Special Episode: Live from DCG’s 40th Annual Conference with Chris Low

Chris Low, Chief Economist at FHN Financial, joins the guys for a live appearance from DCG’s 40th Annual Balance Sheet Management Conference in Boston.  Throughout a sweeping economic discussion, Chris digs into the mindset of the Federal Reserve and what to expect from their upcoming meetings, inflation trends and why “time” could be the answer, confusion within the unemployment data, resilient GDP, and the outlook for lending in the banking industry.

For more insights and ideas, visit DCG at DarlingConsulting.com or follow us on LinkedIn.

Transcript

On the Balance Sheet S3E62 – Special Episode:  Live from DCG’s 40th Annual Conference with Chris Lowe

[Vinny, 00:05]

What does Bill O'Reilly say? We'll do it live?

[Chris, 00:07]

Yeah, let's do it.

[Vinny, 00:09]

Welcome to On the Balance Sheet. Very excited, our second live podcast with Chris Lowe. This is taking place here at the Marriott Long Wharf in Boston at the 40th annual DCG Balance Sheet Conference. Chris will be our keynote speaker tomorrow morning at the conference. We're so excited to have you back, Chris. Thank you for joining us. Thank you for trekking here, and thanks for taking the time to kind of enlighten us. I know our listeners love this.  Chris, I gotta start right here. This is as hard hitting as it's going to get today. You look at the Atlanta GDP now, figure it's over 3%. We have payroll reports now. We're going to probably get into the disparity between the payroll report and the Household survey report. But that report is showing 277,000 jobs. You got CPI greater than 3%. You got PC on the high end of the 2s. Why would the Federal Reserve ever lower interest rates?

[Chris, 01:04]

Wow. Vinny, Zach, thank you. Great to be here again. And with that, let's wrap it up.  (LAUGHTER)

[Chris, 01:12]

I think that’s the ultimate question - it doesn't make a whole lot of sense. So, here's their logic. Their logic is that if you look at the nominal level of Fed funds, that's not the right measure for how restrictive policy is. You have to look at real interest rates and if inflation, which did fall last year, if it continues to fall, then even without raising rates, the real rate is going up because you're subtracting less and less inflation over time. So that was the initial logic for saying in a a little while, very short while, we will start cutting interest rates and then, you know, as as you know, inflation got stuck, and if you look at the CPI, it got stuck in July last summer. It's been at 3%. It's a flat line. Now, the cores moved a little bit. The PCE arguably has moved differently from the CPI, but I think in some really important ways, the CPI is probably a more accurate measure, and I know I'll get in trouble for saying that, but I can explain if you ask. So yeah, I I think it's crazy to think about cutting, and I kind of lean towards Kashkari, who's been making some trouble out in Minneapolis, the Minneapolis Fed president who said, you know, policies, probably restrictive, but it may not be restrictive enough and maybe we need to tighten. And he's not the only one who suggested it.

[Vinny, 02:55]

Right now, it’s so interesting. He's he's clearly been in front of a microphone or two in the last month or so. One thing that's kind of interesting I, you know, think about that 2% CPI target. And I think it dates back to Bernanke in 2012 and then sort of adopting that and sort of… 

[Chris, 03:11]

That’s right, yeah.

[Vinny, 03:15]

So I get this question all the time when I travel to different institutions, they say, well, why is 2% the  target? So I don't know if you want to give a little context background to our listeners in terms of where, if 2% makes sense, the Fed has been explicit. I've heard, gosh, Kashkari explicitly say we're not moving the goal posts. I'm just kind of curious what your sentiments are on seat on the target at 2% and how long it may take us to actually get back to 2%.

[Chris, 03:40]

He here's the crazy thing, right? It it wasn't always 2. So, the actual mandate from Congress is full employment and price stability. And it was always understood that stable prices are prices that don't move. So that's zero, and zero was the goal for, you know, from the Humphrey Hawkins act until Alan Greenspan said, well, you know, 1 to 2%, that seems more realistic and maybe a better target, and actually, originally, it was 0 to 1 and then he went to 1 to 2. But I I I like Greenspan's original thinking for raising the target off of 0, which is, we don't want it at 0 because that would, ultimately, end up with a Fed funds rate that's too low, and we might go into a recession and not be able to cut. And that's happened twice now where we had to have this extraordinary balance sheet policy, which you know, as Bill Dudley pointed out, the last one, if you add up the bill on what it cost to run the balance sheet as big as it is right now and the interest they're paying on reserves to fund it, it's cost half a trillion dollars, 500 billion for that – right, for a couple of years of stimulus. And his question, is that worth it? So, that would be the logic for having some inflation in the system and then they went with 2 because they figured that was the biggest number where it wouldn't affect economic decision making. They don't want people making decisions about buying a house, buying a car, starting a business, investing based on this fear that inflation is going to make it more difficult to do later. They they want inflation out of it and at 2% that seems to work. Can they go to 3? Maybe someday. But I would argue, given that we just came out of this much higher inflationary environment, and if you look at surveys of voter concerns, for example, number 1 is the economy, number 2 is inflation. And if inflation is that high on the list of concerns, then you can never argue that it's not being taken into account in in business decision making, and therefore it's too high.

[Vinny, 06:00]

What do you think it'll take to get it back down? I mean, this is kind of like asking the crystal ball, yeah.

[Chris, 06:05]

Time. It just it takes time and there's this great illustration of it actually in the recent data, which is the biggest contribution to inflation right now in the CPI is car insurance. It's up 22 1/2 percent in in the last year, which is uncanny. So why is car insurance up 22 1/2 percent? Well, because in 2020 and 21, we had a shortage of microchips because of the pandemic, and we couldn't ship stuff. And then there was a drought in in Taiwan where they manufacture them. So, then what happened was shortage of new cars, then shortage of used cars, then price of all cars went up and people start driving older cars. They start getting into more accidents, and then the manufacturers are rushing to catch up. So, they're not making parts. They're making cars. So, the price of all that stuff went up, and the reason insurance now is so expensive and rising so rapidly is because the replacement cost of cars and parts is rising rapidly as a ripple effect from something that happened 3-4 years ago. So what? What it boils down to is when you have a period of high inflation, the price increases that you have in some places cause increases in other places, and it ripples through. Inflation begets inflation. And it's really hard to damp it down once it's once it’s high.

[Zach, 07:38]

Chris, how much do you think some of the things that maybe Kashkari is saying, or others, is like jawboning, like they don't really want to raise rates to 6, let's say, but they want to make sure the long end doesn't come down a lot more, or like cause I think that's a scenario with our bankers. We talked about it -  rates are gonna fall or the curves gonna, you know, bull steepen. But the curve going higher and maybe bear steepening up, yeah, probably not a great scenario. So how much do you do, you kind of look at that and think is that realistic or is it more posturing, you think?

[Chris, 08:08]

Okay, Zach. That’s the conversation that you have with the economists on the team who've been there for 25 years where you start getting into the weeds on what are they really thinking? And we have had that conversation, and I think it's spot on and it's not just Kashkari.  Williams does it in New York, and of course Jay Powell does it. The idea and and cash Garry's been really transparent on this. He doesn't think the Fed funds rate per se is the right measure of how restrictive policy is. He he comes right out and says real 10 year note yields, the tipped yield. So, why is that? Well, because the tips yield is inclusive of where the Fed funds rate is today, tomorrow and every day for 10 years down the road, and I think they what they're doing is they're jawboning. They know those rates should be higher because that that that they know we need restriction, they know inflation needs to come down. Last year they figured out it had to be a lot higher, but they don't want, they don't want to force the change in a day. They don't want to force a change in a month. So, what they're doing is they're jawboning – a quarter point at a time and then wait and see if the economy can handle it, and if we in the market run rates up 50 basis points, half a point in in a month, then they start talking about easing, and they talk it back the other way. And and I think that's exactly what they're doing. And when you look at where the curve is, how restrictive policy probably is, based on the way the economy's behaving and everything else, I honestly think fair value on 10s is  5%, it's not 4 1/2 which is where we are now – ball parkish.  And that last 50 basis points, you know, we actually touched 5 briefly for a day for a day we were at 5% last year and the economy stumbled. So, now we'll they'll slow walk us back to that.

[Vinny, 10:16]

What is your take, Chris? On the consumer, it it's interesting to me where the, obviously, consumer making us such a big part of our GDP, and and and you of these, it's almost like a tale of two sort of consumers. You have the ones who cite inflation as the second biggest issue in the election cycle, and then you've got the other consumers who are probably sitting there living off the interest in their savings accounts. What is your outlook for that for the consumer? Because the first cohort is kind of - you hear anecdotally, certainly all of us are influenced by it, but they're scaling back - the second cohort, there was an article in the Wall Street Journal last week on how older folks are paying through the roof to go on vacations and trips and so forth. I'm wondering what your, sort of, perspective and outlook is for the consumer.

[Chris, 11:02]

Uh, it's it's complicated, too, by the fact that we've got this unexpected population growth, there's more people contributing to GDP than we expected that we would see. And so, what what's happening is there's GDP growth, which as you said, is tracking 3% right now. Grew 3% last year, and then there's per capita GDP and per capita income not growing very fast as in the aggregate. Consumers are beating inflation on an individual basis. The average consumer is barely hanging on relative to inflation. And then there's rental income, interest income, and capital gains. People who have wealth are doing just fine, and then there's another group, too, which is retirees whose Social Security benefits are indexed to the CPI, which is rising faster than PCE inflation. So, arguably, they're beating inflation as well. I, you know, I I know people who are retired on a fixed income who've been complaining about not having enough money for 20 years, and all of a sudden, this year, they're like, yeah, things are pretty good, actually.

[Vinny, 12:17]

Yeah. Unless they live in Florida and they need a homeowners insurance home.

[Chris, 12:21]

Oh, my God. I I can tell you some stories there.

[Vinny, 12:25]

No, it's it's.so true. No,  thanks for that. I think it's it's so interesting because it's like the economy and this consumer just keep humming along. But then you see outstanding credit card debt. There's a lot of different things where you're going. Consumer sentiment. Yeah. Yeah.

[Chris, 12:35]

Consumer sentiment, which is lousy, and the University of Michigan, which survey sentiment, they break it down into 3 income cohorts. The the middle income, they're fine. Top income, they're actually happier than they've ever been and, It's the lower third that are just screaming, you know; they are not in good shape.

[Zach, 12:59]

Chris, what about jobs and, what I mean by that very vague question is, it seems hard to believe that the Fed would cut or you're in a recession without job losses and the job market still appears to be quite strong. What what are your thoughts of what? What's going on there?

[Chris, 13:12]

Well, yeah. I mean, there's two reasons to cut interest rates. One would be significant job losses, which we don't have, and the other would be, you know, inflation is so clearly down to target and at risk of going below target, which we actually don't have either, so it's yet another reason not to cut. And I think one of the biggest reasons they were gung ho to cut last year is that the Fed staff was forecasting a recession. A lot of economists on the street were forecasting recession, and and a lot of that is based on the anecdotal evidence, which has split from the real economic so, for example, the ISM surveys, which are business confidence surveys. Those turned quite negative, consumer confidence was negative. But then you've got big job growth, big GDP growth, clearly not a recession. So, I think you know what it adds up to is exactly what we've seen this year. The Fed said they would cut, but they're not cutting.

[Vinny, 14:15]

That's so interesting. You, you know, I'm kind of just curious. We're talking a little bit, you know, the Fed forecast had a recession and everybody was talking about a recession. I think this time last year we were talking about a recession. And if you've been betting on a recession, you would have lost a lot of money because just hasn't hasn't. I guess my question to you is you look at the last I guess really. 3 significantly inverted yield curves, with the exception of like sort of that COVID period. They've all ended very similarly, which is significant rates down recession. How doesn't that happen this time?

[Chris, 14:49]

Ah! That that is a great question, and I I I've been doing this now. She's 37 years, but. For 37 years, and this is a unique cycle. I started in the 1980s and in every single cycle, it ended because the curve inverted. Why? Because the Fed tightened too much, and they left the rate up too long because they thought that the target for Fed funds would be neutral would be the same as it was in the prior cycle. And it wasn't. It was always lower. Neutral always moved down. So, interest rates fell for 40 years, inflation fell for 40 years, and that was the story. And it it's it's not happening this time, right? Interest rates are higher than they were in the last cycle. And inflation is higher than the last cycle. So, if the curve is inverted, it's inverted for one of two reasons. Either the Fed sets rates too high and, you know, they they ultimately trash the economy and lower it to where it should be, or the alternative is the market has rates too low and that's why it's inverted. And I I think it is that very rare case where collectively we in the markets don't recognize that, in fact, neutral interest rates have risen so significantly from where they were before the the the pandemic. And why is that? Well, you know, what's the big thing that changed - what's happening now in this cycle that hasn't happened since World War two, and that is aggressively stimulative fiscal policy year after year after year. We're still running this huge fiscal deficit, which means the governments putting, you know, 1.6 trillion into the economy, that is not taking out, and the the Fed policy was, honestly, was pretty easy to do through most of my career. You could analyze how it would play out because fiscal policy was there were tiny changes from year to year, but never major changes. This is the first major departure since World War 2.

[Zach, 17:03] That’s a huge infusion, right, 5-6 trillion dollars. I mean it’s big.

[Chris, 17:07]

Ohh, it's it's enormous. No. And, and you know, I just saw what's his name? Dent. This economist who's best selling author predicting that the mother of all market crashes. And my CEO, I I love that you know, 5 minutes till I board my plane I get a text from him saying., “What do you think? Should I take all my money out of the market? And so, the thesis is actually really simple. There's these multi trillion dollar deficits, most of that money's going to corporations. It's allowing companies that otherwise wouldn't be viable to have monster market caps and the spigots are going to get turned off.  Is it this year? No. But is it next year or the year after?  Maybe, so you know, if if you think about it in those terms, there's this flood of liquidity that's going to go away, but it's not going away in, in an election year. So, it's not happening this year, this year it's going to be fine.

[Zach, 18:02]

In terms of the inverted yield curve, Chris, we're almost at 2 years, I believe with the 210. Yeah. Can you give our listeners a bit of a history lesson, how unique that is? And then also could we be seeing another year of this or two years of this or what, what do you think about some of those things?

[Chris, 18:16]

The the only time we came close to being inverted as long as this was in the late 70s, and in the very, very early 80s, between 1980 and the 82-83 recession. And what what's striking about that is that was a time when inflation was out of control, when interest rates had to go very high to contain inflation. And in the markets, we clearly underestimated how high interest rates had to be and for how long? So, if that sounds familiar, it's the story of the last two years. It's exactly the same situation. The big difference and the reason this inversion just, I mean last month, took out the prior record is because Paul Volcker went, you know ,he went nuts and and took the Fed funds right up through 20%. And Powell you know he he. we got to 5 ¼ , 5 ½, and decided that's enough and it's restrictive, and we're done, and that's why, you know, again, going back to Kashkari, maybe we need another couple of quarter points move you know, just to sort of shake the last kinks out of this thing, but I don't think we're gonna’ get it. I think the Fed is just going to be patient and wait it out. And the inversion, therefore, is more likely to end by traders saying, you know what, actually the economy is working just fine at this level of rates and take those long rates up.

[Vinny, 19:47]

Chris, just a follow up on the jobs question, I'm there's a couple of things that have just been on my mind and I'm sure everyone's sort of they've been in the press, too.  One would be the disparity between the payroll report and the household survey. That's a pretty wide disparity. It's almost like you drive a truck through it, and secondarily, I'm just kind of curious with the influence of immigration on jobs numbers like in, you know, in a, in a generic way, kind of how that's all playing out and how that's influencing sort of the unemployment rate and what we're seeing. 

[Chris, 20:26]

Yeah. So, I assume what you’re alluding to is in the last four or five months we’ve seen solid job growth in the payroll, and then you get months like last month where you had an outright hundreds of thousands of job losses in the household survey. I think I I added it up in the last three months, 40,000 jobs created in the household survey and it's about 600,000 jobs in the establishment survey, so it that it comes down to methodology - that in in the establishment survey, they actually know every company that pays unemployment insurance. Those are the ones who were surveyed, and they they're giving hard numbers that we paid this number of people last month. Now what's interesting is, that's far short of a total count because they're not picking up any 1099s, they're only picking up W twos. If you're technically self-employed and a good example of this is a 10,000 people who were let go in fast food included in California after the minimum wage went up, included 2100 drivers for Pizza Hut, and Pizza Hut is now using Uber eats and DoorDash to make those deliveries, so those are self-employed. Those are 1099s. They'll no longer show up in the establishment survey, but obviously that's somebody who's working. So, the household survey should be a bigger universe of people. It should be growing faster, but it's not. And I think the the the reason is, it is a survey. They talked to 60,000 households, so it's a tiny portion of the population and then they have to expand that up to 340 million or whatever it is now in the population. And to do that, they use population estimates from the Census Department. The census does a total count;  they count everybody in the country every 10 years and then basically lay a yardstick across that and assume that population growth is going to continue at that same rate into the future, adjusted for demographic stuff that they know like more people retiring, that kind of thing. What they miss, of course, is immigration. So, in the last three years, we know from a CBO study that was really very, very well done, that the number is about 2 million or 3 million, rather, it’s about a million a year who are coming in. So, 85,000 a month, And, therefore, the population's a lot bigger - it they're not inflating it enough. So, what that means is, in the households or employment is understated, labor force is understated, but the ratios, right, the labor force participation rate, the unemployment rate, where you've got, you know, the population blown up by the same amount in the numerator and the denominator of the population drops out, those are accurate, so what it tells you when you've got an unemployment rate that's risen from 3.4% to 4% in about 8 months, and you have job growth that's running at about 250,000 in that period, it's telling you that 250,000 isn't enough, that we have so much immigration right now that a neutral jobs number is 300 plus, that a neutral GDP growth rate is 4% ish, 3 1/2 to 4. You know, it's suddenly the numbers have to be a lot bigger and the reason we can't wrap our minds around this is that you know the native population growth rate in the US with a secure border is effectively 0 and that's why we thought the growth speed limit, the job speed limit was a lot lower. But if you're going to have a relatively open border policy and so many people coming in, then then you need more GDP and you need more jobs and the other way that's manifested in the jobs numbers is huge growth in part time versus full time and, huge growth in immigrant employment versus native born employment. Those of us who were born here are more picky about the jobs we take, the CBO, study again found that the immigrants who are coming in are very fast to enter the labor force and very fast to take a job. They just want to start earning cash as soon as they can, and then they'll worry about, “Is it enough?”, Whereas, those of us born here, wet tend to be picky.

[Vinny, 25:24]

Chris, it's a probably great segue. The the Fed is meeting this week. We're again at the, for our listeners, we're at the 40th annual DCG Balance Sheet Conference. One of the attendees was telling me that he's like, yeah, I listened to Crystal years ago and he said, you know, there's really 10 economic indicators that you know, I think the markets follow, but they can only focus on three at one time. So it seems like to me, as we there are really three things moving the account - whether it's CPIPC and job numbers, it seems like that's you see the 10-year flowing, ebbing and flowing with whatever information, how it's disseminated, we have the Fed meeting here actually Tuesday, Wednesday of this week. What are you going to be focused on, and what are you looking to hear out of the Fed at  this meeting.

[Chris, 26:08]

Well, the three things from the Fed, but four things on the day. We we we get them a CPI in the morning, and that will determine whether or not they enjoy breakfast because if it's a high number, you know, here's the crazy thing about the feds forecast, the way it's laid out and what they've told us they're going to do is based on everything being as good as it can be from now until the end of the year, right? I mean, they've told us all they need to see is inflation coming down in a credible way towards 2%. So, what is that? Well, actually, if if the numbers for the last, we've got four months already. So, if the last eight months of the year are .2, it's 3% inflation this year. Their forecast in March was 2.6. So, it's already too low. They're they're. So, there's three things I'm watching for in the meeting. The first one is the Forward Guidance in the statement. That was a bit saying, we don't feel comfortable cutting rates until we see more evidence that inflation is on a sustainable downward path. I I like the fact that it's written as a negative. We don't feel comfortable. They could even just give us a little bit of encouragement by by saying we will feel comfortable, flip it around,  and then the second thing I'm watching is the inflation forecast. I think 3% is is a reasonable number for the median for this year. I bet you it's like, they stick with 2.6 or they go with 2.8 like they'll they'll stay with an unreasonably optimistic number, and then the dot plot. There's three cuts in the dock plot now. I think they'll have two. And again, I I think if they were really honest, it would be one because maybe they can cut in the fourth quarter. But even Chris Waller, who's been Stalwart, he's one of the governors, and he's been absolutely Stalwart in echoing whatever Jay Powell sentiment is over and over and over again. And last time he talked about rates, he said, I I still think we can ease maybe toward the end of this year or the beginning of next year. So he's already talking about forget about this year, all together. Maybe we'll do it next year.

[Vinny, 28:27]

Yeah. I guess just one last thing, Chris, just sort of the outlook for lending, what you're seeing in terms of credit. Obviously, a lot's been made of commercial real estate and multi fam and some pockets, quite frankly, where you live. But just curious what your outlook is for demand in terms of lending. It seems like all the banks we’re visiting, it's pretty clear that things have slowed down.

[Chris, 28:50]

Yeah. No, they've definitely slowed down. And my thinking on that is there's there's a few things at Play. One is that with the Fed out constantly saying we're gonna cut rates, there's pent up demand for lending where people are thinking, well, why am I going to borrow today if I can get a a full percentage point lower by waiting a few months. I think the Fed has encouraged that weighting and of course, some of that is just jawboning to try to make this policy effective, but at the same time, I think we have seen enough projects delayed, particularly stuff that's related to green energy projects and related to chips projects where there's hundreds of billions in tax savings potentially at stake - that stimulus is not going to be there forever, and the people who wait too long to build and take advantage of that they're going to lose that opportunity and they know it. So, I think we're going to see selective building, and then in terms of, you know, real estate it, it depends where you live, you know there's multifamily shortages all over the country, but at the same time, New York City, for example, just you know, we changed rental laws in a way that was so punitive to landlords that, you know, some of the biggest landlords in the city are contemplating bankruptcy. They're hardly going to be taking out loans to put up new buildings in that environment. So, it it's going to happen in the places where, you know, the market is friendly and population growth is strong. Look at the southeast, that's where most of it will be.

Zach, 30:31]

Yeah, Chris, we really appreciate the time, and it seems like one of the themes for the, you know this and the the outlook is we just need some more time, right, to - see some of these things work their way through. It's - nothing's happening overnight, probably, but all these things, people are waiting and seeing. Is that a fair kind of?

[Chris, 30:45]

Yeah, absolutely it then. So, it's it's super frustrating when your job is to write about this stuff because when it moves quickly, you get to write something new all the time and it's exciting. But this is what happens when the Fed doesn't mess it up when they they get to a place where arguably OK, the inflation rate is stalling, but they've made good progress so far and they haven't killed the expansion and maybe actually they can pull off a soft landing, although they've stopped using that language, which is kind of interesting, but yeah, they haven't overstepped. They're tiptoeing. And because of that, you know, hopefully we can avoid the severe pain - the the job losses and business losses that come with the recession, which would be great. 

[Vinny, 31:35]

Thanks so much for your time, Chris. This was absolutely spectacular. I think we could keep going, but the cocktail hour has started. So, I think we should probably call it here, and and thank you again for your time. Thank you, Benny. Zach, a lot of.

[Chris, 31:48]

Thank you, Vinny, Zach.  A lot of fun. Appreciate it.

[Dana, 31:53]

On the Balance Sheet is a podcast produced by Darling Consulting Group (DCG). All views and opinions expressed by the hosts and guests, are solely their own and may not represent those of DCG. All third parties are independent entities and are not affiliated with DCG. This podcast is intended for informational and educational purposes only and is not considered as advice. All views and opinions expressed are based on the information available at the time, and may have changed based on current market and other conditions. For more information about DCG, please visit www.foundingconsulting.com or e-mail us at info@darlingconsulting.com. Today's background music is provided by John, Sid and Comma Media and can be found on Pixabay.com.

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