Why the U.S. is on the Precipice of a Recession — ft. Mark Zandi

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Speaker 10 All right. Welcome to Property Markets.
It is our final day of Scott-Free August. We're going to be taking a break on Labor Day, but then we will be back to our regular scheduled programming.

Speaker 10 Until then, today we are speaking with our friend Mark Zandi, who is the chief economist of Moody's Analytics.

Speaker 10 We're going to discuss a lot on this episode, including your outlook for America, which you recently published, Mark.

Speaker 10 We're very happy to have you on the show. Thank you for joining us.

Speaker 9 100,000 hairs? 100,000. I may have 5,000 hairs on my opinion.

Speaker 10 I shaved all mine off.

Speaker 10 Well, it's good to have you on the show. Thank you.

Speaker 10 I want to... jump right into it because we read your U.S.
Outlook, which you published recently.

Speaker 10 There was a lot in there, a lot that I found very interesting and a lot that I found very concerning, to be honest.

Speaker 10 And I'm just going to start, I've collected a few quotes from your report and I'm going to start with the opening quote, which I think really sums it up.

Speaker 10 You said, quote, this is actually how you opened the report. This is what you said, quote, the economy is on the precipice of a recession.

Speaker 10 While our baseline most likely outlook does not feature a downturn, the economy is struggling and it wouldn't take much to push the economy over.

Speaker 10 Really getting right to the point there.

Speaker 9 Give us the headline. I like that now that I hear it again.
I like that first line.

Speaker 9 Well done, Mark.

Speaker 10 But not very good news.

Speaker 10 Let's hear

Speaker 10 your summary, and then we'll get into some of the more fine details.

Speaker 9 But your summary of that outlook. Yeah, I mean, the economy is struggling.
Pick your statistic.

Speaker 9 GDP, that's the value of all the things we produce. That grew just over 1% in the first half of the year.
That's pretty punk. It's consumer spending.

Speaker 9 If you add up all the spending done by everybody after inflation, it's gone nowhere this year.

Speaker 9 In fact, it's down a little bit from where it was at the end of last year. Construction spending is falling, and that's despite the boom in construction-related data centers.

Speaker 9 Everything else is falling. Manufacturing activity would be consistent with recession in manufacturing.

Speaker 9 And most importantly, obviously, is jobs. The job market has really kind of hit a wall.
Job growth in the last few months has come to a standstill.

Speaker 9 Hiring is really,

Speaker 9 it's almost like we have a hiring freeze across the country. Layoffs are low, and that's good.

Speaker 9 And that's the kind of the firewall between the struggling economy and a recession when businesses aren't lying off, so no recession yet.

Speaker 9 But when the economy is struggling like this, when it's having a hard time growing, it's when it's vulnerable to anything anything that might go off script.

Speaker 9 And, you know, goodness knows, there's a lot of things that could go off script.

Speaker 10 And yet, if you look at the stock market, if you were to look at the NASDAQ or the SP, we're at record highs, that's telling quite a different story, no?

Speaker 9 Yeah, that's hard to square that circle. I mean,

Speaker 9 there's a couple of things to keep in mind. One is the stock market is being driven to a significant degree by the stocks of a few tech companies, Magnificent 7, AI-driven.

Speaker 9 They run on their own dynamic. They're independent of what's going on with regard to the business cycle.
So

Speaker 9 you got to abstract from that. Of course, the big beautiful bill has some pretty significant tax cuts for businesses, corporations.
So just by definition,

Speaker 9 that's going to lift stock prices after tax. Earnings are now going to be higher.

Speaker 9 It's also important to realize that a lot of the companies, the big companies that are publicly traded that certainly are in the S ⁇ P 500, which is the index that most people look at, they get a lot of their revenues from overseas.

Speaker 9 It has nothing to do with the U.S.

Speaker 9 So it's a broader measure of things. But having said that,

Speaker 9 if you take out all those kind of caveats, I'd say the stock market is basically, here it is, punk, flat. It's gone, it's not down.
That would be consistent with recession, but

Speaker 9 it's gone nowhere fast. And that's consistent with the economy that we're experiencing, one that's kind of going

Speaker 9 sideways here. So, you know, not great, but not bad.
Now, I will say, I mentioned layoffs as being a firewall between the punk economy and the recession.

Speaker 9 Another is the stock prices.

Speaker 9 If stock prices were to correct, if we did see, say, the S ⁇ P 500 down, let's say 10% and it stayed down for a month, two or three, that would be one of those things that would push us into recession because that's off script.

Speaker 9 And consumers, particularly high-end consumers, the well-to-do, are very focused on their stock portfolios.

Speaker 9 And if stocks go down and they feel less wealthy, many of them are older in retirement or close to retirement, they'll pull back on their spending.

Speaker 9 Consumer spending, instead of going flat here, will go down. And that's recession.

Speaker 10 Yeah, it's striking that, and you point this out in the report, that basically all of the gains that we're seeing this year, because the S ⁇ P is up.

Speaker 9 we can't dispute that, we're up 7%.

Speaker 10 Basically all of the gains are because of AI. I mean, that is essentially what is juicing the entire market right now.

Speaker 10 And we're seeing that both in the increases that we've seen this year, but also just the concentration. I mean,

Speaker 10 we discussed this in our episode last week, but the fact that NVIDIA is at nearly 10% of the entire SP, that's a completely different story from all of those things that you have described.

Speaker 10 I mean, NVIDIA has only so many employees at the company. Meanwhile, you've got nearly 400 million people living in America.
Those are two very different stories.

Speaker 10 Yet NVIDIA and the tech stocks and the AI stocks, they have this massively outsized impact on the way we perceive how the economy is doing and the extent to which we are dependent on the tech stocks and the AI stocks.

Speaker 10 I think that is the scary part of this, which is why I think your recession risk model is so important.

Speaker 10 I mean, last week we saw this study out of MIT, which said that basically a lot of companies aren't seeing returns on their gen AI investments. And suddenly we saw the markets,

Speaker 10 you know, not freak out, but certainly there was a wobble there, which emphasizes this point that you're also making, which is AI is the story here.

Speaker 10 But if we were to see something even worse, if we were to see a correction that really took that leg out of the stool when it comes to AI, then we're running into trouble.

Speaker 10 And I just want to read you your quote from the report here.

Speaker 10 You said, quote, our machine learning-based leading recession indicator puts the probability of a downturn beginning in the next 12 months at 49%.

Speaker 10 Since 1960, the indicator has accurately predicted an ensuing recession whenever it has risen to more than 50%.

Speaker 10 And there have been no false positives when the indicator has breached the 50% threshold and a recession has not ensued. So what you're basically describing is you have this model.

Speaker 10 Every time it's hit 50% or higher, recession has happened.

Speaker 9 We're at 49%.

Speaker 9 Yeah,

Speaker 9 I'm not making that up. That's the result.

Speaker 9 And,

Speaker 9 you know, I don't want to overstate my confidence in the, you know, models are good. They're useful.
But, you know,

Speaker 9 there are all kinds of problems, issues with models. But it's pretty telling.

Speaker 9 And if we're not

Speaker 9 at 49%, we're pretty darn close. Feels like we're in a pretty precarious position.
And I should say,

Speaker 9 you can go look at all the tried and true kind of leading indicators of recession, and they're all kind of saying the same thing.

Speaker 9 You know, if you look at the, say, the conference board leading economic indicator, which has been around for decades, that's been falling consistently over the last couple of three years.

Speaker 9 And in the past six months, it's fallen very sharply, consistent with the recession. The yield curve is inverted.
Consumer confidence is weak.

Speaker 9 One kind of esoteric leading indicator that I find useful is that if you go look at the Bureau of Labor Statistics jobs report for businesses, the employment survey, the payroll survey, there's 400 roughly industries that BLS canvasses when they construct

Speaker 9 the employment estimate. Every time the percent of those 400 industries that are reducing payrolls is more than 50%.

Speaker 9 So more than 50% of industries are reducing payrolls, we go into recession, and we're over 50%, we're 53%.

Speaker 9 So it's almost like you pick any leading indicator you want. And my machine learning recession indicator is

Speaker 9 a new indicator based on these new statistical techniques. But go take a look at all the kind of tried and true ones that we've been using over the years, over the decades.

Speaker 9 They're all saying that roughly the same thing. They're saying this economy is really,

Speaker 9 I use the word precipice, on the precipice of recession.

Speaker 10 My lazy response to that, when I think about

Speaker 10 what is the cause of it, why are we in this position? My lazy, but I think probably accurate response is tariffs.

Speaker 10 I mean, if I were to think about what are the big shocks that we sort of sent into our economy in the past six, seven months, it's that we put up near 20% tariffs on everyone around the world.

Speaker 10 Is that it? Is that what's causing this?

Speaker 10 When you look at what's causing these issues and these heightened recession risk, what do you think is the cause?

Speaker 9 I think what ails the economy is pretty clear. It's policy, economic policy.
You mentioned the tariffs and trade. That's kind of at the top of the list.

Speaker 9 The effective tariff rate now is 10%, up from 2% at the start of the year. It feels like it's headed to 15% to 20%.
You said 20%, but

Speaker 9 in that kind of directionally in that ballpark. That's where we're headed.
And that's going to pass through.

Speaker 9 That's going to, that's starting to pass through in the form of higher prices, higher inflation. And that's going to be very clear what's happening over the next six, 12 months.

Speaker 9 And as that happens, that's going to undermine going back to the consumer, people's purchasing power and spending. And that's the fodder for a downturn.

Speaker 9 Of course, immigration policy, highly restrictive, is having an impact.

Speaker 9 It's really done a number on the labor force. If you go back a year ago, the foreign-born labor force was growing 4% or 5% year over year.
Now it's falling.

Speaker 9 This began last year when Biden put in the executive, put it, had an executive order

Speaker 9 constraining or limiting asylum seekers coming into the country. And of course, President Trump has double, tripled down on that.

Speaker 9 But with no labor force growth, with the labor force growing nowhere, that's putting real significant pressure on the economy as well.

Speaker 9 In sectors that really need immigrants, agriculture, construction, transportation, distribution, leisure hospitality, retailing, health care, elder care, child care, all these things, all these industries really depend on those immigrants.

Speaker 9 And if you can't find those folks, we see disruptions and higher higher prices and weaker growth and so that's also contributing and obviously the doge cuts the department of government efficiency those cuts have haven't had an impact uh that'll become even clearer in coming months as many of those government workers who lost their jobs got deferrals or severance packages and as those things come to an end they'll show up in the data as a as a job loss and so it's the policy writ large that's the the issue But I agree with you.

Speaker 9 I think tariffs are at the top of the list. You outline this in the report.

Speaker 10 And I have this other quote I want to read you here in regards to tariffs.

Speaker 10 Quote: Based on a counterfactual simulation of our global macroeconomic model, assuming that none of these economic policies had been implemented, US real GDP would have been 1.1 percentage points higher by the end of 2025.

Speaker 10 Our baseline forecast with the policies in place puts real GDP growth at a meager 1.1 percent on a year-over-year basis.

Speaker 10 Without the policies, growth would have been 2.2 percent, which is consistent with its potential.

Speaker 9 So again,

Speaker 10 you put the policies in place, growth gets cut in half. Get rid of the policies, you're back up to more than 2% GDP growth.
Tell us what went into that. I assume tariffs are a big piece of it.

Speaker 10 Perhaps the immigration policy as well. Perhaps the Doge cuts, though I'm sort of...

Speaker 10 hesitant about that because I feel like Doge didn't really do that much in the end in terms of the overall economy. But

Speaker 10 what's going into that model there?

Speaker 9 Number one is the tariffs.

Speaker 9 You know, a good rule of thumb is that for every percentage point increase in the effective tariff rate, that reduces real GDP by seven, eight basis points in the subsequent year.

Speaker 9 So if we went from two,

Speaker 9 let's say to say we go to 15, let's just let's just say 15, that's a 13 percentage point increase. You do the arithmetic, that's a percentage point off of growth, GDP growth.

Speaker 9 That's the bulk of what's going on in that simulation. The effects of immigration also weigh, but those become much more significant as we move towards the

Speaker 9 latter part of 26, going into 27 and 28.

Speaker 9 And I don't know that I push back too hard on your comments about Doge. That's just more about jobs.

Speaker 9 It has had an impact. If you go look at, if you look across the country and look at which regions of the country are struggling the most, at the top of

Speaker 9 the list of recessionary economies is the broad DC area. DC, deep recession around Maryland, Virginia, very, very slow economic growth.

Speaker 9 And that's consistent with the idea that the Doge is having an impact. And those job impacts

Speaker 9 are already evident in the data. It's one reason why job growth has slowed quite sharply so far this year.

Speaker 9 But that'll become much clearer as all those severance and deferrals wind down and start showing up in the data. And that'll be second half of this year going into next.

Speaker 10 Just in terms of inflation itself, so we're at, I think our last reading was 2.7%,

Speaker 10 which isn't, I mean, it's not great. The Fed target is 2%.

Speaker 9 But it's not horrible.

Speaker 10 And of course, we just had this Jackson Hull speech from Jerome Powell.

Speaker 10 It appears that he's probably going to cut rates at the next meeting in September. At least that's what traders are betting on.

Speaker 10 But you point out, and I think this is really important, and I'd like to hear again what went into this.

Speaker 10 You point out that if we had not implemented these policies, these very inflationary policies that are tariffs, you say that we would be at 2% by Q2 2026.

Speaker 10 And the prediction in your model is that at that point, we're going to be at 3.4% inflation.

Speaker 10 And that to me, I mean, we'll see. And as you say, you never know with these predictions, you never know with these models.

Speaker 10 But to me, that that basically summarizes what I've been saying for the longest time, which is, of course, these tariffs are going to raise prices. And the reality is it's going to take a while.

Speaker 10 They're not going to suddenly flip and go to 3% overnight. It's going to take months and months and months.
And your model is saying it's projecting out to Q2 2026, 3.4%.

Speaker 10 So take us through those predictions as well.

Speaker 9 Yeah, I mean, there's been a lot of debate about how much of the tariffs will be passed through to consumers because some of it will be eaten by U.S. businesses in the form of lower profitability.

Speaker 9 They just won't pass it all the way through. They'll just lower their margin.
And some of it will be borne by foreign producers.

Speaker 9 The poster child of that so far has been Japanese automakers haven't they have a 15% tariff, but they haven't passed that through yet. My sense is that

Speaker 9 by this time next year, when inflation peaks, the bulk of the price increases will have been passed through, that two-thirds, three-quarters would be passed through to the consumers.

Speaker 9 It's just taking a little bit of time, in part because the tariffs, the stated tariffs, are all over the map. You know, they're up, they're down, they're all around.

Speaker 9 So if you're a foreign producer looking at that,

Speaker 9 you're concerned that if I raise prices now and the tariff goes away, then I'll be wrong-footed. I could lose market share, and I don't want to do that.

Speaker 9 So I'll just eat a little bit of this for a while, see where the tariffs kind of land. Once they settle down, I know where they are, then I'll pass through the tariff increases.

Speaker 9 And I think that's the kind of in the minds of most CEOs that are trading with the U.S. globally.
You know, there's also,

Speaker 9 you know, this is harder to prove, but I suspect.

Speaker 9 that companies, particularly bigger, publicly traded companies, really don't want to get into the political spotlight around price increases you know it's that that's a pretty uncomfortable place for a ceo to be and so i think they're just taking their time uh and uh you know

Speaker 9 eventually those price increases will happen it just won't happen it'll happen more on the radar screen not uh you know not publicly so that don't they don't get called out um the other thing i point i'd make that that forecast i just you just articulated with regard regarding inflation and growth that does assume we don't go into recession right i mean that we are on the precipice, but we never actually go over.

Speaker 9 Because if we actually go over into recession, then we have weaker growth, but also weaker inflation. So

Speaker 9 there's a lot of different scenarios on how this can all play out.

Speaker 9 The scenario I just described in the piece that you're quoting from is one that's sort of my baseline, most likely, that we kind of squeak through without an outright economic downturn.

Speaker 10 Trump Powell even acknowledged that point at Jackson Hollow. He said, yes, tariffs are raising prices.
And, you know, to your point, it's, it's happening slowly and kind of quietly.

Speaker 10 And a lot of companies and a lot of CEOs don't want to cause a stink about it because they know they're going to get the wrath from the king. But that is exactly what we've seen.

Speaker 10 We've seen Walmart raising their prices. We're seeing Amazon raising their prices, not making an announcement about it.

Speaker 10 The only way we find out is when a team of researchers goes in and looks at the price and says, yes, we saw a little increase in these products here and these products here, all of these products that are largely affected by tariffs, i.e., we import them from abroad.

Speaker 10 Given all of that, and by the way, just to be plainly honest, I completely agree with you.

Speaker 10 There's no way prices aren't going to keep rising if the tariffs remain as they are. It's 100%, in my view, going to keep rising.

Speaker 9 Businesses are also

Speaker 9 strategic when they raise prices. Take the automate.
They're going to wait till the changeover in the model year because in the changeover in the model year, they always raise prices.

Speaker 9 But this year, they're going to wait there. They're going to raise prices, but they'll raise them more than they typically do because that's when they'll try to account for the effects of the tariff.

Speaker 9 So

Speaker 9 that's why, in my view, we haven't seen those price increases coming out of the automakers yet, but they will come. They're just going to come in a more strategic point in time.

Speaker 10 Totally. And also, you're not going to immediately raise your prices by 10 or 15% if there's a chance that the tariff is going to be revoked

Speaker 10 the next week. I mean, you need to wait until you know.
It's the same thing that I've been saying about Jerome Powell.

Speaker 10 He needs to wait until he knows what the story is.

Speaker 9 No one knows what the story is yet. And yet, at that speech at Jackson Hole, he

Speaker 10 said that essentially rate cuts are on the table in September. And he pointed to the employment data.
He looked at the labor market. But

Speaker 10 I just, I wonder what your views are on that speech and on the possibility of a rate cut.

Speaker 10 If it is true, as you say, and as I would agree with you, that prices are set to rise and it's probably going to come end of this year, maybe very, very beginning of next year in quite a big way.

Speaker 10 If we're on track for 3.4%

Speaker 10 by Q2,

Speaker 10 and here we have

Speaker 10 this dovish position coming from Jerome Powell saying we're probably going to cut rates. What are your your thoughts on that?

Speaker 9 I think it's reasonable for the Fed to cut rates at the September meeting. Now, we got one more jobs number coming out between now and then.
So let's just see what that says.

Speaker 9 That'll have some impact on whether they actually cut rates or not. But I think

Speaker 9 the way I would frame it is the Fed's so-called reaction function has shifted.

Speaker 9 They put a weight on inflation above target. They put a weight on unemployment above full employment.

Speaker 9 Usually those weights are roughly the same, but now they're putting more of the weight on unemployment than inflation. And a couple of reasons.

Speaker 9 One is they kind of sort of view the inflation as more kind of one-off, that you get this price increase related to the terrorists, but doesn't persist, cause persistent increases in inflation going forward.

Speaker 9 That's a pretty tricky thing to get right, but okay, that's okay. But here's the other thing that matters more.

Speaker 9 They desperately, they, the Fed, and Chair Powell in particular, does not want to go into recession. Think about the political pressure that he will face if we go into into recession.

Speaker 9 He's already, as he should be, very worried about Federal Reserve independence. What's going to happen if we actually do go into recession

Speaker 9 and the Federal Reserve is blamed? And what does that mean about

Speaker 9 Fed independence going forward? So they're kind of they put it on a much higher weight, and again, I think appropriately so, on

Speaker 9 growth, on unemployment,

Speaker 9 where unemployment is relative to full employment than the inflation numbers, at least at this point in time.

Speaker 9 And in that context, it makes sense for them to start cutting rates at the September meeting. Go slow, because again, you have to be worried about inflation becoming entrenched and persistent.

Speaker 9 So maybe you cut a quarter point each quarter until you get back to something that's more consistent with

Speaker 9 a policy neither supporting or restraining economic growth, so-called the neutral rate,

Speaker 9 but still you cut rates.

Speaker 10 We'll be right back after the break. If you're enjoying the show so far, be sure to give Profit Markets a follow wherever you get your podcasts.

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Speaker 10 We're back with Prof G Markets. Just sticking on the Fed here for a second.

Speaker 10 This week, we've had some pretty shocking news.

Speaker 10 The president firing the governor of the Federal Reserve, Lisa Cook.

Speaker 10 You know, the accusation of mortgage fraud,

Speaker 10 these are all allegations right now. Nothing's been actually brought to the court.

Speaker 10 We haven't even seen a formal charge yet.

Speaker 10 I'm not trying to make a prediction on whether or not she's guilty, but the point is he's firing her for something that has not been proven, which is, you know, notable.

Speaker 10 Your reactions to the pressure that the Federal Reserve is receiving from the administration right now. And one thing that I've been thinking about, about, which I'd like to get your reactions to, is,

Speaker 9 you know,

Speaker 10 this is a very political issue.

Speaker 10 And I would imagine it's hard to model these kinds of things out as an economist. You know, your job is primarily to assess the data and the numbers.
And here we have this very kind of

Speaker 10 I don't know how to describe it other than political. It's sort of a soft issue.
You can't really quantify what the threat to the independence of the Federal Reserve actually is.

Speaker 10 But if it truly is under threat, as many people are concerned, then,

Speaker 9 you know,

Speaker 10 how do we quantify that? I mean,

Speaker 10 what is the hit to the markets? What is the hit to the dollar? What can we expect, perhaps in the bond markets, perhaps in the stock market itself?

Speaker 10 I mean, how do we model all of this out and how do we quantify this? What are you thinking about as an economist?

Speaker 9 Federal Reserve independence is under a lot of pressure.

Speaker 9 President Trump has made no bones about it. He wants lower interest rates and he wants people at the Fed that

Speaker 9 have views that are consistent with that. That is an affront to the principle of independence of the Federal Reserve.

Speaker 9 And I do think that the Fed independence, like the independence of any central bank around the world, is a cornerstone of a well-functioning economy.

Speaker 9 If you have a Fed that's been, let's say, captured by the executive branch and is making policy based on political as opposed to economic decisions, historically, and we've got a lot of case studies here, even here in the U.S., Nixon, Arthur Burns would be the best example, that that always ends up with interest rates being too low, which ultimately leads to uncomfortably high inflation.

Speaker 9 That's the result.

Speaker 9 And it never ends well. It always ends with, at some point, much higher interest rates in a much weaker, diminished economy.
So we really don't want to go down that path.

Speaker 9 I think we've learned that lesson over the decades across lots of different experiences here and abroad. So

Speaker 9 I think this is a major concern, a very significant issue. Now, I have not changed my forecast for what the Fed will do as a result of this, at least not yet.

Speaker 9 And maybe that's why markets really haven't reacted yet. And I think the key here will be who does the president

Speaker 9 nominate to be the next Fed chair? As you know, Fed chair Jay Powell's term is up in May of 26.

Speaker 9 The President Trump is going to put forward a nominee here sometime before the end of the year. And a lot rides on that choice.

Speaker 9 If the choice is, you know, and I don't have any insight here, but I'm just going from press accounts.

Speaker 9 If it's Scott Besant, the Treasury Secretary, Kevin Hassett, the head of the National Economic Council, even Kevin Warsh, who was on the Fed under Bernanke many years ago during the crisis.

Speaker 9 You know, they would be viewed as

Speaker 9 solid individuals with an appreciation of the need for an independent Federal Reserve. And I think we can feel reasonably confident,

Speaker 9 trust but verify, kind of confident that they're going to

Speaker 9 maintain that independence sufficiently that

Speaker 9 my forecast won't change. Now, if it's somebody else, we'll have to see who that is and what that implies.

Speaker 9 But that probably is kind of the inflection point for when everyone kind of wakes up and says, Hey,

Speaker 9 we got a problem here.

Speaker 9 Forecasts are going to change. It means higher inflation.
It means higher long-term interest rates, probably, because long-term bond investors don't like inflation.

Speaker 9 That's, you know, something that's, it's kryptonite to a bond investor. They're going to ask for a higher interest rate.

Speaker 9 It's going to mean a weaker dollar because foreign investors are going to have some real reasonable questions about the safe and haven status of the u.s and its management uh the how things are being managed and there are already some questions about that so i but i think that's the key here and we'll we'll see how this plays out but at this point uh ed i have not i've not changed my forecast when you look at the inflation of pretty much any third world country in the world and i i i'm saying this because You know, this idea of central bank independence and capture of the central bank, This isn't like

Speaker 10 a fairy tale that we're imagining. This is a thing that regularly happens in societies, hence why people are so worried about it.

Speaker 10 And when you look at the charts of inflation in basically any third world country where you've had rampant inflation,

Speaker 10 look at Turkey, for example.

Speaker 9 Yeah, it's a poster chart.

Speaker 10 What you found is, you know,

Speaker 10 there is a larger-than-life

Speaker 10 president, bordering on dictator, who installs

Speaker 10 a loyalist into the Federal Reserve, captures the central bank, installs the loyalist in there. And then, as soon as that happens, the inflation literally skyrockets.

Speaker 9 It goes up like this.

Speaker 10 And,

Speaker 10 you know,

Speaker 10 this has happened so many times, and it's such a tried and true playbook. We see it so often in politics

Speaker 10 that it feels as though I always try to check myself and make sure that I'm not being a larmist and make sure that we're not

Speaker 10 getting too worked up over something that isn't really likely. But it feels as though this is one of those things that is like actually quite likely or actually quite probable.

Speaker 10 Maybe likely is too strong. But the idea that Trump would put a loyalist in the Federal Reserve and they just do exactly what he wants in terms of interest rates, cut rates, cut rates, cut rates.

Speaker 10 And then we have rampant inflation, which is already being pushed by the tariffs.

Speaker 9 I mean,

Speaker 10 we're increasingly going away from a fairy tale scenario to something that could actually happen in the very near future. And to your point, markets haven't reacted that much as of this recording.

Speaker 10 My belief is basically you can't fire her. I mean,

Speaker 10 you have to have a cause. It's not going to go through.
It's going to be litigated in court. But how probable is it that we could have have that sort of third world inflationary outcome?

Speaker 10 Is that us being alarmist? Is that us being

Speaker 10 biased and just having some level of Trump derangement syndrome? Or is it like an actual possibility?

Speaker 9 How probable do you think this could be? I think low probability, that kind of scenario, you know, I think

Speaker 9 I don't think this is a cliff event and I wouldn't articulate it as such. It's not like the Fed's captured.
We know what that means exactly, and it affects policy, and immediately you get inflation.

Speaker 9 Okay. There's a long lag here, a lot of pro.
It's more of a corrosive, I would think. You know, it plays out over a period of years.
And inflation expectations, you know, have been well anchored.

Speaker 9 So

Speaker 9 that can change quickly, but so far, so good. So I think it's, that's not a likely scenario.
It's a scenario, likely, but I don't think it's a

Speaker 9 likely scenario.

Speaker 9 I think a more likely scenario is that, you know, you get into next year and the economic data would say, oh, okay, the funds rate should be, the federal funds rate, that's the rate the Fed controls should be 3%.

Speaker 9 That's that equilibrium rate I was talking about earlier, that rate where policy is neither supporting or restraining growth.

Speaker 9 But the Fed chair and the Fed at the time decided to push the rate even lower, say to 2% to try to keep the economy strong going into next year's election.

Speaker 9 That's not going to generate runaway inflation right. It's not going to be turkey, but it will mean higher inflation going into 2027 and 2028.
And you can see how it can become a, it's a corrosive.

Speaker 9 It becomes more of a problem as you as you move forward. And it's, you know, maybe the case study for us would be President Nixon and Arthur Burns, who was chair of the Fed back in the 70s.

Speaker 9 Arthur Burns was, and this is all based on the Nixon tape. So we have firsthand knowledge of kind of how this all played out.

Speaker 9 President Nixon wanted lower rates, Arthur Burns obliged leading into the 1972 election. And of course, go look at what happened in the 70s and 80s.

Speaker 9 You know, we saw a very significant run-up in inflation. Of course, other things were going on, oil price embargo,

Speaker 9 the Iranian hostage crisis, higher oil prices, that kind of stuff. So it wasn't, and the Fed really didn't understand the role of inflation expectations like they do today.

Speaker 9 So there's a lot of differences between now and then, but that's kind of more like what would happen. It would be more of a long running, it would play out over a long running period of time, years,

Speaker 9 not months, certainly not weeks. So,

Speaker 9 you know,

Speaker 9 it's a scenario, what you've articulated is a scenario, certainly prudent to consider, but I think probably a low probability scenario.

Speaker 10 I want to shift us to your what keeps me up at night chart, which I love. I love this chart.
You basically...

Speaker 9 Yeah, don't you like it? I call it the risk matrix. I should trademark it.

Speaker 10 The risk matrix, right.

Speaker 10 it's great you basically have on on one side on the y-axis you've got likelihood of risk on the x-axis you've got economic severity of risk and there's just this dot plot of all these concerning things that could happen uh based on how likely they are to occur um

Speaker 10 I don't describe necessarily exactly the whole chart, but if you could rank sort of your top three or four concerns for America right now based on their likelihood and also the severity

Speaker 10 of each risk. What would they be? Rank your top three.

Speaker 9 Well, and you said Y and X. That's interesting.
So people know what Y and X are. It's the horizontal and vertical axes, right?

Speaker 9 That's great. They have a very sophisticated listenership.

Speaker 10 Very sophisticated audience, yeah.

Speaker 9 Yeah, very sophisticated.

Speaker 9 I mean, obviously, you want to look at the part of the matrix where high severity, if the thing goes off the rails, it's going to do a lot of damage to the economy and high probability.

Speaker 9 And that's kind of in the northeast part of the matrix. If you can kind of visualize that.

Speaker 9 And, you know, obviously trade war is up there as a real threat. Who knows how that's going to play out?

Speaker 9 We think we know. We're doing forecasts based on what we expect, but who the heck knows how that's going to play out and whether there's at some point going to be more retaliation from U.S.

Speaker 9 trading partners. Fed independence is up there.
I call it Fed capture in the matrix, but that's what I mean by Fed,

Speaker 10 what I'm using as a term for Fed independence.

Speaker 9 I talk about institutional erosion more broadly. And there's a whole slew of things that go into that.

Speaker 9 You know, the recent decision by the executive, by the government to take a stake in Intel would, in my view, could be in that bucket of institutional erosion that raises all kinds of

Speaker 9 questions about

Speaker 9 the efficacy of that. But the one thing I would call out

Speaker 9 is a meltdown in the bond market. So while the Fed's lowering rates, obviously the Fed doesn't control long-term rates directly.

Speaker 9 And it could be the case that investors get spooked by the lack of Fed independence and the prospect for higher inflation. Then you throw into the mix our large budget deficits, which are gigantic.

Speaker 9 Our deficit is 6% of GDP. Our primary deficit, excluding interest payments, is 3% of GDP.
That's massive, particularly in the context of an economy that's a full employment.

Speaker 9 Debt to GDP is 100% and rising very quickly. And given the big, beautiful bill, there's nothing that's going to stop that.

Speaker 9 Interest payments on the debt as a share of GDP or revenue is at or just about breaching the record high. We're spending more on our interest than we are on defense at this point.

Speaker 9 Also,

Speaker 9 who's owning Treasury, the bonds is shifting.

Speaker 9 We're going from the Fed owning the bonds because they QE'd and bought all the bonds. They're now QTing and letting the bonds roll off.

Speaker 9 Institutional investors and banks that are less price sensitive, they don't care as much about the rate that they're parking their money there for as a safe haven.

Speaker 9 They're exiting the market. And in the void, there are hedge funds.
Hedge funds are coming in. They're becoming very large players in the market.

Speaker 9 And these guys, you know, they're very price sensitive. I mean, they're there when times are good.
They are completely out of there en masse.

Speaker 9 They all run for the door at the same time when times are bad.

Speaker 9 So I'm, you know, I can go on, but, you know, you've got this dark brew of stuff coming together that could suggest that at some point, I don't know, and I don't know when, but it could be my sense is the risk is, and that's why it's where it is in the matrix.

Speaker 9 In the next six, 12, 18 months, we sell, we see a sell-off in the bar market, which means much higher long-term interest rates.

Speaker 9 I mean, the 10-year treasury yield is not four and a quarter, it's five and a quarter, it's 6%, you know, something like that.

Speaker 9 And think about what that means for mortgage rates, what it means for borrowing costs for businesses and consumers. That's a pretty bad situation.
So that's not my baseline. This is a risk matrix.

Speaker 9 What could keep go wrong? You know, that's not, that's less than

Speaker 9 likely, but still

Speaker 9 a possibility that we should consider. That would be kind of at the top of the list of my concerns.

Speaker 10 Stay with us.

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Speaker 10 We're back with Prof G Markets.

Speaker 10 I found it very interesting that the bond market meltdown, I mean, it's high up there in terms of severity of risk, but it's also pretty high up there in terms of likelihood of risk compared to all of your other scenarios.

Speaker 10 I know you said you can't predict when, and of course,

Speaker 10 no one can, but do you have any thoughts on what might trigger that some sort of bond market meltdown? I mean, this is kind of the ultimate question that everyone's trying to wrap their head around.

Speaker 10 And, you know, we see what happens when this big, beautiful bill is passed and we already have these insane debt to GDP levels, this insane deficit to GDP level that we're going to explode even further.

Speaker 10 And yet people,

Speaker 10 people say they're worried. I hear people talking about it.

Speaker 10 I look around, everyone says, yeah, we're really worried about this. But then you look at the markets and the markets, you know,

Speaker 9 they're not...

Speaker 10 They're not unphased by it, but they're certainly not scrambling right now. And I'm just wondering if you have any thoughts on what it might take

Speaker 10 to cause a bond market meltdown and especially for investors to actually get legitimately concerned about

Speaker 10 our national deficit and our debt problems in America, such that they start actually selling.

Speaker 9 Yeah, I go back to

Speaker 9 Fed independence and who the president is going to nominate for the next Fed chair.

Speaker 9 That feels like a pretty good stress point when bond investors all over the world are going to be looking at that and saying,

Speaker 9 who's that person? And how should we think about that person in the context of an independent Federal Reserve?

Speaker 9 So if I had to pick a catalyst for that sell-off, that would be a pretty good inflection point.

Speaker 9 There's also,

Speaker 9 I think it would be good at governance issues with regard to the budget itself.

Speaker 9 We get into the next fiscal year. There's another reconciliation package.

Speaker 9 What does that look like exactly? Will that add to the deficits and debt? And if it does, to what degree, and could that be the catalyst?

Speaker 9 Or, you know, maybe we get to a place where government comes to a standstill. There's a government shutdown.

Speaker 9 The Democrats don't go along with whatever, and the Republicans can't get enough votes to keep the government open.

Speaker 9 Or there's a, you know, I don't think the treasury debt limit is not going to be an issue for a few years because they extended that out until 27 or 28.

Speaker 9 But, you know, it could be some kind of governance issues where global investors say, hey,

Speaker 9 I'm really not sure I'm going to get paid on it in a timely way. Not that the U.S.
can't pay me. The U.S.
is a, you know, can pay. That's not the issue.
But will they pay me? And

Speaker 9 will they pay me on time? That's the real issue. But I think the catalyst probably has to come from global investors

Speaker 9 saying,

Speaker 9 no, Moss, I can't take this anymore. You're going to have to pay me.

Speaker 9 You, the U.S. government, is going to have to pay me more to compensate for the risk that I'm not going to get paid on them.

Speaker 9 By the way, there's evidence that it's already affecting tenured treasury yields.

Speaker 9 I mean, there's, you could make, you got to, I don't want to stretch this too far, but you could look at other corners of the financial system and they're signaling, saying, hey, there is a risk premium in the tenured treasury.

Speaker 9 Go look at credit default swaps on U.S. treasuries and where they're trading or look at the swap market prices in general.
And they're saying, look, the investors are already nervous about

Speaker 9 the safe haven status of the United States. So I don't know that it would take a whole lot to trigger that bond market meltdown that we've been talking about.

Speaker 10 I want to slightly shift gears here

Speaker 10 and hear about how you work,

Speaker 10 because

Speaker 10 what I've found is that everything is getting politicized in a way that we haven't really seen before. And it's been true of, we've seen it with the Federal Reserve this week, where

Speaker 10 basically, if you want to maintain rates, then that is a political position. You are against the president.

Speaker 10 If you want to cut rates,

Speaker 10 then you are pro-MAGA, you're pro-Trump.

Speaker 10 I mean, I'm simplifying it a lot, but basically, what we are seeing is that the governorship of the Federal Reserve is being split into factions, and that is certainly what Trump is trying to do.

Speaker 10 He wants to fire someone, get her out of there, and then install someone who's on his side.

Speaker 10 And we're seeing this in lots of different areas

Speaker 10 of the economy. I mean, we're seeing it even with the Bureau of Labor Statistics, where the data has become politicized.
I mean, you put out a bad report or you adjust

Speaker 10 the previous numbers and that is a political action, or at least it is perceived to be a political action. And I find this in my own work too.

Speaker 10 I try to

Speaker 10 balance politics as much as possible on this podcast without being distracted by it. But what I find is that whenever we discuss the data, whenever we discuss economics, it oftentimes

Speaker 10 is perceived to be a political conversation

Speaker 10 and that it is biased in some way. And when I look at your report and the things that you highlight that are problems in the economy right now,

Speaker 9 one, I agree with them.

Speaker 10 But two, all I can think about is some other, some guy

Speaker 10 on the Republican side of the aisle who would say, this guy's biased.

Speaker 9 He just wants Trump to lose.

Speaker 10 And I'm wondering how you think about that today. Do you find that your work is increasingly viewed as political?

Speaker 10 Do you find that it is increasingly difficult to put work out there and to teach about economics and to talk about economics in a way that isn't politically swayed or politically influenced?

Speaker 10 And if so, how are you dealing with that?

Speaker 9 I do my best to be apolitical. You know, I think it's important to acknowledge that we all have a political prism that we look at the world through, you know, whether it's explicit or implicit.
So

Speaker 9 I think I'm self-aware of that prism and the biases that I potentially have.

Speaker 9 And I apologize if I come across as being political, but it's very difficult, as you say, not to,

Speaker 9 because we're talking about economic policy as the kind of the driving force behind what's going on in the economy. So how can you not talk about policy?

Speaker 9 And once you talk about policy, it's difficult not to be perceived as political. And I apologize to everyone if I come across that way.
I try not to. I try to be apolitical.

Speaker 9 And by the way, when we talk about trade and tariffs, you know, that's the one issue where really we're debating that.

Speaker 9 I mean, that economists debate everything, reasonably so, every issue, you know, because they look at first order, second order, third order, fourth order effects, depending on, you know, whether you're an academic or a guy like me.

Speaker 9 And it's all reasonable. But on trade and tariffs, broad-based tariffs, there's no, like, there isn't a debate.
I mean, that's like,

Speaker 9 if we're going to debate anything, that's a great one to debate because there's no question that that's a pretty bad idea. It's a pretty bad idea.
We know this.

Speaker 9 We know that this is, this is tested over the years, over the decades, over the centuries. We know that this is, this is a corrosive on the economy.

Speaker 9 And so if we're going to pick one issue that we're going to get that we will focus on, it's a

Speaker 9 fortunate it's trade because there's no debate here. My views are entirely consistent with the broad consensus of views of economists on either side of the aisle.
Yes.

Speaker 9 So, okay, if you think I'm political, then you think there's no way to talk about this in any sense whatsoever. Now, it hasn't changed the way I approach things or the way I forecast.

Speaker 9 You know, and that's, you got to give Moody's credit for that. You know, that I have independence.
I can think about, write about, speak about what I want.

Speaker 9 Now, I have to be careful in the context of the current environment. There's no doubt about that.
But I have not said anything that I do not believe.

Speaker 9 And

Speaker 9 my forecast has not changed as a result of any. any kind of pressure or anything else.
So I find that very fortunate. And I think that's critical to the work that I'm doing and that we do.

Speaker 9 We provide a lot. Our clients are all over the world, major financial institutions, governments, non-financial corporates that use our information in lots of different ways.

Speaker 9 They rely on that and they are dependent on our being

Speaker 9 as

Speaker 9 unbiased and as true to our thinking as we possibly can. Now, we are fortunately very

Speaker 9 quantitative.

Speaker 9 We're not qualitative. We're very quantitative.

Speaker 9 We've got very sophisticated, and I don't mean to oversell, but we spent a lot of time and energy on the models that we are using to produce these forecasts.

Speaker 9 And so that provides a very significant discipline to what we're doing. At the end of the day, we have to make some assumptions.

Speaker 9 But the way I handle assumptions is I say, okay, here's what I'm my baseline assumption, and here are the risk. And that goes to the risk matrix.

Speaker 9 Let's go do different scenarios so we can think about, and it's prudent to think about, you know, what if the world is different than

Speaker 9 the assumptions are different than the ones that I've articulated that are my baseline.

Speaker 9 But because we are a quantitative shop, I also think that imposes a discipline on what we're doing that makes it less likely we'll be political and more likely it will be apolitical. But

Speaker 9 this is all new. I've been a professional economist for 35 years.
I've never been in this kind of situation. Never, never.
Wasn't even close to what we're going through.

Speaker 9 It's a real, what I call stress tests on

Speaker 9 everything, including economic analysis and forecasting.

Speaker 10 It's a huge stress test on just numbers, in a way. I mean, the idea that a number

Speaker 10 could be

Speaker 10 a political statement.

Speaker 9 Right.

Speaker 9 That's sort of a new world.

Speaker 10 And I felt that way certainly after the chief of the Bureau of Labor Statistics was fired, because that to me sort of blasted us through the door of a new situation where, you know, if we can't agree that the data is real, if we can't agree that the fundamental economic data that has come from the US government is true,

Speaker 10 or at least the truest thing we have,

Speaker 10 then what are we doing?

Speaker 9 You know, what am I doing with this podcast?

Speaker 10 What are you doing over at Moody's?

Speaker 9 And

Speaker 10 I wonder what the implications of that are for

Speaker 10 the study of economics itself. I mean,

Speaker 10 how are economists supposed to move forward? How do you move forward? I mean, another question might be like, do you trust the data? Will you trust the data when it comes out in the next six months?

Speaker 10 Say he hires someone that is perhaps another loyalist?

Speaker 10 Will you believe that the data that's coming out of the Bureau of Labor Statistics? I mean,

Speaker 10 where does this leave you if

Speaker 10 America cannot agree on whether or not the data is even real?

Speaker 9 Right now, it's trust but verify.

Speaker 9 So working really hard to come up with approaches, techniques, methodologies, other data sources to test to make sure that we are confident in the data, the quality, the comprehensiveness, the timeliness of the data that we're receiving.

Speaker 9 So we're not going to simply, well, this has always been the case, but obviously we're now on hyperdrive trying to figure out how to do this in a kind of consistent, rigorous way.

Speaker 9 And we're thinking about and actually working on producing alternative data sources. So that, for example, on consumer prices CPI, here's, I worry about,

Speaker 9 really worry because of the BLS cuts, the funding and staffing cuts, they are unable to canvass as many

Speaker 9 products and services for calculating the CPI, the consumer price index. I think 35%, I don't think I'm making this up, 35%.

Speaker 9 of the prices of goods and services in the CPI are now so-called imputed. That's up from 10% at the start of the year.
35% is a lot, in my mind.

Speaker 9 And so there we're starting to think about how do we scrape websites, produce our own estimates of CPI.

Speaker 9 There's some researchers that have already gone down this path, Caballo at Harvard, the Billions Pieces Project. So we're piggybacking off with some of that work.

Speaker 9 So we're hopeful that we get alternative data sources just so that we can make sure that we feel confident in the information that we're getting and that we're providing.

Speaker 9 But having said all that, it's a pretty tough spot to be in because the government is critical. There's,

Speaker 9 Congress call it a public good. It's a public good.
There's no better example of a public good. We need the government to collect this data because

Speaker 9 we're getting, we need, because of privacy issues and security issues, we need the federal government to be fully engaged here. So we're not going to be able to completely fill the void.

Speaker 9 But so hopefully the integrity of the data is maintained going forward as best as possible. But

Speaker 9 we're not going to stand still. We're doing the best we can to, again, verify and also construct new data sources.

Speaker 9 And there are, by the way, there are a lot of data sources out there that kind of haven't really thought about as carefully.

Speaker 9 Starting to think about them more carefully because they are valuable sources of information.

Speaker 9 Like we have relationships with companies tracking the credit performance of consumer credit cards or mortgage loans, that kind of thing.

Speaker 9 Another partnership with a company to try to calculate house prices and commercial real estate values.

Speaker 9 There's a payroll processing company that does a really good ADP, which does a really good job of

Speaker 9 figuring out what's going on in the private sector in terms of jobs by industry and by region. So there are, and I can go on and on, there are a lot of data sources out there.

Speaker 9 We just now have to think about this more

Speaker 9 with greater urgency and in a more systematic way.

Speaker 10 Just to wrap up here, we've had a lot of kind of grim predictions, and we opened this

Speaker 10 show with your point that we are on the precipice of a recession or at least that is what the model is telling you uh is there anything that you are feeling optimistic about in the economy is there anything you're bullish on is there anything that we could end this show uh on more of a positive note i mean you know the american economy uh is a marvel i mean it's just you know if you just let it have at it.

Speaker 9 You have a problem. You may allow people to make money.
They figure out the problem.

Speaker 9 If we just get out of the way, if government just gets out of the way, you know, regulate, but you know, just let the let the economy go,

Speaker 9 it will be just fine. And I keep going back to, I think Churchill said this, or

Speaker 9 maybe I've got this wrong, but something to the effect, you know, Americans try everything and then ultimately do the right thing.

Speaker 9 And I just, I fundamentally believe that we are going to, we're trying everything,

Speaker 9 but we will ultimately find the right way. And, you know, we'll land in a pretty good spot.
So I, you know, I'm near-term nervous about what's going on, obviously, but I'm long-term bullish. You know,

Speaker 9 I think the American economy is just a marvelous thing and it's going to be pretty hard to

Speaker 9 upset it

Speaker 9 in a systematic and long-term way.

Speaker 10 Mark Zandi is the chief economist of Moody's, a leading provider of economic research, data, and analytical tools.

Speaker 10 He also hosts the Inside Economics podcast, and he serves on the board of directors of MGIC, the nation's largest private mortgage insurance company.

Speaker 9 Mark, this was great.

Speaker 10 It was great to have you on the show again. We really appreciate your time.

Speaker 9 Thanks. I appreciate the great questions.
I've all lot to think about there. So awesome.
Yep. Take care now.
Thanks, Mark.

Speaker 10 This episode was produced by Claire Miller and Alison Weiss and engineered by Benjamin Spencer. Miel Severio is our research lead, our research associates are Isabella Kinsel and Dan Shallan.

Speaker 10 Drew Burroughs is our technical director, and Catherine Dylan is our executive producer. Thank you for listening to Property Markets from the Vox Media Podcast Network.

Speaker 10 If you liked what you heard, heard, give us a follow, enjoy your labor day, and we will be back with a fresh take on markets not on Monday, but on Tuesday.

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