Faucher on the Fed and Fiscal Policy

Episode Summary

Executive Summary: The episode centered on whether the U.S. economy has achieved a soft landing, with guests arguing growth remains solid while inflation is easing and the Fed is likely to cut rates starting in September. The discussion also examined why the yield curve’s recession signal failed this cycle, the neutrality rate, the 2% inflation target, and how a possible Republican sweep could alter fiscal policy, tariffs, immigration, and inflation.

Main Topics: Soft landing assessment (Priority: 5/5): The hosts and guest debated whether the economy has already soft-landed or is merely approaching one. Gus argued the economy looks strong but not fully there until inflation reaches target and the Fed begins cutting; Marissa was more willing to call it a soft landing already; Chris wanted both inflation and normalized markets. Why the yield curve missed the recession (Priority: 5/5): They revisited the classic yield-curve inversion signal and why it did not lead to recession this time. Explanations included transitory inflation, consumer balance-sheet strength, QE, supply-chain normalization, immigration, oil prices, and banks managing margins and credit better than in past cycles. Fed policy and the rate-cut path (Priority: 5/5): Consensus was that the Fed will likely cut rates in September and then proceed gradually, roughly every other meeting, as inflation cools and labor-market risk rises. Speakers agreed policy is still restrictive and that waiting for a perfect 2% print could be too late. Neutral rate and the level of restriction (Priority: 4/5): The discussion focused on where the neutral federal funds rate (R-star) now lies. Estimates ranged from about 3% to 4%, above pre-pandemic norms, reflecting stronger growth, less rate sensitivity, and uncertainty about productivity and demographics. Inflation target and the role of shelter/OER (Priority: 4/5): The group debated whether 2% is the right inflation target, especially given that owner’s equivalent rent distorts current readings. While most agreed the Fed needs to reach 2% first to preserve credibility, there was openness to future review of the target or measure. Banking system resilience and credit transmission (Priority: 4/5): A theory was advanced that banks handled the inverted curve better than in prior cycles, preserving credit flow and limiting recessionary damage. Strong liquidity, improved risk management, and weaker pre-crisis credit booms likely kept the banking system from amplifying the slowdown. Election, fiscal policy, and a Republican sweep scenario (Priority: 5/5): The conversation turned to the 2024 election and macro implications. A Republican sweep was framed as more likely and potentially more inflationary via tariffs, tax cuts, spending dynamics, and tighter immigration, though growth effects could be roughly neutral depending on offsets.

Key Arguments: The economy is still growing near potential, supported by consumer spending, real wage gains, and business investment, while housing is no longer a drag. A true soft landing requires not just good growth but sustained progress to 2% inflation and an eventual Fed rate-cut cycle. The yield curve’s usual recession signal failed because post-pandemic conditions were unusual: supply shocks, QE, fiscal stimulus, savings buffers, and better bank behavior all muted the transmission to recession. Banks likely preserved credit availability better than in prior cycles by managing net interest margins and avoiding the kind of aggressive lending boom that typically precedes recession. The Fed is likely to start cutting even before inflation hits exactly 2% because policy is already restrictive and lagged effects could damage the labor market. Neutral policy rates appear higher than before the pandemic, but estimates are uncertain and could drift lower over time as balance sheets and debt structures normalize. The 2% inflation target may eventually be reevaluated, especially if shelter/OER continues to distort core PCE, but the Fed must first achieve its current target to protect credibility. A Republican sweep would likely be more inflationary through tariffs, tax cuts, constrained immigration, and potentially deficit expansion, with global spillovers if other countries retaliate.

Data Points: Yield curve inversion duration: Long enough to be one of the longest on record - Used to explain why a recession was widely expected but never arrived. Wage growth: Around 4% year over year - Cooler than two years ago, but still above the Fed’s preferred pace. Potential growth rate: About 1.8% to 2% - Gus’s estimate of the economy’s longer-run growth pace. Consumer debt service burden: 9.8% - Share of after-tax income devoted to debt service; presented as manageable. Initial unemployment claims: 243,000 - Week ending July 13, cited by Marissa as a labor-market risk signal. Claims increase: +20,000 - Weekly rise in initial unemployment insurance filings. Four-week moving average of claims: ~235,000 - Presented as smoothing the weekly spike. Housing completions: 656,000 - Single-family/multifamily completions cited by Chris as evidence construction remains active. Total housing completions: 1.7 million - Referenced to show broader housing activity remains solid. Core PCE inflation: 2.6% - Current inflation rate discussed as above the Fed’s target. Inflation excluding OER: Below 2% for almost a year - Used to argue shelter is artificially keeping core inflation elevated. Fed funds rate: Just south of 5.5% - Current policy rate before expected cuts. Expected first Fed cut: September - Broad consensus view for the first quarter-point reduction. Expected path of cuts: Roughly every other meeting in 2025 - Consensus forecast for gradual easing. Neutral rate estimate: ~3.25% (Gus); 3% to 4% range across speakers - Discussion of where the equilibrium federal funds rate may settle. Existing mortgage coupon: About 3.5% - Used to explain why households are less rate-sensitive. Immigration inflow: 3.3 million last year - Cited as a surprise that boosted labor supply and softened wage/labor pressure. PNC share price: $175.51 - Used as a proxy for banking-sector strength and stability. FOMC target: 2% - Official inflation objective under debate.

Pivotal Quotes: "I think that we are headed for a soft landing." — Gus Faucher: Opening macro outlook on growth, inflation, and the labor market. "I think we're headed towards a soft landing, but until we get consistent 2% inflation, I would not want to say that we're there yet." — Gus Faucher: Defining what would qualify as a completed soft landing. "I feel good about the economy. Of course, there's risk. There's always risk." — Marissa Di Natale: Her more optimistic view that the economy may already have achieved the desired landing.

Implications: Listeners should expect a mild-easing cycle, not an abrupt recession. The biggest risks are policy mistakes, renewed inflation shocks, and election-driven fiscal changes that could lift inflation and rates while reshaping growth.