Podcast Summary
Local insights and global expertise in real estate investing: Principal Asset Management combines local knowledge and global perspectives to identify the best real estate investing opportunities, while the Fed faces challenges in lowering inflation without causing a painful recession.
Principal Asset Management, as a real estate manager, offers a unique perspective with local insights and global expertise in public and private equity and debt markets. They aim to identify the best investing opportunities by combining local insights and global perspectives. Meanwhile, the ongoing debate in the macroeconomy is whether the Fed can lower inflation to its target of 2% without causing a painful recession or significant unemployment rise. History suggests this might be challenging, but some argue that the current economic situation, shaped by the pandemic and unprecedented fiscal stimulus, could be an exception. Despite this, the stakes are high as inflation remains persistently high, and the Fed is determined to bring it down, potentially causing economic pain. Our guest, an expert in the field, will provide further insights on this topic.
Navigating Inflation: A Narrow Path to 2% Without Recession: Goldman Sachs' chief economist sees a possible return of 2% inflation without recession, but it's a tightrope walk requiring labor market adjustment. The Fed aims to reduce open positions without raising unemployment, and a strong labor market could allow for slightly higher inflation.
Jan Hatzius, the chief economist at Goldman Sachs, believes it's possible for inflation to return to around 2% without causing a painful recession in the US, but it will be a narrow path and requires a labor market adjustment. The labor market is currently overheated, with a large gap between open positions and unemployed workers. The Fed aims to address this imbalance by bringing down open positions without raising unemployment too much. So far, there has been a significant adjustment in open positions without an increase in unemployment. The Fed is unlikely to accept inflation above 2%, even if it's only slightly higher, and a strong labor market would allow for a slightly higher inflation rate without tipping the economy into recession. The goal is for growth below trend with a decline in labor demand, which ultimately brings down wage growth and allows for inflation to return to around 2%.
The Federal Reserve's goal is to reduce inflation back to 2%: The Fed is addressing high inflation from commodity price increases, supply disruptions, labor market imbalance, pandemic impact, and underinvestment in commodities.
The Federal Reserve's primary goal is to bring inflation back down to 2%, as people generally dislike inflation. The current high inflation rates can be attributed to a combination of factors, including commodity price increases, pandemic-related supply disruptions, and the labor market imbalance. The ongoing Russia-Ukraine conflict and underinvestment in the commodity industry have been significant contributors to the sharp increase in commodity prices. The pandemic's impact on the labor market has also played a role, with job openings now playing a more central role in determining labor market balance. The labor market is currently overheated, and the Federal Reserve is working to address these issues. As a leading real estate manager, Principal Asset Management offers a 360-degree perspective, delivering local insights and global expertise to uncover compelling opportunities in today's market. Investing involves risk, including possible loss of principal.
Tight Labor Market and Surprising Inflation: The tight labor market, indicated by rising job openings and a high quit rate, has contributed to the current higher-than-expected inflation rates, along with unforeseen shocks like the Russia-Ukraine conflict.
The current high inflation rates have taken many by surprise, and while there are several factors contributing to this trend, there is still uncertainty about the exact causes. Some believe it's due to unforeseen shocks like the Russia-Ukraine conflict, while others argue that the underestimation of the labor market's tightness played a significant role. The labor market indicators, such as employment-to-population ratio and job openings, have shown concerning trends. The job opening data, while not perfect, is considered reliable by many economists, and the recent surge in job openings can be attributed to the labor market's tightness. The quit rate, another indicator, also supports the notion of a very tight labor market, although it's showing signs of loosening at the margin. Overall, the consensus is that we're in a very tight labor market, and the interplay of various factors has led to higher inflation than initially anticipated.
Labor market supply-demand mismatch: The labor market's current supply-demand imbalance is due to structural factors and a decline in job openings, which allows for rebalancing and contrasts with unemployment increases that can lead to recessions.
The labor market is experiencing a significant supply-demand mismatch, which has led to a slower employment growth and a lower employment-to-population ratio than before the pandemic. This trend is due to structural factors such as an aging population, early retirements, and a decrease in immigration. Additionally, the decline in job openings is not concerning as it allows for a rebalancing of the labor market, unlike increases in unemployment which can lead to negative second-round effects and potential recessions. Historically, large increases in the unemployment rate have been associated with recessions, but the current situation may be different due to inflation and fiscal tightening being the primary drivers of disposable income weakness.
Challenges for the Fed as Labor Market Heats Up: The Fed faces uncertainty in policy response if unemployment rises but inflation falls slowly, while anchored inflation expectations are crucial to prevent economic pain and inflation experiences similar to the 1970s and 80s.
While wage decisions are primarily influenced by nominal wages rather than real wages, the current labor market is considered overheated based on the high nominal wage growth rates. The Fed faces a challenge if unemployment starts to rise but inflation falls more slowly than expected, as it could indicate a recession but the correct policy response is uncertain. Inflation expectations, which are currently reasonably anchored, are crucial in helping the Fed bring down inflation without causing significant economic pain. If inflation expectations were to become significantly unmoored, it could lead to a repeat of the painful inflation experiences of the late 1970s and early 1980s.
Global inflation expectations remain anchored despite high rates: Global inflation expectations are surprisingly stable despite rising rates, driven by common shocks like energy prices. Labor markets and rental inflation vary between countries, with Europe's wage growth at 3% and US's at 5.5%, and US rental inflation decelerating but expected to continue by 2023.
Despite high inflation rates in many countries around the world, including the US, the inflation expectations remain anchored and consistent with a 2% rate. This is a significant upside surprise given the inflation indicators a year ago. The common shocks, such as energy prices, have played a major role in this global trend. However, there are still differences between countries, such as the labor market, where wage growth is accelerating in Europe but still relatively well-behaved at 3%, while in the US, it has moved to 5.5%. Regarding rental inflation in the US, it has been an ongoing upside surprise, but there are signs of deceleration, such as decelerating rents on new leases and the decelerating housing and labor markets. By 2023, it is expected that rental inflation will also decelerate.
Consumer spending resilient despite drop in confidence: Though consumer confidence has dropped due to inflation and gas prices, actual spending remains strong due to a robust labor market. Inflation is expected to decrease modestly, and the Fed will raise interest rates to combat it, with a predicted funds rate of 3.25% by end of 2023.
While consumer sentiment surveys indicate a significant drop in confidence due to inflation and rising gas prices, actual consumer spending has remained relatively resilient. This discrepancy can be attributed to the fact that the Conference Board consumer confidence survey places more emphasis on the labor market situation, which remains strong. For inflation, it is expected to decrease modestly through the end of the year and more significantly in 2023, with core PCE forecasted to be at 2.5% by the end of 2023. The Fed is expected to raise interest rates by 50 basis points in September, followed by two 25 basis point moves in November and December, bringing the funds rate to 3.25%. In 2023, the funds rate is predicted to remain at 3-3.5%. Despite market pricing suggesting significant cuts, the hurdle for cuts in 2023 is high due to persistent inflation. As a leading real estate manager, Principal Asset Management leverages a 360 degree perspective to deliver local insights and global expertise across public and private equity and debt.
Economic growth may face lower speed limit due to supply constraints: Persistent supply constraints in industries like commodities limit substitution and innovation, making it harder to predict broader macroeconomic picture, requiring a more micro focus on specific industries and their supply chains.
The current economic landscape, marked by tight commodity markets and cautious monetary and fiscal policies, may impose a lower speed limit on growth in the coming decade. This is due to the persistent issue of supply constraints in industries like commodities, which could limit substitution and innovation in the short term. Additionally, the economy is experiencing varying growth rates across different sectors, making it harder to predict the broader macroeconomic picture. These factors require a more micro focus on specific industries and their supply chains to understand their impact on the economy as a whole.
Balancing Demand and Supply in the Economy: Central banks and fiscal policymakers are working to balance demand and supply in the economy and labor market, with uncertainty around permanent changes brought about by the pandemic.
The economy's response to the pandemic and subsequent recovery has been complex, making it challenging to draw definitive conclusions based on partial indicators. The pandemic may have led to some permanent changes, such as increased office adjacent consumption and remote work, but the extent of these changes is still uncertain. Central banks and fiscal policymakers have learned from past economic downturns and have responded aggressively, but the risk exists of overcompensating and causing unintended consequences. At Jackson Hole this year, the focus will likely be on balancing demand and supply in the economy and labor market, as central banks work towards bringing the parts of the economy under their control back into balance.
Balancing Inflation and Recession Risk: Central banks face a challenge in managing inflation above target while avoiding a potential recession. Indicators of inflationary pressures include job openings and supply chain disruptions. Global economic situations and geopolitical events may impact the US economy and influence interest rate hikes.
Central banks are currently grappling with the challenge of balancing inflation that remains above target with the risk of a potential recession. This is a central question in macroeconomic policy, and the interpretation of the dual mandate, focusing on both inflation and maximum employment, is under debate. Indicators such as job openings and supply chain disruptions were warning signs of inflationary pressures in 2021. Looking ahead, the global economic situation, including potential recessions in the Euro area and Italy, as well as developments in China, will be closely monitored for their potential impact on the US economy. The pace of interest rate hikes could increase if inflation and labor market adjustments take longer than expected. Additionally, geopolitical events, such as the Italian election and the ongoing situation in Ukraine, could have significant implications for financial markets.
Economic Outlook: Uncertainty and Downside Risks: Despite ongoing discussions about inflation, the economic outlook is uncertain with downside risks to global activity. The labor market could be a concern, and the Fed faces a challenging decision about addressing inflation or a potential recession. Europe also faces high inflation, lack of wage growth, and bond market fragmentation.
The economic outlook remains uncertain, with downside risks to global activity despite ongoing discussions about inflation. Jan Hatzius, Goldman Sachs' chief economist, believes the risks to their forecast are skewed towards a lower growth rate. While there's a chance of a soft landing, it may require significant economic pain to bring inflation down from current levels. The labor market could be a potential concern, as initial claims and corporate layoff announcements have been increasing, even though the unemployment rate remains low. The Fed faces a challenging decision about which economic issue to address first: inflation or a potential recession. Europe, on the other hand, is facing its own set of economic challenges, including high inflation, lack of wage growth, and bond market fragmentation. The combination of these issues makes it difficult for European countries to bring down inflation while also narrowing bond spreads. Overall, the economic landscape is complex, and the path forward remains uncertain.
