David Wessel on the Debt Ceiling

Episode Summary

Executive Summary: The episode centered on a softer-than-expected January CPI report, with the hosts and guest David Wessel agreeing inflation is clearly cooling but not enough to prompt a Fed pivot yet. They debated the Fed’s next move, the likely terminal rate, labor-market cooling, recession odds, and the risks of a debt-ceiling standoff. A recurring theme was that policy is improving, but uncertainty remains high.

Main Topics: January CPI and the inflation outlook (Priority: 5/5): The panel reviewed a strong disinflation report: headline CPI fell, energy prices dragged inflation lower, goods deflation continued, and food inflation slowed. Core services and shelter remained sticky, reinforcing the Fed’s focus on wage-driven service inflation. Federal Reserve policy and the terminal rate (Priority: 5/5): Guests debated how far the Fed still needs to raise rates, whether 25 bps in February is likely, and whether the terminal rate sits above 5%. The discussion emphasized that the Fed is now balancing progress on inflation against the risk of overtightening. Labor market and wage dynamics (Priority: 4/5): The conversation highlighted weakening wage growth, real wage declines, and the importance of labor costs in service inflation. The group agreed the labor market is cooling but not collapsing. Debt ceiling risk and fiscal dysfunction (Priority: 5/5): Wessel argued the debt-limit fight could trigger market stress and even a brief breach before Congress acts. They discussed the political mechanics, market consequences, and why gimmicks like the 14th Amendment or a platinum coin are unlikely. Recession probability and 'slowcession' (Priority: 4/5): The hosts revisited recession odds and narrowed their views somewhat, with consensus shifting toward a near 50/50 or slightly-above-50 chance. They also discussed the idea of a slowcession rather than a sharp downturn. Credit conditions and bank provisioning (Priority: 3/5): A sidebar on small-business credit access and bank loan-loss reserves explored whether tighter lending is countercyclical or pro-cyclical. The panel suggested banks are preparing for downside risk, but capital is still broadly available. Podcast statistics game and regional inflation (Priority: 2/5): The episode ended with a statistics game using CPI, wages, small-business credit, and regional inflation figures to illustrate how uneven price and labor dynamics remain across the U.S.

Key Arguments: Inflation is decelerating broadly, especially in goods, food, and energy, but services inflation and shelter remain the Fed’s main concern. The Fed likely remains on track for a 25-basis-point hike next meeting, with the terminal rate likely above 5%. Markets may be underpricing how long the Fed will keep rates elevated; cuts by year-end may be too optimistic. Wage growth is cooling, which supports the disinflation narrative, but the pace is still too high for the Fed’s comfort. The labor market is cooling in a controlled way, which improves the odds of a soft landing but does not eliminate recession risk. A debt-ceiling breach could create severe market and administrative disruption, and any workaround would be legally and politically risky. Small-business credit conditions are tightening, and bank loan-loss provisioning may reduce near-term earnings while helping banks absorb future losses. Recession odds were judged roughly even to moderately above even, but all speakers acknowledged that the data have improved materially in recent weeks.

Data Points: Headline CPI month-over-month: -0.1% - First rounded monthly decline since May 2020, reflecting falling energy prices. Headline CPI year-over-year: 6.4% - Softest annual increase since October 2021. Energy prices month-over-month: -4.5% - Main drag on headline inflation; fuel prices fell sharply. Energy prices year-over-year: 7% - Still elevated despite monthly decline. Fuel prices month-over-month: -17% - Large monthly decline within the energy category. Core CPI month-over-month: 0.3% - Slightly faster than the prior month. Core CPI year-over-year: 5.7% - Slowest pace since December 2021. Food inflation month-over-month: 0.3% - Slowest pace since April 2021. Egg prices year-over-year: 60% - A visible outlier in food inflation headlines. New car prices month-over-month: -0.1% - First decline in a year. New car prices year-over-year: 6% - Still elevated despite monthly easing. Used vehicle prices year-over-year: -9% - Declined for six straight months. Core services year-over-year: 7% - Sticky inflation area watched closely by the Fed. Core services including housing month-over-month: 0.5% - Noted as strong in the CPI release. Housing month-over-month: 0.8% - Shelter remained firm in the CPI report. Employment Cost Index release date: January 31, 2023 - Expected to be a key wage metric before the next Fed meeting. Small-business credit harder to get: 7% net in December - NFIB survey; highest since 2014. Annualized core CPI, 3-month pace: 3.1% - Shown during the statistics game as recent disinflation progress. Annualized headline CPI, 3-month pace: 1.8% - Recent short-term inflation pace looked near target. Annualized average hourly earnings growth, 3-month pace: 4.1% - Used to show wage cooling but still above desired inflation-consistent levels. Real average hourly earnings year-over-year: -1.7% - Wages lagged inflation over the prior year. Regional CPI high: South: 7.0% year-over-year - Illustrated uneven inflation across U.S. regions. Regional CPI low: Midwest: 6.0% year-over-year - Compared with higher inflation in the South and lower West Coast metros. Metro CPI low example: Los Angeles: 4.9% year-over-year - Used in the statistics game to show geographic variation. Metro CPI high example: Miami: 9.9% year-over-year - Used in the statistics game to show much higher local inflation. Terminal fed funds rate estimate: Above 5%; likely 5.25% to 5.5% - David Wessel’s view of where the Fed may stop hiking. Fed hike expectation for February: 25 basis points - Consensus expectation after the CPI report. Recession probability (Marissa): 50% - She moved down slightly as inflation and labor data improved. Recession probability (Mark): 50% - Still sees a highly uncertain outlook and no recession in the baseline. Recession probability (Chris): 66% - Still leaning toward recession, though less than earlier. Recession probability (David Wessel): 55% - Would include recession in his forecast, but less certain than before.

Pivotal Quotes: "I think they're going above 5%. I would say 5.25 if I had to put a number on it. And maybe even 5.5%." — David Wessel: His estimate of the Fed’s terminal rate and expectations for tighter policy. "I think that the probabilities of a recession are high; you know, kind of an NBER-defined recession are high." — Mark Zandi: His assessment of recession risk after the CPI discussion. "The Fed seems to think that Powell said ... the pace of nominal wage increases is too high to be consistent with meeting their target." — David Wessel: Why wages and services inflation remain central to Fed policy.

Implications: Listeners should expect more Fed tightening, but at a slower pace, while watching wages, shelter, and credit conditions for confirmation that inflation is truly fading. Recession risk remains real, and the debt ceiling could become a major market shock.