"Take the Under" with Dr. Lacy Hunt

In the first episode of Season 4, Dr. Lacy Hunt, Chief Economist and Executive Vice President of Hoisington Investment Management Company, rejoins the show for a timely and engaging discussion on what to expect from markets in 2025. Lacy delves into the reasons he would "take the under" on inflation, GDP, and unemployment vs Blue Chip economic consensus forecasts, why the US is "the strongest ship in the sea," how tariffs are not inflationary, and where he thinks interest rates will move this year. 

Disclaimer: Dr. Hunt's views expressed on the show are for educational purposes only and are not solicitation or marketing for Hoisington Investment Management Company.

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

Transcript

On the Balance Sheet S4E1 – Dr. Lacy Hunt – Hoisington Investment Company

[Vinny, 00:14]

Welcome to On the Balance Sheet, Season 4, Episode 1, and what a way to start 2025! We are so thrilled, for the second time, to be joined by Doctor Lacy Hunt. He is chief economist at Hoisington Investment Company. Lacy, how are you today?

[Dr. Hunt, 00:29]

I’m very well. Nice to be with you today.

[Vinny, 00:31]

And as always, we're joined by my colleague Zack Zoia, and I guess a great place to start - so many of the financial institutions that would be listening to our podcast and the ones that we work with around the country, you know, they're in the process of, most of them have probably finalized their forecasts and their budget for the year. I was at a bank in the Midwest earlier this week, who the ink is not yet dry, and they're kind of just waiting - and it’s funny how some institutions do that. But I was just looking at the median of the blue chip economic forecast. And and I don't know, say what you may about the blue chip economic forecast median, but here's what I found. The median GDP is 2.1. That's the forecast. The median CPI forecast for 2025 is 2.4, and the median unemployment forecast is 4.3. When I sit back, I say to myself, hmmm, that's kind of boring. So, I'm curious, Lacy, when you look ahead to 2025 and you see something like 2.1% GDP, 2.4% CPI, 4.3% unemployment, what are your thoughts on those numbers and what do you see? Are any of those, you know, in line with your expectations, or any of them way off?

[Dr. Hunt, 01:43]

 I would take the under on all three, and I think there's, I think there's several reasons why I would do that.  First of all, the Federal Reserve has engineered money and liquidity squeeze. It’s quite serious. The key variable that I look at is the modernized version of World dollar liquidity, which is the based on holdings of government based securities and  U.S. government securities owned by foreign financial  institutions, and if you view the American financial system or the global financial system as an inverted pyramid, world dollar liquidity is at the Max of the pyramid. And, basically, the United States is playing the same role today,  in a “de-facto” sense as when the world was operating in the Gold Standard. And the Fed is the central bank of the united states, but it’s also the the central Bank of the world. And historically, world dollar liquidity has risen since 1976 when we had sufficient comparable data. It has grown at 10% per annum and currently we are contracting at 10% per annum.  That’s the same as 20 basis points or 20%. It's a very restrictive monetary policy, and it is had not only a significant impact on money supply growth in the United States, but in all the major countries of the world. I prefer to look at money when it's de trended and in real terms. And right now, the US is negative over the latest four years, which I think is quite significant because there are long and variable lags, and also there is a very strong relationship between my de trended real measurement of money and what happens to real earnings of all hourly and salary employees, which is has declined in a 1 1/2 % rate now in the last (inaudible) years. So, when the Fed shrinks its balance sheet, it tends to drain liquidity from the rest of the world. It then forces, you know, other central banks to sell their government debt paying making them less liquid and in order to support their currencies. And so, this is a very monumental development and in negative territory now. But what is critical is the world dollar liquidity is still contracting, and we have a important illustration of that in what happened since September. The Fed cut the federal funds rate by 100 basis points, but monetary conditions actually became more restrictive because the modernized low dollar liquidity contracted, and so the Fed was was selling governments (debt), forcing the hand of other central banks to sell governments to support their currencies – the Feds production of the balance sheet then force the commercial banks to liquidate (inaudible).

Another critical factor that tells me to take the under is that economic performance in the world is abysmal. Absolutely abysmal. The EU used to be led by Germany, and German GDP declined in both 2023 and 2024. That's the first time that's happened in two decades. The German GDP is unchanged from 2017, once powerfully gone and somebody say, well, isn't China doing OK? Just posted 5% growth for last year. Unfortunately, when the premier team predicted that they would not hit the 5% target, they muzzled a very prominent Chinese economist for saying that the actual growth was only half of the published numbers. And  the telling thing that the Chinese situation is even worse is that it was reported today that the Chinese population fell again in 2024. They have a mismatch between young women and young men. Far too few women, plus the young women are very reluctant to get married because the economic conditions are so poor, and if they do get married, they’re not willing to have children. China's problems are very grave. It's massively overindebted. Europe is massively over indebted. They have poor demographics as well, and Japan seems to be doing a little bit better, relative to what it's done, but the fact of the matter is the Japanese economy is a wreck and the best confirmation of that is the extreme weakness that we're seeing in the Japanese yen, just as we are getting confirmation from a precipitous fall in the Chinese yuen. And one little thing about China is that today, the last night in trading in China of the long term, government yields reached a new all-time low. That doesn't happen by chance. It's a reflection of serious underlying weakness, and so I would, I think the outlook is not nearly as good as the consensus says.

[Vinny, 08:15]

I appreciate that it takes courage to kind of, you know, make a stand, doesn't feel like anyone on the blue chip economic forecasts on average are really kind of putting their nose out there with these numbers that all seem quite consistent with what kind of experiencing right now. So, I appreciate that. I guess I I just want to turn the focus domestically. In particular, I I went back and listened to the last time. And for those new to the podcast, we had a conversation with Lacy in a podcast dating back to March of 2023, and at that point in time, I was relistening to it I couldn’t help myself, I went back down memory road, if you will, and one of the things that you mentioned at that point in time was I believe the Fed will win the battle on inflation. And I'm really quite curious how you would characterize that battle today. What your outlook is for inflation, the numbers that are reported here for 2025, and lastly, so I guess this is a three-part question, forgive my indulgence, but lastly, is that sort of quasi 2% explicit inflation target? Is that reasonable?

There’s clearly folks in the media. I've heard Mohammad El-Erain talking about its being too low, they need to recalibrate, etc. So, I'm curious where you believe the Fed is in the fight on Inflation, what it looks like for 2025, and is the 2% target - does it hold the same water?

[Dr. Hunt, 9.:32] 

I think the Fed is going to hit the target and most likely under shoot the target. In other words, the inflation rate will move below 2%. Inflation is too much money chasing too few goods. And I just gave you the monetary statistic, the old money liquidity squeeze. Domestically and globally, and we have deflation in in China, the world's largest producer of consumer business goods and their currency is falling, which means that they're selling their production on world markets even less than dollar terms. And the other thing that is critical here - some people may say that what I'm about to say, to argue is outdated, but I've just done a complete reexamination of the relationship but, our factory use rate is down in the United States and for other large economic regions, the UK, (inaudible), and China. The US capacity utilization in the fourth quarter was below where we entered all of the cyclical recessions since 1967. And I was also able to identify that when the foreign capacity utilization tends to lead the US capacity utilization. So, when it goes down, it tends to pull the US down. We are strongest ship in the sea. And so, they have to move more of their product here. Also, people may say well, capacity only applies to 8 or 10% of the time. However, it's more than double that value added. It's our big ticket sector and when we looked at the relationships, we found that the best measure still of the cost of production is the amount of items and factories in the US involved, and the fact of the matter is that idleness is increasing around the world. So, an environment of restrained monetary conditions that we're not alleviating by the 100 basis point reduction in Federal fund rate and a worldwide capacity reduce the inflationary rate is gonna go lower. Take one final point. The  Consumer price index, to a very large extent, and even the personal consumption (PCE), to a lesser extent, are both overstated because  they're not properly capturing the rent component. And  we know, for example, from national rental price that list prices at December were about 6/10 of a percent below a year ago, whereas the rent component of these indexes is still showing again, you know slightly more than 4%. And so, if you make adjustments for the possible error in the rental policy, then we're actually below the Feds target right now.

[Zach, 13:15]

Lacy, it sounds like we're taking the under, as you mentioned, for the various reasons explained, and we're talking with bankers out there, community bankers, you know, regional bankers, too. It was, they're always worried about longer-term rates and what that means for lending rates, what that means for unrealized losses, bond yield, etcetera. Where do you think longer-term rates are going this year with the batch up of we were as low as 360 or so in the 10 year. In September, we hit as high as about 475, a few days ago, and we're sitting today, at about 460, you know, at time of this call.

[Dr. Hunt, 13:51]

I think we’re going to see more press in the short rates standard 25 basis point cut. I think I think we'll see the rates fall commensurately across the yield curve. We'll end up with basically the same slope of the curve that we have today, but it will be at lower levels.

[Zach, 14:12]

Lacy, I think part of that, too, is the curve really doesn't have a whole lot of slope in it at the moment. We’re, finally I suppose, positive at different tenors here. I mean, how long do you think that can last knowing that, I mean, from the banking perspective, spread is a good thing. It helps making the lending a little bit more profitable, usually. So, what do you think from I guess credit formation and just from a bank lending standpoint, does that portend if we do go down but stay pretty flat across the curve?

[Dr. Hunt, 14:39]

Well, I I don't think that you curve can normalize to any significant degree until we see a resumption in world Dollar liquidity growth, which then translates into an acceleration in the real trend adjusted month. And it's not just that, it's not just a world of liquidity and money are contracting domestically and globally, but the  bank loan situation is not good. And in real dollars, which is the way it needs to be looked at, bank loans and leases last year declined. And why shouldn't they, because money liquidity squeeze? And if you, if you look at the individual components of bank loans, the strongest category by far are the loans to the non-depository financial institutions and it a very murky category, but it includes a lot of folks that are very risky borrowers, and in fact, there's some intermediaries who come into the picture that are borrowing from banks and then need intermediaries are then lending on to the very risky players. So, for example, if you take out the loans and non-depository financial institutions, whole loans and nominal dollars rose only 1.5% last year. The inflation rate is as you said is close to 2.5%You cant move the economy forward. And another problem, I think, is not being properly weighted, is that the rates are really not affordable to our consumers and to our small businesses. Maybe just a large business, but one of the most important concepts I'm sure that you know it - Rule of 72. (Inaudible). You got your credit card loan rates for Prime borrowings for 22%. That means in 3 1/2 years, if you borrow 10,000, you pay 10,000 in interest expense. The consumer can’t afford that, and the small business loan rates are 10 by the rule of 72, you borrow 100,000. You're going to have to pay 100,000 in interest expense in seven years. (Inaudible.) I'm going to be able to have those kinds of returns. And so, what are we seeing? We've seen from the private estimators that the consumer installment loans surged to a14 year high in the fourth quarter. And we, we saw an uptick in the mortgage delinquency rates, I mean the mortgage delinquency rates in the third even larger one in the fourth. And the problem is that the rates are simply not affordable. And it is an indication of really how desperate the consumers and small businesses are because the rates that they're paying are exorbitant and they're really not reasonable from a viability standpoint. And so,, we shouldn't be surprised that the delinquency rates are increasing. Last year the charge-offs of consumer loans were up 50% from the year before. Also, consumer loans were up 50% from the year before, and this is an environment in which, as a result of the pandemic, Student Loans were all deferred until October. But they' now have to be paid, and January will be the first month, though, that the delinquencies will be counted as they give the 90-day grace period. So, the consumer is in very delicate shape. They've been spending, but they do not have, they do not have income. And they're paying far too high for the rates. Which tells  rates have to come down. Time is always uncertain, but it's it's not a healthy or normal situation.

[Zach, 19:07]

So, Lacy, what would stop this from happening? What I mean is, like does the end of quantitative tightening if that's going to happen soon, does that help with this, or do we just need kind of a reset?

Does there need to be the R word - some level of recession or some credit breakdown to kind of reset this whole thing so we can get back to a normalized type of environment.

[Dr. Hunt, 19:27]

But, when you have a serious inflation like we had in 20, 21 and 22 that has a devastating impact on our modest and moderate income households. Everyone suffers under inflation, but the two critical sectors really pile on to carry a heavy load for the country and raise households and so forth. Make sure the children get to school, properly taken care of; they're under severe pressure and the confirmation of that is number 1: they're paying these exorbitant rates to try to sustain their spending, but at the same time, they're divergent? That's simply not sustainable. And it's gonna take time. Another another difficulty is when you have an inflation such as we did, it led to an inordinately large increases in your big ticket, particularly houses and cars. And, depending upon the exact time you choose to use, but after adjusting for inflation, the home and car prices up 10 to 20% from where they were in 2019, and they're just not affordable. And so, it's going to take time to unwind. There are no - there's no quick fixes, and the path is not clear at all.

[Vinny, 21:23]

Lacy, Vin here again. You know, one of the things I'm kind of curious about and mentioned prior that I went back and listened to our our podcast from just about two years ago now. You had talked about, that there was really a fiscal or monetary partnership that existed when the Fed going back to 21, 22, and so forth, and then basically, you know the fiscal partnership basically fled the coop, if you will. I'm kind of curious if we think about fiscal policy moving forward. Is there anything that could be really stimulative with this new administration and/or counterproductive? Obviously, there's so much that's been made of tariffs and whether or not they are inflationary. Seems like economics 101 is yes, tariffs are inflationary. I'm kind of curious if you see anything on the fiscal front that's been sort of put out there that you think is, you know really could be, you know, helpful for this economy moving forward, U.S. economy moving forward.

[Dr. Hunt, 22:19]

Well, first of all, let's be honest, talk to have a little argument with you. I know it's a commonly held view that tariffs are inflationary, and if you do a very simple model under all things (inaudible) being equal, you would reach that conclusion. However, Certera Parabis that you really don't hold because everything's changing at the same time. That’s the Latin phrase meaning all things are equal .And when the President elect proposed tariffs in his first term, it had no inflationary impact because the bond currency markets led to an appreciation of - and as a result, the cost of imports went down in other areas where there were no tariffs: your foreign currency markets, you're going to adjust for the action and so, it wasn’t inflationary then and it will not be now. One of the great concepts that students of economics are taught is Ricardian law of comparative advantage, and Ricardo showed that if you have two countries, the one who has the lowest cost of production each of two commodities, you can still have favorable trade with another country whose absolute cost of production is higher of the two. However, that Ricardian model assumes that everyone plays by the rules of the game. In other words, you allow Adam Smith invisible lane to work (inaudible), but in the current situation, the Chinese do not play by the invisible lane, and they try to take additional share of global trade by not paying for patents, copyrights, and even cost reductions, interest rates, sometimes do not enforcing contracts in the line, and so, when you have that situation the law of comparative advantage does not hold. And what the world is allowing to happen to itself is that the world, then is bent to the will of highly government-controlled economy, China, which is more inefficient and so in the current environment, by forcing the market and its player to conform to the behavior that is expected under the general agreement of tariffs and trade, then you can improve the system efficiency. And so, I would attend that it would be just inflation, although there would be definitely price increases in the areas where you oppose the tariffs, but it's a revenue raising device. It's really not that important. The Trump tax cuts will be helpful, but given the fact that we're so indebted, it's important that cost reductions be achieved. And if that's the case, that will make the economy much stronger over the longer term. When President Reagan was through with his tax cuts in 1981, it wasn't until the mid-1980s that we really began to see the significant improvement. And so the programs could be could be very helpful news in the right direction domestically and globally, but this is something that does not work like waving a magic wand. And I want to make one other point that when you’re in an international trade situation, and one of the major players does not allow an invisible hand, then other countries like us who play by the rules, they're they're hurt as well. That's that's true for Germany, Canada, Australia, and a lot of other folks. And so, it's not just that the United States has been damaged by the mercantilist policies of China, but there are other critical players in the world that have been damaged as much or more in relative terms than we in the United States.

[Vinny, 27:09]

Yeah. So simply a matter of let, let's hold those accountable to play by the same sets of rules and see where it goes from there. Is that too, is that too simplistic?

[Dr. Hunt 27:19]

No, and and in this in this particular case, I thought that the fact that the incoming administration announced that they were going to impose the tariffs even before they were installed in office has already started to change behavior. And they want to negotiate and find a way to reach a common ground. And so, in, in large measure, then it a very astute move. Very astute. And in large measure, that's a way of saying you're going to tariff. But you know, it forces the bad actors to come to you and work out a deal in which you both can benefit, and one which the playing field will be more level. And that's a good thing.

[Vinny, 28:18]

It's kind of like when I was misbehaving as a child and my mother was trying to punish me, and then it was kind of wait till your dad gets home and then start the negotiation that so. You know, hey, one last thing, Lacy, to just kind of bring it all back together.

[Dr. Hunt, 28:31]

Yeah.

[Vinny, 28:34]

Talking about taking the the under on the blue chip forecast for GDP CPI, unemployment, so unemployment the under would be, meaning that we're going to see higher levels. Yeah. So, so I'm kind of you know, just I guess a two part question. I’ve always got these multi-phase questions. One would be the impact of immigration on that number, and then the subsequent maybe reaction to that number, if there's some deportation programs that are in place and, and just generally your comments on the outlook for unemployment.

[Dr. Hunt 29:11]

Well, I think the I think the unemployment rate is gonna move higher and. I don't do any sort of scientific analysis, but last month there were 1.6 million people that have now been unemployed for more than , for 27 weeks, and that's very, very critical because unemployment compensation is only paid for  26 weeks. So, Up until now, the firms have laid people off - people have not been, the layoffs are very low, but those folks have not been able to find new jobs. So, there's very little new hiring, and I also want to say that I think that the non-farm payroll survey, which is probably one of the most widely watched and impactful of all economic data appears to have been considerably overstated in 2024, was overstated in 2023, but even more so now. The source here is something called the Quarterly census of Employment and Wages, the QCEW - it comes out with a 5 month lag,  so at this point in time, we only have data for through March and June of of 2024, but in the June quarter, the non-farm payroll overshot the QCEW by a record percentage was all the way back to 1976. The QCEW is the full samples, 12 million institutions. The non-farm payroll is only 670,000 institutions. And so, like that, I think that the labor markets are actually weaker. And another thing, another dichotomy, if you look at the non-farm payroll, the BLS, is telling us that firms have been hiring while they have dramatically been cutting the work week. In fact, the work week, in final quarter of last year, was below where it was when we entered the recession. It was called the GFC recession. So, and I think the drop in the work week is a reflection that firms have been substituted full time employees for part time, and there's less Pay and less non-wage compensation. And so there is even inconsistency in the payroll survey. But I think that the job gains have been terribly overstated. And because the work week has fallen so precipitously, your real weekly earnings with hourly and salary people, as I said to you earlier, has declined 1 1/2% per annum in the last four years, it's up point 0.7% in the latest year, but that does not reflect the QCEW data which suggests it is not up, it’s  back down.

[Zach, 32:39]

Lacy, thanks so much for, I know we spent a lot of time here and kind of jumping around with questions, but that's all we had. You know, for you today. We really want to hear your thoughts on, you know, obviously the economy, GDP, inflation, unemployment and then kind of your your rate outlook. We're we're really pleased that you're able to join us today; we're really happy with with that. I know our listeners are going to love hearing from you, so not much else from us. Is there anything else you want to say before we go?

[Dr. Hunt, 33:02]

No, no, no great questions. Thank you very much. Have a great new year.

[Zach, 33:09]

Thank you. You as well, Lacy.

[Vinny, 33:11]

Best of luck to you, Lacy.

[Zach, 33:11]

Take care.

[Vinny, 33:11]

Thank you so much for your time. Take care.

[Zach, 33:14] 

And we are back Vin, what an interview. I mean, Lacy's the best. I always love hearing, you know, how deep he gets into things in his worldview. What was your takeaway?  1, 2, 3 takeaways.  Whatever you got, given given kind of that performance that he put on and teaching us a lot, a lot of new things, I think, and for our listeners probably a lot of new things too.

[Vinny, 33:33]

Well, Zach, I think, for starters, I - it reminds me, these conversations, of how little I know about economics. I mean Lacy has just a wealth of knowledge and you know, we obviously could have been talking to him for a very long time. And he was so generous with his time today, but I guess the easy take away for me is how sort of sobering his forecast for the economy is moving forward. Also, I have a lot of appreciation for the fact that he was pretty definitive as well. You know, takes courage to kind of say, Hey, rates are going this direction and we are commonly referred to the the blue chip forecast is really quite, just more status quo, if you will, of what the market’s kind of looking at right now. So, you can't help but look at some of the the data points that he suggested and as to why and how they're going to influence a lot of those different ratios domestically and internationally as well.  I mean, he spent some time talking about that, so. I think it's very timely, this interview. Like we said at the outset of this thing, so many different institutions are still kind of thinking through things. And if you take a hard listen to this, you might change your outlook and, really, your strategy for your balance sheet moving. Forward What about you, Zach?

[Zach, 34:40]

Now, 100% agree and I think for a lot of banks too, like the budgets are pretty flat for the year on rates, maybe one or two cuts seems to be where the mainstream is. But you talk to a lot of bankers and, at least in my in my conversations, I know talking with you guys and your clients, people think something is going to change, like somethings going to break. Either we're going way up. Or we're going way down, and clearly Lacy's in the camp of we’re going  down. He pretty much set a parallel down 100 from we're going to use a modeling term, you know, from interest rate risk models. But I think one of the things here that I kind of took away was he mentioned the piece about inflation, which I think is kind of the Boogeyman of, well, that reignites that's a problem. He's kind of saying, inflation is defined as, was it, too much money chasing too few goods and his whole kind of deal about the world dollar liquidity and even the money supply which he's been talking about for forever, I think are in the same alignment of that’s not going to be a problem. Macro level, right? And I would definitely tell our listeners, too, that he went into detail on a number of concepts that aren't what we talk about everyday. So, go to his website. It's the Hoisington Investment Management company website. And he gives quarterly economic overviews that gives you charts. It gives you a number of things there, and he gave us a ton of charts, too, that we could, that we're happy to share if anybody wants to see them, that will dig into some of these type of acronyms and things he's talking about. But I just thought that the inflation piece seems to be where people kind of get unnerved about, and he seems to think that that's going to get, you know, taken care of, you know, overall here. So, I it's always a pleasure to hear what Lacy says. We could talk for 30 more minutes about some more takeaways, but I just thought that was a really interesting view and, obviously, he has the whole debt thing. He's always been talking about how debt, too much debt, slows down growth. It's it's future consumption pulled to today, and he's still at the end, right? I was talking about how that's a problem, right? If we, the debt is still one of those things hanging over us that I think cast a shadow over why we we’re not seeing rates keep going higher. And we’ll see. it's always a pleasure talking to Lacy.

[Vinny 36:44]

Sure was. So, I hope you folks enjoyed that and look very much forward to you joining us on the next On the Balance Sheet.

[Dana Bernier, 36:54]

On the Balance Sheet is a podcast produced by Darling Consulting Group (DCG). All views and opinions expressed by the host 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. It is not considered as advice. All views and opinions expressed are based on the information available at the time. It may have changed based on current market and other conditions. For more information about DCG, please visit www.darlingconsulting.com or e-mail us at info@darlingconsulting.com. 

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