.

Mark Zandi:                       She'll be back soon. So we'll miss her. But in her stead, we've got four other folks, colleagues, we've got Juan Pablo Fuentes, JP, how are you?

Juan Fuentes:                    I'm good, mark. How are you?

Mark Zandi:                       I'm always good. I'm always good Juan Pablo. Yeah. And I'll explain in a minute why we've got this bevy of economists, but just to finish the introductions, we've got Mike Bisson, Mike.

Michael Bisson:                Hey Mark. How's it going?

Mark Zandi:                       And I should say Juan Pablo is an expert on energy markets, oil markets, and Mike is our expert on the auto vehicle market. And maybe you're kind of figuring out now what the topic at hand is going to be. Give you one more hit. We've got Bernard Yaros. Bernard, how are you?

Bernard Yaros Jr:              Good. I'm doing well. Good to see you, mark.

Mark Zandi:                       Lee's the Renaissance man. I won't explain. I embarrass him every time he's on, but I won't do that this time. And Martin Moore. Hey Martin.

Martin Wurm:                   Hey Mark. Howyou doing?

Mark Zandi:                       Good. And the thing about Martin is I always get the city he's in wrong. I keep saying Portland, but you're actually saying Seattle.

Martin Wurm:                   Yeah, I'm in Seattle and it very much goes with east coast stereotypes about the Pacific Northwest out here, it's where you go [inaudible] and it's all kind of in the woods summer.

Mark Zandi:                       All I have to say is Martin, you look like you belong in Portland. I don't know what that means exactly. Don't take it the wrong way. But-

Martin Wurm:                   Yeah, I will say this. I come off surgery, so I haven't trimmed my beard and I was going to do it today, but my wife hates the hair, so I didn't quite get to it.

Mark Zandi:                       Is smoking a reefer in Portland or no, you're in Seattle.

Martin Wurm:                   In Seattle.

Mark Zandi:                       Is that legal?

Martin Wurm:                   Well, it is legal by state law, but of course not by federal law. I'll say that. And it's about the general look here, I think what we're referring to is more closing time at the lumber mill. And I've adapted that since I've been living here, not so much the habit.

Mark Zandi:                       Okay, very good. Very good. And Martin's going to focus on, he's our expert on monetary, all things monetary policy. Of course Bernard obviously is on the federal government. Listener, are you figuring this out yet? What's going to go on here or what we're going to do? And this may be the title of the podcast, I'm not sure what could go wrong. And we've been, I think relatively optimistic about the economy's prospects pretty consistently. So saying, yeah, recession risks are high, but we think we'll be able to get through this period without an actual NBER defined recession. And I'll have to say too early to declare victory here on that one, but it's feeling pretty good at this point. Inflation's been coming in very nicely. It's not going to be straight line back to the fed's target, but it's going to take some time.

                                                But we're headed in that direction and that's all happened without a single basis point increase in the unemployment rate, which is pretty incredible. So things are going pretty well, certainly compared to the fears. And the purpose of this podcast is going to be focused on what could go wrong? What could send things off the rails here? And obviously recession risks are still high, the economy's still very fragile, we're not growing very quickly, and in that context, if anything doesn't stick to script here, we could go into recession.

                                                So recession risks are high. So each of my colleagues here are going to be focused on one of those, what could go wrong things. And I thought we'd organize this in terms of what is the most immediate threat to what would be kind of a longer term threat. So we're going to begin with oil prices, but before we go down that path, the other thing that happened this morning right before we started the podcast is Jay Powell, chair of the Federal Reserve gave his speech at the Jackson Hole Confab. And I thought it'd be useful just to get a sense of what he said and what it means. So maybe Martin, because you are the expert on monetary policy for us, what did the chair have to say?

Martin Wurm:                   Yeah, so in many ways the meeting was, I guess the speech was perceived as a little bit hawkish, but it was certainly much less hawkish than it was a year ago when the Fed really pivoted on inflation. The mainline narrative continues that the Fed remains committed to the 2% inflation target and it will essentially do whatever it takes to get there. The particular points of concern that the chairman spoke about a little bit is the fact that consumption growth still looks remarkably stable. The economy hasn't quite cooled as much as the Fed would like to see that labor markets haven't quite softened as much.

                                                In part that leaves open the probability of another hike at one of the next two meetings, but it will certainly mean beyond that is the Fed is going to start cutting rates much, much later than we previously anticipated. If you go back to March, markets thought that the Fed might cut later in this year, but now the expectation is really more towards summer of next year and it will take a lot for the Fed to be ready to take that step. In terms of market reaction, we didn't see a very strong reaction far as I can tell as of now, certainly not like we saw last year. So markets are still taking going in strides. So the Fed is certainly a little bit more relaxed than they were a year ago, but the risks remain and commitment to the inflation target is sort of a strong takeaway from the speech I would say.

Mark Zandi:                       So really no new news. I mean basically reaffirming the 2% inflation target, reaffirming that rates likely will remain high for an extended period to ensure that inflation comes back into that target in a timely way. Did I get that right? Is that the message, the overarching message?

Martin Wurm:                   I think that's fair to say. I mean really if there is any new data point, which is really not all that new, is that economic data up until the second quarter came in a little higher than expected, which is great of course, because it reduces recession risks. It's a bit of a double-edged sword in the sense that it also might mean the Fed will have to get rates higher for longer. That's sort of what Powell again stressed.

Mark Zandi:                       Okay. Hey Chris, I think you had a chance to read the speech too. I actually haven't had a chance to read it. Do you want to fill any gaps there that Martin left or did he get that? Is this synopsis kind of complete?

Cristian deRitis:                Yeah, I think he got it. And the market reaction, as you mentioned, was fairly neutral. There was a bit of whipsawing and the stock market went up first and then it came back down, but it's kind of where it started the day. So not a very significant reaction. Treasury yields also climbed what four or five basis points on the 10 year.

Mark Zandi:                       Which isn't a whole lot given the volatility in that market. It seems like every day it's moving four or five basis points.

Cristian deRitis:                So maybe there was some excuse or 10 basis. So clearly investors are reacting to the speech does suggest higher for longer or confirm, I guess higher for longer. But nothing to your point out of the ordinary. Perhaps one omission if you will, in the speech as Powell didn't really talk about R Star, the neutral rate at all. So that's the subject of debate among economists. R star being what is the neutral rate for federal funds. So the real neutral rate, there's a considerable debate of what that should be. So how much above the inflation rate should the-

Mark Zandi:                       So just for the listener though, the R star neutral rate, equilibrium rate is the rate that would be consistent with the monetary policy, neither adding or subtracting to economic growth, kind of neutral to growth.

Cristian deRitis:                That's right, that's right.

Mark Zandi:                       And right now, if you look at the fed's estimate of the neutral rate, or at least implied looking at their projections every quarter, it's two and a half percent nominal federal funds rate's two point a half percent. And of course the federal funds rate today is five and a quarter to five and a half, so well above neutral. So monetary policy by that standard is highly restrictive. But you're saying there's a lot of debate as to, is it two and a half?

Cristian deRitis:                Is it still two and a half?

Mark Zandi:                       Is it still two and a half? I think people are saying could it be higher?

Cristian deRitis:                That's right, that's right. There seems to be more consensus building around maybe three, some even go to three and a half percent because of some structural shifts in the economy that maybe when the Fed does start to cut, they won't go all the way back to two and a half, they'll land at three and that will be to your point, equilibrium. So Powell didn't really engage in that part of the bait, probably appropriate at this point because it is more of a theoretical discussion. You can't really measure this that well, certainly not in real time. It's more retroactively and it's more conceptual or theoretical. So I think not something that you necessarily want to engage with in a public forum like this when you're trying to still calm some nerves out there. So he committed to the 2% inflation target. I think that was important. But other than that, I didn't see much in the speech that would derail investor opinion.

Mark Zandi:                       In our forecast, we have the current funds rate target five and a quarter, five and a half. That's the terminal rate, that's the highest the rate's going to get in this cycle. That's our forecast. And the first-rate cut isn't until June of next year, the June FOMC meeting, is that pretty consistent with market expectations at this point? Do you know Chris? Looking at futures?

Cristian deRitis:                I just took a quick peek to see if there was any reaction. It looks like markets are pretty convinced that there will be no hike or cut I guess in September. And then things get a little bit more mixed as you look a little further out. So in November, later this year, investors, it looks closer to 50-50 between those that think that the Fed is done and they'll pause and others who think that we'll have another quarter point hike.

                                                And then again, you're seeing more of a distribution as you go further out in terms of when the cuts may start in 2024. But I think our assessment of mid-year seems fairly consistent with the market view.

Mark Zandi:                       Okay. Okay. Very good. Well thank you for that. So let's turn to what could go wrong and again, feels like the economy is kind of sticking to the script we've laid out previously with slow growth, but no recession inflation coming in large part because the inflation was driven primarily by the supply shocks of the pandemic and Russian war. And as those shocks fade, the fallout from those shocks fade, then inflation can come back in and we don't need a recession or even meaningfully higher unemployment to get inflation back into the bottle, into the fed's target. And that script still being written and it's still premature to conclude that that's right and we're going to get through this without an economic downturn.

                                                So still a lot of risk around that. But even in the optimism I've been expressing there is the concern that the economy is growing slowly at best and in that kind of environment, very vulnerable to anything else that can go wrong. And it just feels like there's a whole slew of things out there that could go wrong. And so I thought we'd use this podcast as an opportunity to hear about those threats and how big a threat they might be. And I'm going to tackle this, what are the threats that are most immediate to those that are going to be around for a while?

                                                And obviously it is very difficult to get timing here, but just roughly speaking. And so I thought we'd begin with oil prices and we forecast lots of things. Some things we feel pretty confident and some things not so much. And this is just Mark Zandi talking. I'm really curious to hear what Juan Pablo has to say. Forecasting oil prices is pretty tough to do. There's just so many kind of moving parts here, a lot of geopolitical dynamics that are difficult to gauge and so very tough to do. So maybe Juan Pablo, I'll turn back to you and maybe you can give us a sense of what our baseline forecast is. What are the drivers behind that forecast and what are the risks around that forecast?

Juan Fuentes:                    Yes, so our forecast actually has been pretty good this year. I think we haven't made-

Mark Zandi:                       Are you tooting your own horn? Are you tooting your own horn? That sounds like-

Juan Fuentes:                    Yeah,

Mark Zandi:                       I guess you're supposed to do that. It's like Muhammad Ali, I'm the greatest. Just keep saying it until everyone believes it. Is that what it is? The strategy?

Juan Fuentes:                    When you write right about forecasting oil prices, yeah, it doesn't happen too often.

Mark Zandi:                       Doesn't happen too often. Fair enough, fair enough. Go ahead.

Juan Fuentes:                    I feel good. We haven't made substantial changes to our forecast. Prices were lower than expected I guess in the first half of the year, mostly because Russia production really was resilience despite all the sanctions, all the pressures from the war. Russian oil exports actually haven't changed that much. So I think that was the biggest surprise in the first half of the year. So that kept the oil market in a small surplus. So production above demand for most of the first half. Things have started to change mostly because of the OPEC plus cut in the last three, four months. The latest one was a voluntary cut by Saudi Arabia that was unexpected. It's a sizeable 1 million barrels per day cut cut from June levels. So that cut started in July and it's going to go through at least September. So in the face of that change in the supply, we have our forecast called for oil prices to increase from around 80 right now to 85 later this year and into next year. I felt pretty comfortable with that forecast. 85, we already touched on 85 in July. There was-

Mark Zandi:                       Juan, is that WTI? West Texas Intermediate?

Juan Fuentes:                    Yes, that's WTI. So the spread right now with Brent is around three $4 per barrel.

Mark Zandi:                       So for 80, 85 on WTI, we'd be 85 to 90 on Brent.

Juan Fuentes:                    Right.

Mark Zandi:                       Yeah. Got it.

Juan Fuentes:                    Okay. So 90, that's our baseline 90 for Brent in the last quarter and the first quarter of next year. And then as the prices start to gradually decline after that. So I mean I think it's there a risk of course. I think the main one-

Mark Zandi:                       Can I just stop you for a second? My sense is bringing that back home to something that's more tangible to people. And correct me if I'm wrong, but this is kind of roughly the way I think about it. $80 a barrel of oil, which is sort on WTI, which is where we are now, would be consistent with something close to $4 a gallon for regular unleaded nationwide. That's sort of where we are.

                                                If we go to $85, that may add a quarter to the cost for a gallon regular, we go from four to four and a quarter. And just to give people full context, if we go to a hundred dollars barrel oil, people say a hundred dollars really? Well back when Russia invaded Ukraine, we've got as high as a hundred twenty, a hundred twenty-five briefly, briefly, but we got there. But if we go to a hundred dollar of barrel oil, that gets you pretty close to $5 a gallon for regular unleaded. And that of course was the record high back last summer when Russia did invade Ukraine. Is that roughly right? Did I get that roughly right?

Juan Fuentes:                    Yes. Yes.

Mark Zandi:                       Okay.

Juan Fuentes:                    One thing that has happened, started happening last year and this year is that we have inventory. So we track crude oil inventories and that's a big part of the fundamentals in the market, but there is also the products inventory, and those are really low in the US for diesel and gasoline. So that tells you that is the crack spread, which is what made mostly how much money refineries make that also contributes to the retail price of gasoline. So basically tide inventories, refineries have more pricing power and there can push prices for gasoline higher compared to oil prices. So that's the situation we're right now. So that's why gasoline prices are actually almost at the level they were a year ago, even though oil prices still are a little bit below that.

Mark Zandi:                       So our baseline most likely scenario is oil goes from 80 to 85 over the course of the remainder of the year. Gasoline prices go from four to four and a quarter through the end of the year, and then we see some moderation next year as we get more supplies into the market. Okay. That's the baseline.

Juan Fuentes:                    On average, we have WTI 70-85 for this year and almost 80 for 24. So not a big change next year in terms of the average for the year. The partner is, prices stay high in the first quarter and they start to slowly come down.

Mark Zandi:                       In my thinking, and correct me if I'm wrong, is that the price of oil now globally is almost a calibrated price. It feels like Saudi Arabia, you said OPEC is cutting back production. It's really Saudi, that they're cutting production in an effort to offset weakened demand for oil from China and maybe other factors to try to keep prices in that $80 barrel range. Because at 80 bucks they're making enough money to cover their nut, to pay for their fiscal programs. If it's below 80, then they start running deficits, which they don't want to do, but they don't want prices too high over 90 because if it goes over 90, then they start demand destruction, people start pulling back on use. And also just in sense a more rapid transition from fossil fuel to green. Do you think about it roughly the same way?

Juan Fuentes:                    Yes, yes.

Mark Zandi:                       You do. Okay.

Juan Fuentes:                    Yeah, with gas, prices could go up to 100, but they wouldn't stay there for long. The prices will react rapidly to the recession that will probably happen after that. So they don't like that scenario. They prefer more stable prices. So I think that for the Saudi Arabia, especially stability and a reasonable price, which I think is around between 80 and 90 for them, that's the ideal scenario.

Mark Zandi:                       And the risks feel like, and I don't want to put words in your mouth, but they feel like the risks at this point are to the upside that if we're wrong, it's going to be, prices are going to be higher rather than lower. Is that right?

Juan Fuentes:                    Yes, I feel less comfortable about that compared to two, three weeks ago, just because of the latest news on China. China is going to account for 70% of the increase in oil demand this year. So really what matters in terms of global oil demand growth is China. So yeah, we are, we're seeing a lot of back economic news coming out of China, and that has actually stopped that rally that we had in July following the... But still, I think that I will put the probability or the chances of oil topping 90 in the next six months at around 35%.

                                                So still high I think is higher than the other option of prices coming down substantially below our forecast. And I think the main reason is that the market is the fundamentals, the global balance is on deficit. So that could put the pressure on oil inventories. So low inventories, Saudi Arabia's apparent commitment to keeping prices around 85, 90. I can see a scenario where they extended 1 million voluntary cut through the end of the year. They haven't committed to the fourth quarter yet. So if they keep that in place for the last quarter and we see some more positive news in China, I can see prices getting to 90 in the last part of the year.

Mark Zandi:                       Okay. Well that's consistent with my recession on. So you're saying 35% probability that oil prices could be meaningfully higher than our baseline, which is 85 bucks on WTI, and that's about the probability attached to a recession occurring between now and the end of next year. So it feels consistent. And of course... Oh, sorry, go ahead.

Juan Fuentes:                    So do you think 90 will be enough to trigger a recession in the US?

Mark Zandi:                       I think 90 we're right on the ledge. I think a hundred, if we get closer to five bucks a gallon, I think we're toast. And that goes to the fact that oils play such a central role, the obvious that it cuts into consumer's purchasing power, but more importantly in the current context, it adds to inflation expectations, juices up wage growth inflames inflationary pressures. And I think we'll put pressure on the Fed to do what Martin said they might do. And that is raise rates again more than once. And I don't know that it's going to take many more rate hikes on top of the higher oil prices to do us in. So again, because so fragile, Chris, let me quickly turn to you. Does that all sound right to you? Anything you want to add on that?

Cristian deRitis:                It does. The only thing I'd add is I've noticed that US oil rig counts have been falling over the last year pretty quickly. Do you expect that to continue? I mean that seems to me another risk factor that the US producers won't respond in short order.

Juan Fuentes:                    Well, yeah, I mean obviously I think that the Shell boom as we saw before, the pandemic, that's over. That's not going to happen again. Still production is growing in the US it's actually going to reach a record level this year and there is going to be a little bit more increase next year, but the rate of growth is not going to be nearly enough, nearly as high as it used to be. And I think the main reason is the outlook for the oil for fossil fuels in general. We are seeing the transition. So oil companies don't want to like, these are usually long-term investments and they're very cautious about making those commitments in the face of this outlook for energy transition.

                                                The other factor is productivity. So it doesn't really matter what the situation right now is. Number of new drilling rigs are coming down, but productivity is actually increasing. So that compensates a little bit for the declining in drilling activity. Actually the energy administration recently made a big provision on productivity for existing rigs, so that pump actual output higher. So I think that's going to continue into next year. Don't expect that big jump in drilling activity.

Mark Zandi:                       Thanks Juan Pablo, that was very helpful. So that's risk number one, top of mind. And it feels like that can happen any day. It feels like oil prices can move 10 bucks a barrel in a week. So we've got to watch that very carefully. Let's move to the next, what could go wrong and I think chronologically that would be the UAW strike, is that right Mike? You want to explain what's going on there and when potentially they could strike, and let's talk a little bit about what the economic implications of that might be.

Michael Bisson:                Sure. The strike would start September 15th. We're recording right now. It's August 25th, 11:00 AM on the East Coast, and they should be announcing right now on Facebook Live that they voted for strike approval. So Sean Fein, the head of the UAW, he promised a more aggressive approach this time around to negotiating with the big three US automakers, that's Stellantis, Ford, and Gm. And they're expected to approve strike today, and the strike will go into place September 15th when their contract runs out. So digging in a little bit deeper this time around, they're going after all three automakers. They usually go after one. If you remember back in 2019, the United Auto Workers struck against GM for 40 days instead of striking against all three. This time they're targeting all three automakers instead of just one. So that increases the risk to the economy right there.

                                                The impact to the macro economy is somewhat limited. So we talk about what the risk is, there's risks to localities. So you think of auto manufacturing towns like Lansing, Michigan or Toledo, Ohio. There's a lot of risks for localities, but the risk of the macro economy from our investigation is pretty low. I think we used that 40 day strike in 2019 as our basis, and we saw that if they even increased it to all three, use the same duration of 40 days, it's still about three tenths of a percent off GDP in terms of economic loss from the strike. So it's not going to-

Mark Zandi:                       Would that be in the fourth quarter of the year annualized or is that just quarter over quarter? Is that annualized impact?

Michael Bisson:                No, just quarter of quarter.

Mark Zandi:                       So if I multiply by four, is that 1.2 percentage points off of annualized growth?

Michael Bisson:                But if it kept on going, but it's just going to be off that one quarter.

Mark Zandi:                       Right, right. If it kept on going, right. Okay. Okay. Yeah. Okay. But you're saying though, if it's a 40-day strike, it's going to shave three tenths of a percent off growth. I can't just annualize that to get to 1.2% roughly?

Michael Bisson:                If it's not annualized, so you wouldn't multiply it by four since the way it's calculated.

Mark Zandi:                       Okay. So you're saying it's three tenths off of growth in Q four?

Michael Bisson:                Yeah.

Mark Zandi:                       Okay. So meaningful, measurable, but not existential in any sense of the word. If it's a 40-day strike?

Michael Bisson:                Correct.

Mark Zandi:                       Okay.

Michael Bisson:                And right now, the likelihood of it going more than 40 days, I'd put that probably about 40%. A strike at all, I'd put about 75% likelihood. Just the way that both sides are talking right now. They're not anywhere close in terms of where they would need to be to get a contract passed. But at 75%, they still haven't said if they're going to go after one company, they're going to do all three. They have said that they have about 825 million in their strike fund, which gets paid out to workers at $500 per week. So if they had all, they have about 150,000 workers that all got paid $500 a week, that's 11 weeks that they could strike and still keep getting paid. So 77 days would be, and that's when the strike fund would run out if they're striking across all three companies. But of course if they only struck against one company, then that would increase the duration that they could have that strike fund.

Mark Zandi:                       So you're focused on the lost output. So they go on strike, cars don't get produced, and that lost output, and I assume the multiplier, so-called multipliers translates into that three tenths of a percent impact, which again is meaningful, measurable, but not existential. I guess the other concern would be in the current context, kind of like oil is the inflationary effects. So one of the thoughts, my thought was that vehicle prices are going to decline here over the next six, nine months, getting more supply primarily from Japan and Germany. They've had supply chain issues because of the pandemic and Russian War, and they haven't been able to ramp things up as quickly, but that's now changing, getting more supply, more inventory on dealer lots. Prices are starting to roll over and that's going to continue. This UAW strike though, feels like it would throw a monkey wrench into that, at least to some degree. Is that right?

Michael Bisson:                Definitely, yes. So the last strike that we used as comparison, GM reported they'd lost about 900,000 units from production from that 40 days. So if you take out, we multiply that by 3.17, be the size of the three companies. I take that out, it'd be about 30% of US production for the quarter, and that would really cut into inventories. Inventories are about 70% below where they were coming into 2019. We didn't really see any impact on prices when that inventories came off in 2019, but they were stock full on the dealer lots. Now dealer lots are less full than they were. They're more full than they were last year, the year before that, but they're less full than they were in 2019. And so you should expect to see used vehicle prices which have come down by 17% from their peak according to wholesale numbers. We expect to, if there's another 40 day strike, we'd expect it to go about another 10% on the used vehicle prices and new vehicle prices we also expect to see some increase in price, but not that significant. We're estimating about 5% for a 40-day strike.

Mark Zandi:                       Okay. Let me ask it this way. How long a strike would there need to be for it to push us into recession and assume like in Q4 without UAW or anything else going wrong, we're going to get growth that's kind of around one to 1.5% GDP growth. What kind of strike would take us in a negative territory, do you think? Would it have to last all quarter for that to happen?

Michael Bisson:                Yeah, it'd have to be over 90 days.

Mark Zandi:                       It'd have to be over 90 days. And you think if it was then if we'd come pretty close to that zero line?

Michael Bisson:                Yes.

Mark Zandi:                       Okay. All right. And of course, the fact that we have less inventory and now more higher vehicle prices or certainly not declining vehicle prices, that just makes it more difficult for the Fed to hold onto the current interest rate and not raise?

Michael Bisson:                If we have housing prices going up and auto prices going up. it's going to be tough to keep the pause on the interest rates and that's going to be the real impact if the Fed isn't able to keep the pause.

Mark Zandi:                       Right. And I guess, I suppose the other point here is that the UAW is just an example of increased labor market strife, right? I mean, we've got all kinds of labor it feels like compared to the history of the past 20, 25 years. A lot of labor market actions going on right now.

Michael Bisson:                Yeah, they see Success Union didn't see success at different companies. So you saw the UPS-

Mark Zandi:                       UPS.

Michael Bisson:                -Contract went through, they thankfully didn't have a strike where more supply chain issues would've happened, the Canadian port workers you see going on. And then when the unions see success in different places, I think that they call it the contagion effect where other labor unions hold out for better wages, hold out for better terms of agreement.

Mark Zandi:                       Okay. So let me ask you, what's the probability in your mind of a 40-day strike?

Michael Bisson:                Probability of 40-day strike is about 5%, I'd say.

Mark Zandi:                       Okay. And what's the probability of a 90 day strike?

Michael Bisson:                5%.

Mark Zandi:                       Oh, you think it's very low?

Michael Bisson:                Yeah.

Mark Zandi:                       Okay. Because they run out of cash and they want to settle.

Michael Bisson:                Anything over three months, I'd say is 5%. So maybe between two and three, 25. One and two, 45 less than one, 75.

Mark Zandi:                       Okay. I was hoping for symmetry you'd say 35%, but okay, fair enough. It's less of a threat than that.

Michael Bisson:                Yes, because they don't have enough in the strike fund to stay that way.

Mark Zandi:                       All right. Anything else on this you want to bring up before we move on to Bernard and the potential government shutdown as what could go wrong?

Michael Bisson:                Not unless you want to play the statistics game.

Mark Zandi:                       I do, I do. I do. We're going to play statistics game and I got a good one actually, but I want to do one more. What could go wrong and that's the government shutdown.

Michael Bisson:                before That, I just wanted to say, I got a news notification that I think they authorized the strike just a couple minutes ago.

Mark Zandi:                       Oh, do they? Okay.

Michael Bisson:                Yes. +.

Mark Zandi:                       All right. So Mike got that forecast right, is what you're saying?

Michael Bisson:                Exactly.

Mark Zandi:                       Way to go, Mike.

Michael Bisson:                I'll toot my own horn then, I guess.

Mark Zandi:                       Yeah, absolutely. Like Juan Pablo, like Juan Pablo says, my forecast was damn good.

Michael Bisson:                The pre-bills were coming at 95%, so I felt pretty confident on that one.

Mark Zandi:                       Yeah. But nonetheless, take credit. I heard a great story. I digress. I won't digress. I was going to tell you a great story, but I'll tell you some other time. Let's move on to the government shutdown. So Bernard, of course, the federal government's fiscal year ends at the end of September on October one. The new fiscal year, the government needs funding to remain open and continue do business and continue to operate. That needs a piece of legislation that feels like that's up in the air. So what are the prospects for the government shutting down on October one or at some point here in the year?

Bernard Yaros Jr:              Yeah, yeah. So I think before I get into that, I just want to set the stage just a little bit to see, just to show how we got here. Sure. If you had told me a couple months ago that we'd be talking pretty seriously about the risk of a prolonged shutdown, I would've been a bit surprised, not fully surprised given gridlock these days, but still a bit surprised because if you go back to June, president Biden signed into law the Fiscal Responsibility Act, which resolved the debt limit crisis, but it also established limits on federal discretionary spending for the coming fiscal year. So fiscal 2024 as well as for fiscal 2025. And originally, I think you me, everyone else, we were all hopeful that the spending limits would have reduced, if not eliminated the potential for brinkmanship over the federal budget for this coming fiscal year.

                                                And my assumption was just that Congress would without much fuss or in a reasonably graceful manner, they would pass the 12 annual spending bills that fund all government operations. And then all these 12 spending bills would sum up to the limits established by the Fiscal Responsibility Act. And this assumption of mine was partly correct because the Senate has done just that, but unfortunately it's the House of Representatives, which continues to be the problem child. Back in June, many house Republicans were dissatisfied with the Fiscal Responsibility Act because they want to cut federal spending more than the agreed upon limits in the Fiscal Responsibility Act. So in June you had a small block of Republicans who brought legislative action on the house for essentially to a halt for about a week. And this was overtly out of dissatisfaction to the debt limit deal.

                                                And so far they've only passed one of the 12 annual spending bills. So we haven't really heard much at all about government shutdown risks thus far. And that's because Congress is right now in its August recess, but the house returns from its August break on September 12th, and at that point they're only going to have three weeks left to pass their own 11 versions of those annual spending bills. Then they'll have to forge a compromise with the Senate before funding runs out on September 30th. So that's a very, very small period of time for some sort of a budget agreement for the next fiscal year to come about, especially when you have many Republicans who are just fundamentally dissatisfied with the limits on discretionary spending for these next two years.

                                                Historically, what we've seen, whenever it's rare that we get a full year budget on October 1st or by October 1st, what typically happens is that we get a continuing resolution or a short-term spending bill that will fund the government typically through mid or early December. And then by then you typically, that gives enough time for lawmakers to negotiate, come together and pass a bill that funds the government through the rest of the fiscal year. But because of really the extreme dissatisfaction that many in the Republican Party have shown towards the debt limit deal, I think there's a possibility that they want to really take a stand, shut the government down to really just show their constituents or show their supporters that they're really fighting for lower spending.

                                                And as a result, I think the risks of a shutdown of any length, I would say is about 50%. A shutdown lasting more than two weeks, and the reason why I say two weeks, because that's the typical pay period for a federal employee, I'd say probably a third, that we get a three week, four week shutdown, which would be similar to the record long shutdown that we got in 2018 and 2019. But I think there's a non-zero chance that we really do get another record-breaking shutdown, maybe a month and a half, two months. And we could also explore a scenario where it lasts the full quarter and those in that case, shutdowns, which generally have been non-events for the economy, I think would be a shutdown of that length would be potentially it would bring the economy to the brink.

Mark Zandi:                       Yeah, we had Matt Robinson on a few podcasts ago, a very good political analyst, and he scared the heebie-jeebies out of me. He seemed to be attaching a pretty high, I don't know if that's a word heebie-jeebie, but you know what I mean? He attached a pretty high probability, very high that we'd have a shutdown in the not an inconsequential probability that it would be prolonged. He was even contemplating it lasting through the end of the year and ultimately resulting that 1% sequestration that cut across all discretionary defense, non-defense spending that was put into the legislation, the Fiscal Responsibility Act you mentioned previously.

                                                But since then, my sense is that things are moving in a more positive direction that we've heard kind of sort from Kevin McCarthy, the house leader, speaker of the House, and even I think Mitch McConnell, the leader of the Senate Republicans saying they didn't really want to go down the shutdown path. They were contemplating because historically, if you go back and look, it feels like the Republicans got blamed for previous shutdowns. Politically, that doesn't feel like it's something you'd want to do, get blamed for that in the lead up to the next election. Do I have that right? Is that why you're talking?

Bernard Yaros Jr:              Yeah, you have that, right. We had the first presidential debate just a couple nights ago. So the presidential isn't-

Mark Zandi:                       Wasn't it this last night, isn't that presidential debate-

Bernard Yaros Jr:              Last night or two nights ago.

Mark Zandi:                       Oh, was it two nights ago? It's all a-

Bernard Yaros Jr:              Yeah, so the 2024 presidential election cycle is underway. So I think both sides are going to try to refrain from a brinkmanship where they could potentially be blamed by the public.

Mark Zandi:                       And a good rule of thumb, you've taught me this and I'm just going to regurgitate it back and sound like I know what I'm talking about, but every week the government is shut down, shaves about a 10th of a percent annualized off of GDP growth or GDP growth in the quarter in which it occurs, probably a little less than that in the first few weeks, but a lot more than that after 3, 4, 5 weeks. So if you kind of do the simple arithmetic, if the shutdown began on October one lasted through the end of the year, that would shave 1.2 percentage points off growth. And again, if growth without that was going to be one a half percent, that puts us right on the ledge for recession. Is that about right?

Bernard Yaros Jr:              That's correct. But the key thing is that as every week that this lasts or the longer that the shutdown lasts, the costs become even bigger and they become even more difficult to quantify. So the longer that the shutdown goes on, federal employees are not being paid, so they have to pull back on their spending. Then you have the whole constellation of federal contractors throughout the country who also start to see stoppages in the work contracts that they were expecting from the federal government. So they also have to lay off or they also have to tighten the belt. And then I think the most obvious to everyone is, for example, things like the national parks start to close. So areas in the country, tourism hubs in the country start to suffer from a lack of consumer spending. So over time, the costs really start to snowball, but it's just more difficult to game out what they are.

Mark Zandi:                       And just very quickly, correct me if I'm wrong. The longest shutdown was under President Trump for 35 days?

Bernard Yaros Jr:              And even that being the longest, that shutdown straddled two quarters, so the final quarter of 2018, where it shaved only a 10th of a percent or two tenths of a percent, and then in the first quarter of 2019, and again, that only shaved a 10th or two 10ths of a percent that quarter. So it was very much on the margins. But I also think one last thing that I think is concerning is that when you have a shutdown, all of our favorite government statistical agencies are also shut down. So we have a data fog, and that's problematic for financial markets, for businesses especially for us that rely on these key government statistics to get a sense of where the current state of the economy is. So that's-

Mark Zandi:                       It's more likely we'll be right. It's more likely we'll be right if there's no data. Yeah. Just saying. I had one other thing. Oh, one last question, Bernard. So how long a strike, or excuse me, shutdown, would there need to be, do you think, to push us into recession?

Bernard Yaros Jr:              It would have to last-

Mark Zandi:                       The entire quarter

Bernard Yaros Jr:              Through Thanksgiving, I'd say for that to really be-

Mark Zandi:                       Oh, okay. Oh, only through Thanksgiving. Okay,

Bernard Yaros Jr:              Thanksgiving, December, yeah, yeah,

Mark Zandi:                       Something like that. Okay.

Bernard Yaros Jr:              Yeah. And even if we get that 1% automatic spending cuts, it wouldn't help. But we still have to think that for this current fiscal year, we got a significant year, 10% increase in the discretionary budget, and about 40% of that is going to bleed over into these next two years. So that would help ameliorate some of the hit to federal spending. So we wouldn't feel that cut necessarily this next year, but over time, that would hurt and would be a drag on the economy.

Mark Zandi:                       Got it. Okay. Perfect. Okay, let's move forward. Let's play the statistics game, and then we'll come back to student loans and long-term rates. The game is we each come up with a statistic. The rest of us try to figure that out through clues and deductive reasoning and questions. And the best statistic is one that's not so easy, we get it immediately. One that's not so hard that we never get it, and it'd be great if it's apropos to the topic at hand. So Chris, I'm going to go with you because these other guys are novices, so I'll let you go first.

Cristian deRitis:                Okay. We'll start easy too again. Okay. It's not that difficult. 3.5%.

Mark Zandi:                       The unemployment rate. Okay. Is that it?

Cristian deRitis:                Close 3.3.

Mark Zandi:                       What is it?

Cristian deRitis:                3.3.

Mark Zandi:                       3.3%?

Cristian deRitis:                Months.

Mark Zandi:                       Oh, 3.3

Martin Wurm:                   Housing inventory.

Mark Zandi:                       I was going to switch. What specifically?

Juan Fuentes:                    Probably single family new housing at hand. That's roughly, I looked at housing statistics yesterday and I saw that number, but I don't remember quite what it was.

Mark Zandi:                       It might be playing a little bit with us, Martin. It might be like condo inventories or something.

Martin Wurm:                   No, no, I don't-

Mark Zandi:                       It's single family detached?

Martin Wurm:                   Is it existing or new?

Mark Zandi:                       Oh, no, it's existing.

Cristian deRitis:                It's existing.

Mark Zandi:                       Yeah, it's existing. Yeah. Yeah, that's a good one. So explain, that's a good statistic.

Cristian deRitis:                Yeah, so that number's rising a little bit, right? 3.3 months is still a very low level of months of inventory out there relative to history or pre-pandemic levels, but it's been increasing now over the last six to nine months here. So things have been steadily moving in that positive direction, but mostly because sales are so low, it's just that the level of sales activity is so low. It's not that you have a large number of people listing their homes for sale. Those inventories in absolute terms remain very low. So just going to the Fed policies and high interest rates, we have mortgage rates now, well above 7% on their way to probably seven and half, maybe 8% even. So that we're going to continue to see a slow-down in home sales for the foreseeable future. And so that's going to be part of the outlook here in terms of potential negative.

Mark Zandi:                       Do you think the increase in inventory is consistent with kind of the narrative we've been thinking was going to play out where because of life events, divorce, death, children, job change, that people they don't really want economically, they don't want to move because they've got a three and a half percent mortgage. If they sell and buy and get another mortgage, it's going to be at seven and the cost is prohibitive. So they're really holding on, but at some point there's no choice here. They got to move and that inventory build, we're starting to see, is a reflection of that starting to happen, or do you think something else is going on?

Cristian deRitis:                Yeah, I think that's certainly a big part of it. To your point, the lock-in effect is even larger now as the rates keep going on. So my incentive is even stronger to some extent, although it's already pretty strong if I have a three and a half percent mortgage. So I think there's that. You might have some shedding of second homes or investment properties to some extent, right? There is some weakness out there. Consumer's a little nervous about the future of house prices. You might see some inventory there, but that's pretty limited as well, right? There are not a lot of people with second homes that are looking to offload at this point. So yeah, I think it's going to be a long slow drag here to restore equilibrium.

Mark Zandi:                       I think we have prices down now 5% peak to trough. The trough being sometime in 2025. Okay. That was pretty good. Martin got that. I mean, I was going to say it, but he beat me to the punch, so that's pretty good.

Cristian deRitis:                Impressive.

Mark Zandi:                       Novice is really inappropriate. That was professional, I thought. Actually well done.

Martin Wurm:                   Just got lucky. It's only 50%.

Mark Zandi:                       Right. And humble too. See Juan Pablo. See how that's done? That's humble. That's humble. I'm only joking. I'm only joking. Mike, you're up next. I can't wait to hear your statistic. I'm sure this is going to be like-

Michael Bisson:                11.5 million.

Mark Zandi:                       Is it vehicle related?

Michael Bisson:                What do you think?

Mark Zandi:                       Oh.

Michael Bisson:                Auto assembly, please.

Mark Zandi:                       11 point number of units, cars, vehicles.

Michael Bisson:                It's a number of vehicles, but what number.

Mark Zandi:                       Okay, is that production? That's North American production of vehicles.

Michael Bisson:                US Assemblies of Motor Vehicles, latest reading as of August 16th, the highest that we've had in over four years.

Mark Zandi:                       Juan Pablo. Juan Pablo. You see how that's done? I'm just saying that's masterful, right?

Juan Fuentes:                    Yeah, yeah.

Mark Zandi:                       Greatest of all time. Of course, I said North American production, but he threw a little monkey wrench in there. It's US production. Are you sure, Mike? It's not North American. It's US?

Michael Bisson:                A hundred percent sure.

Mark Zandi:                       A hundred percent sure. I knew you going to say that. And your point is what? Why'd you bring that up?

Michael Bisson:                US production is above where it was in July 2019. So we are fully back. We were above 2019 total produced at this point for North American production. You got me saying North American, for US production. And so that's a signal that we will have more downward pressure on new vehicle prices and their substitute good used vehicle prices. If we're looking around the world, China, the largest producer of vehicles, they are above where they were in 2019. They are where they were last year, so they haven't slowed down production. Japan and Germany are both 20% above where they were last year. So we do have more coming online if we don't have a major strike taking all these inventories, we should continue to see pressure, especially on the new vehicle side of things.

Mark Zandi:                       That's great. Okay, perfect. That was a great statistic. Okay, I don't want to run out of time, and we've got a number of participants there, although I've got actually a pretty good one. I might save it for next week, but Bernard, Martin, Juan Pablo, who thinks they've got a really good statistic.

Bernard Yaros Jr:              I do.

Mark Zandi:                       I knew Bernard does. Renaissance man, baby, right? Bernard, you're next.

Bernard Yaros Jr:              16,000. And this statistic literally came out within the past 30 minutes. I've been refreshing the BLS page for this statistic.

Mark Zandi:                       Oh, the BLS page. That's a big hint. 16,000. Oh, I know. No, I don't know. Does it have to do with the UAW strike?

Bernard Yaros Jr:              No, but-

Mark Zandi:                       It's in the strike report?

Bernard Yaros Jr:              Yes, exactly.

Mark Zandi:                       But 16K is-

Bernard Yaros Jr:              It's the other big strike that's going on.

Mark Zandi:                       What's the other big strike that's going on right now? Oh, it's the Hollywood actors or writers I should say.

Bernard Yaros Jr:              Exactly. Exactly. So-

Mark Zandi:                       Wait, wait. Juan Pablo. I'm just saying.

Bernard Yaros Jr:              That was very impressive.

Mark Zandi:                       That is how it's done.

Juan Fuentes:                    That's impressive.

Mark Zandi:                       Thank you. He said that so nicely that it, Chris never says that to me. He never says that. It's okay. All right, Bernard, go ahead. Go ahead.

Bernard Yaros Jr:              So normally we don't focus at all on the monthly BLS strike report, but I think this is a month where we do need to pay attention because of all the strike activity. It's not just the forthcoming one potentially with the UAW, but we've had the writer's strike and we're now, but even bigger, we've had the actor's strike. I was actually expecting this to be a much bigger number because when you look at the media reports, it seems that the labor union, the SAG AFTRA Labor Union, that represents about 160,000 actors, recording artists and other media professionals-

Mark Zandi:                       Bernard, let me stop you for a second. I think they actually, in the work stoppage report, they do have that separate.

Bernard Yaros Jr:              They do. Yeah, yeah.

Mark Zandi:                       That's separate. It's in there. The hundred-

Bernard Yaros Jr:              That's separate. Yeah. Yeah. For the-

Mark Zandi:                       This is just the writers or something. Maybe?

Bernard Yaros Jr:              This is just the actors.

Mark Zandi:                       I'm sorry. Just the actors.

Bernard Yaros Jr:              The actors. And do you have two types of strike reports. So you have the work stoppages program, but that's just any strike that occurs in the giving month. But the BLS strike report, these are strikes that affect more than a thousand workers in a given establishment. And then these are strikes that occur throughout the pay period that includes the 12th of the month. So in order for someone who's striking not to be included in the monthly jobs report, they have to be in strike for the entire pay period, that includes the 12th of the month. And that's not normally the case strikes will, you'll have a few days or just depending on the timing, they might not show up. These strikes might not show up in the jobs report, but this Hollywood strike has been ongoing for the past several weeks. We expected it that it would show up in the August jobs report, and based on our preliminary forecast for August non-farm payroll additions was going to be 180K.

                                                But because of this strike report, we're now going to slash that down by little over 16,000. So I think we could get a pretty weak jobs number or weaker jobs, probably one of the weakest jobs number in a while. But I would just caution readers or I would caution the audience that that is in part, due to some of these strike activity, it's not necessarily saying anything about the underlying fundamentals of the economy. So that's, in this case, in the case of looking ahead to the August jobs report, I think this monthly strike report took on added importance.

Mark Zandi:                       Great. That was a good one and very timely. So Martin, JP, I'm going to just move on because running out of time and I want to get to the next what could go wrong, and let me now turn to you, Chris, and can you just give us an update on your thinking around the end of the student loan debt payment moratorium?

Cristian deRitis:                Sure. So unlike oil prices, interest rates, or even the UAW, there's no uncertainty about this one. Student loan payments are going to be restarting here in October. The moratorium actually ends at the end of August, and we have a month of September where statements will go out to borrowers telling them how much they owe and what the payments should be, where they should send them in. And then in October, they'll actually start submitting. We have about 24, we estimate about 24 million borrowers who are in forbearance today who will be at least eligible or required to start making payments in October.

                                                If we estimate about $300 as the average monthly student loan payment, that gives us around 7 billion a month or 86 billion a year. But I would say that that's the outside estimate of what the impact could be. That's if all of these borrowers did start paying that average amount immediately. It's a good reason to believe that actually won't be the case because of several actions that the Biden administration has put forward here. One is that it is told the credit reporting agencies to not report out the delinquencies of borrowers who do not make their student loan payments. So the impact on credit reports would be minimal at this point if a borrower does not start paying right away. That order would go through what would exist for a year with the possibility of being extended. So it limits some of the incentive, if you will, or the necessity of making a payment right away.

Mark Zandi:                       Can I ask on that one, Chris, before you move on, 24 million, what's your sense how many people won't pay? Because there's no real penalty for not paying, because the services aren't going to report that to the bureaus. It's not going to ding their credit score.

Cristian deRitis:                So my thought process is that there were people who weren't able to pay before the pandemic or certainly before, the moratorium there were people already in trouble struggling to make their payments is around 10, 15%. So I expect that same group here, even though there've been increases in wages and whatnot, that group is still facing a lot of financial pressure. These tend to be lower income borrowers, people who didn't necessarily finish their education, so they're not able to reap the benefit that would come from actually having a degree. So I expect that at least 10, 15% are not going to make a payment because they just aren't able to, they don't have the resources to, and that this additional executive order just makes that a little bit easier for them to make that decision. They're going to essentially, at a minimum, they're looking to extend some time here, maybe improve their finances and then start paying again as needed.

                                                But on top of that, another reason to believe that an even smaller share may actually start paying is that there are new repayment programs that have been introduced, particularly the SAVE program. So it's Saving on a Valuable Education, I believe is the acronym, which would reduce the amount that borrowers have to pay to 10% of their income this year, and then 5% would be the maximum they'd have to pay next year. Now, that depends on certain income qualifications, but that would reduce that $300 average for example down to maybe 250, right? So that's going to further reduce the impact here that restarting payments will have. So I'd estimate maybe it's two tenths of a percentage point on GDP.

Mark Zandi:                       Oh, okay. Just two tenths.

Cristian deRitis:                Yeah.

Mark Zandi:                       If it was the outside maximum, if it was 80 billion due to the arithmetic, that would be again, 1.2% of GDP, which would, because 80 billion out of 2.4 trillion is three tenths. Annualized, that's 1.2%. So you're basically at zero if everyone started repaying and they cut all their other spending consistent with that payment. And that's not going to happen. So you're saying after accounting for the income driven repayment plans after accounting for the fact that people just aren't going to pay because they're not going to get dinged after accounting for the fact that some have lots of resources, they're not going to cut back at all just because they're going to be shilling out $300-400 more a month. It comes out to two tenths of a percent. So again, like the UAW strike, meaningful, measurable, but not at all existential.

Cristian deRitis:                On its own, not enough.

Mark Zandi:                       On its own, on its own.

Cristian deRitis:                If we start layering all these factors in, right, we get an oil shock on top of this, yeah, certainly this is going to have some impact, but yeah if the student loan repayments are the only thing that happens, it's going to slow things down, but not materially.

Mark Zandi:                       And then one thing that folks are concerned about clearly in our world and some of our clients is does this mean that delinquencies on other liabilities are going to rise because cars or consumer finance loans, they're already suffering pretty significant increase in delinquencies default. Is this going to add to that to any meaningful degree?

Cristian deRitis:                It'll add some, yeah, I believe, but I think that again, because of that order for delinquencies not to really affect your credit, at least not in the short term, the payment hierarchy, the ordering of payments for student loans is probably going to be pretty low, right? I'm going to pay my auto loans and credit cards first because the impact is greater if I don't.

Mark Zandi:                       So it feels like, and we're going to go now to interest rates, but it feels like all these things we've been talking about are by themselves not enough to do us in. But obviously if more than one or a bunch of these things happened, that could be pretty quickly enough to do us in.

Cristian deRitis:                I think so. And they also are compelling, right? They'll drag on over time.

Mark Zandi:                       Yeah. Right, right. Okay. All right, let's turn to that last, what could go wrong, and I should, before we do this preface it by saying there's a lot of things that can go wrong, we're only picking off a few of them, the ones that seem most pressing most immediately given events. And next step is this recent surge, I don't know if surge is the right word, but this significant increase in long-term interest rates. So the benchmark here is the 10-year treasury yield.

                                                If I go back, I don't know, correct me if I'm wrong, Martin, four, six weeks ago it was sitting 3.75. The 30=year fixed mortgage rate was just north of six, something like that. Now we're sitting at four and a quarter, four three on the 10 year and the 30-year fix is now I think hit a new high. It's at seven and a quarter or something like that, 730, something that, so it's moved up quite a bit. So question to you, first question to you is what's behind this increase? And of course I'm going to ask what do you think where we're headed here in terms of the increase?

Martin Wurm:                   Okay, yeah. So 30-40 basis points in a month is a bit, it's also high-end level by based historical standards where a deal was around two and a half percent in the 2018's. Now the interest rate is a price like many other things. And the way economists think about this is in terms of supply and demand, it's the price that the treasury, for instance, pays to borrow over the next 10 years that lenders are requesting to basically be willing to lend. And over the past month or so, there's essentially three factors of play roughly with equal weight, I should say. The first one is the realization that the US economy is doing better, recession risks are fading, and that has caused the Fed to most strongly signal that rates will have to remain high. Fed has signaled that for a while, but markets weren't necessarily believing that as much.

                                                If you go back a couple of months, a lot of market participants still expected cuts either even late in 2023 or in early 2024. But now that's shifted pretty firmly as we discussed early and later the year. And longer term rates in part are an average of expected short-term rates. As this expectation rises, the long-term rate comes up a little bit. The second component is expected inflation. That was also already discussed. Yields are nominal, if I want 2% after inflation, I think expected inflation is two and a half percent. I have to ask and phenomenal yield of around four and a half percent. Oil plays a big role in this bond traders especially keep an eye on this because obviously it's an important driver of inflation. And the third component is a little bit more technical. That has to do with risk perceptions. Ultimately what is embedded in long-term bonds is what we refer to as a risk term premium.

                                                And that's basically the risk that you as an investor take on by locking yourself into say, a 10-year bond today versus holding 10 successive one year bonds. The reason why that is, broadly speaking, both of these strategies should roughly pay you the same amount, the same annual interest rate should be the same on both of these. But the problem is we don't really know what future interest rates are going to be, right? So I have to make a guess on what the one year is going to be, a year down the road, two years down the road and so forth. And financial markets do this all the time, but there's an error around that guess so if I'm getting that wrong, I may end up doing worse by holding a 10 year, which is fixed in rate.

                                                And that's the term premium. In essence, it is associated with all sorts of risks that we get inflation wrong, that the Federal Reserve becomes less competent in hitting inflation target, that there's more quarreling, for instance, about budget and so forth. The term premium is still very low by historical standards. So it's not per se a red flag, it's negative, but it did take up a little bit in the last four weeks and that contributes to rising in yields.

Mark Zandi:                       So it's a combination of inflation expectations, inflation volatility and uncertainty, so inflation generally. Second, you mentioned the term premium. That's the yield spread that investors demand for buying a long-term versus short-term bond, although weirdly it's negative, but we won't even go down that path. And the third is higher, real short-term interest rates because the economy feels like it's been performing more strongly and that's getting embedded in expectations around what the fed's going to do with short-term interest rates. And this run up, this half a point increase or so in long-term tenure treasury yields is due roughly an equal measure to each of these factors. Is that roughly right?

Martin Wurm:                   That sounds right. I mean the one that stick down a little bit in the last couple of days is the inflation expectation, but it's still a little elevated compared to where it was to a few months ago.

Mark Zandi:                       Okay, so say we're at four and a quarter, our baseline is this is it. We're not going any higher than this. I mean, in the long run, we expect the 10-year treasury yield to be equal to the nominal potential growth rate of the economy. Nominal potential GDP growth, which is 4%, 2% real GDP growth, the real potential growth of the economy, plus 2% inflation. And we're kind of sort of there. And this is a market, like any financial market, there's speculators and momentum players, so it can go above this for a while below this for a while, but right now it's 4%. So that's kind of our forecast.

                                                This is the end of the story right here. Fixed mortgage rates, they're elevated. The spread is very high by historical standards and we won't go down that path either. But in overtime, we expect that spread to get back to something more normal, which would suggest that the 30-year fixed rate loan should settle in somewhere five and a half, five and three quarters. And again, we're over 7%. That's the baseline. Does that sound about right to you and what are the risks to that for higher rates, lower rates here in the near term? What do you think?

Martin Wurm:                   Yeah, so there's two questions. So is near term and what's the equilibrium rate? In terms of near term, I think breaching something like 4.5% is pretty probable actually. And the reason for that is twofold. For one, there is still-

Mark Zandi:                       You see how you said that pretty probable. That's open to a gazillion interpretations of what pretty probable is. That in my interpretation, that's over 50% probability, is that right?

Martin Wurm:                   I would thinkso, yeah.

Mark Zandi:                       Okay, fine.

Martin Wurm:                   I'll give youmy thinking around that. I mean, we've already been at 4.36%, right? It's 15 basis points. It's not a lot. Expectations don't have to shift a lot. There is still a segment of the market as pricing a recession risk. So if you look at CME futures as a rough proxy, as of today, about 20% expected cut in March yesterday before the Jackson Hole speech was closer to 30%. So there are still traders in the market that have a more bearish outlook on interest rates. If recession rates continue to fall, which is our assumption, they're going to come around and that's going to shift expectations a little bit by pure market movements. Inflation risk, the energy thing comes up that also has the potential to push yields a little bit higher. And then of course the question is what's the Fed going to do?

                                                The Fed roughly has a sense that they are where they need to be. Economic data still kept accelerating through the second quarter, but monetary policy acts of lack, it might take some time for that to really fully play out. If the Fed is wrong about that or if they think they're wrong about that, there's always the risk that they're going to pivot again. So in factoring all of that, in just the shift from, we no longer expect a recession broadly versus most people in March expected a recession plus inflation risks plus the Fed pivoting. I would say at least breaching it is more likely than not. If it's going to sit there as a different question. So if you're going to end up at five point half percent, that's probably less likely. I think that's probably less than 50% significantly.

Mark Zandi:                       Because it is a market and it feels like it can move 15 basis points in an hour, getting four and a half that seems pretty probable is what you're saying.

Martin Wurm:                   Yes.

Mark Zandi:                       You're saying it's unlikely it's going to hang there to the degree that it would do a lot of damage?

Martin Wurm:                   Well, carefully, I'm going to say yes to that. I don't think that's unlikely. Of course, the problem in financial markets is always when rates raise above a certain level, things can break. We don't exactly know what can break. So there's uncertainty around, the risk is always there. That for sure, I don't think it's particularly likely enough.

Mark Zandi:                       Right, right. Okay. And what about my frame around where the tenure yields should be longer on the 4%, the nominal potential GDP growth. What do you think about that frame? Is that a useful frame? Do you agree with that?

Martin Wurm:                   I think so. So the way economists think about the long-term rate in general, it's the rate that prevails when the economies an equilibrium. So then there is potential growth is equal factual growth, whether you're not in recession, the economy is not overheating, nothing like that. And historically speaking, we don't know what that is because we're not usually at equilibrium, we have to estimate it. For most of the historical period, the estimates that you find since the 1960s for the real equilibrium rate, pretty much track potential growth. And so you add 2% inflation to that, that gives you the long-term value. There are some complications around this. If you look at estimates after 2008, they actually come in significantly lower. It's about a 50 to 100 basis point. A lot of that is associated with the Fed's quantitative easing. It's a city that the Federal Reserve went out and bought trillions of treasury bonds that may have depressed the level a little bit.

                                                Of course, the Fed has reverted that last year, at least in part is all offer trillion. And the question is, as that continues, is that effect going to go away? So that's one of the factors that plays into this. There's other factors that could go the other way. For instance, if the treasury keeps racking up debt hypothetically, so debt to GDP is pretty high. That's currently well over a hundred percent of GDP. If we keep racking up deficits, eventually credit risk becomes a problem. So lenders bondholders might be concerned about the long-term ability of willingness of the government to repay that. That would push the long-term rate up over potentially what it's right now. And there's literally three or four or five other theories that are out there that create a deviation. But for a bench mark, thinking about it in terms of productivity growth, population growth plus expected inflation, I think is a pretty good baseline.

Mark Zandi:                       Yeah. One last question, and this may be an unfair question. So what 10-year treasury yield do you think would be necessary for what length of period to do us in? And then the answer may be it depends on why long-term rates are higher. But answer that question any way you want to answer it. Or you could say, Mark, I'm not answering the question.

Martin Wurm:                   Yeah, I'm notreally-

Mark Zandi:                       Bernard will then answer the question. He is the renaissance man and he knows the-

Martin Wurm:                   So the reasonwhy I don't have an answer for that, I think if the conventional economic wisdom is correct, I don't think it would be a whole lot higher. I mean, you're looking literally at maybe in the vicinity of-

Mark Zandi:                       He's so good he could be 5th chair.

Martin Wurm:                   [inaudible]

Mark Zandi:                       Pretty probable.

Martin Wurm:                   Yeah, Basically I'm saying nothing.

Mark Zandi:                       Nothing.

Cristian deRitis:                He's data dependent.

Martin Wurm:                   It's data dependent. That's right. So the reason why I don't think if the current economic wisdom is right, if the Fed tightens a lot more, it's a bit like the oil price. So by where we think we are in terms of equilibrium, we look very restrictive. But of course the concern is, and Chris had spoken to this earlier, the labor market still looks by historical standards, very strong. Consumption is picking up and so forth. And maybe the thinking then is, well, it's possible that the neutral federal funds rate is higher than what it is. And if that's the case, then we are not actually that restrictive, which internal also means the tenure has room to go higher. The thing that I'm, from a practical perspective concerned because that's what I do, is how much can the banking system take, how much can the stock market take?

                                                And a lot of that looks stretched as we know. I mean, we've seen the banking turmoil in March. There's other areas of exposure. It's not just securities, it's CRE. A lot of that is going to come due next year. What's credit risk going to be if the tenure picks up on that as people try to refinance these loans? And it's a bit of a black box because in part, the data doesn't exist. And the thing about financial crisis is it usually only takes a couple of bad eggs. If you have one or two players that look really risky, it can infect the entire system. Quantifying that probability is hard. If that's going to hit a 10% at 50 basis points more or 75, it's hard to say.

Mark Zandi:                       Good. Yeah, I think that's a good answer. It's a tough one. Hey, we're at time, but I want to end with one last question to Chris. So Chris, you see how I kind of frame this what could go wrong? I picked my five likely candidates of what could go wrong here most immediately. If you had to pick another one, which, what would it have been? You are the relative bear. So I'm sure you're thinking about this all the time, and you've made the point that if we're going into recession, risks are so high because we're fragile, we're growing slowly, and there's a lot of what could go wrongs out there. What else would you throw into the mix that we didn't consider?

Cristian deRitis:                I think the top is just Fed makes a mistake here, right? Or a bit of a data fog or lags in the data. They're trying to do their best. They're juggling multiple objectives. So that would be top of the list. The one we haven't really touched on all that much is a credit crunch, banking credit crunch. We made it through the spring and looks like the banking system has settled down, but as Martin pointed out, there are still lots of risks to the banks out there.

Mark Zandi:                       I think that as kind of an evergreen, what could go wrong, these others are more here and now. But you're absolutely right. That's clearly a threat at any point in time.

Cristian deRitis:                And I see that as an accelerator, you get some of that interest rate hike activity going on, and suddenly CRE values are impacted and the banking system starts to unravel, right? So that's my preoccupation is that there are some additional risks out there that just get enhanced by even a relatively minor shock.

Mark Zandi:                       Yeah. Okay. Okay. Fair enough. I think we're going to call it a podcast. We covered a lot of ground and I'm going to toot my own horn. I thought this was a well-designed podcast, right Juan Pablo. You see how I do that? I'm going to take a little bit credit for that well-designed podcast, but only because I've got great colleagues who know what they're talking about and can really provide a lot of insight on all these topics. So thank you guys and dear listener, I hope you found this of some value and we will talk to you next week. Take care now.