Mark’s References, Moderating Inflation, and the Midterms

Episode Summary

Executive Summary: The episode centered on two major developments: a better-than-expected October CPI report showing inflation may be rolling over, and the U.S. midterm elections, which likely produced a narrowly divided federal government. The hosts discussed how slower inflation could allow the Fed to downshift to 50 bps in December and keep rates high for longer, while divided government and debt-ceiling brinkmanship could constrain fiscal policy and create shutdown/default risks.

Main Topics: October CPI and the inflation outlook (Priority: 5/5): The group unpacked the CPI report, noting headline inflation fell to 7.7% and core to 6.3%, with signs that used cars, apparel, and some housing-related measures are easing. They stressed that the decline is encouraging but not enough to declare victory. Fed reaction and interest-rate path (Priority: 5/5): The panel linked the cooler CPI to a likely 50-basis-point hike in December and discussed the possibility of a higher terminal rate held longer into 2024. They argued the Fed may slow hikes but still need restrictive policy to curb wage and service inflation. Health insurance and measurement quirks in CPI (Priority: 4/5): Mark and Chris explained why health insurance showed a large decline in CPI despite little change in actual premiums, due to the BLS methodology tied to insurer profits and pandemic-era timing distortions. This was presented as a temporary but meaningful downward influence on core CPI. Midterm election results and divided government (Priority: 5/5): Dan and Emily framed the election as one where neither party got everything it wanted, likely yielding a narrowly Republican House and an unresolved Senate. They argued the outcome points to continued polarization and limited federal legislative action. Fiscal policy, shutdowns, and the debt ceiling (Priority: 5/5): The discussion emphasized that a divided Congress may mostly keep the lights on, but the debt ceiling remains a major tail risk. The hosts contrasted routine shutdowns with the far more serious consequences of any U.S. default or delayed Treasury payment. State-level policy and political sorting (Priority: 3/5): Emily and Dan noted that state governments may become more active because many are unified under one party, enabling tax, spending, and regulatory changes. They also discussed possible migration and demographic sorting by political preference, though the evidence remains mixed. Market reaction and recession odds (Priority: 3/5): The team observed that stocks and bonds rallied on the CPI release, but they cautioned the market may have overreacted. Chris also slightly lowered his recession probability to 67%, citing the stronger inflation data and the Phillies' loss.

Key Arguments: Inflation appears to be decelerating, but one month of data is not enough to conclude it has fully peaked or will continue falling without interruption. The core CPI improvement was helped by temporary factors, especially the health-insurance methodology, so the headline improvement may overstate the underlying trend. The Fed is more likely to slow to a 50-basis-point hike in December, but policy rates may still need to stay at roughly 4.75% to 5.0% well into 2024. A narrowly divided Congress likely means limited new fiscal legislation, which could be helpful in an inflationary environment but risky if shutdown or debt-ceiling fights escalate. The debt ceiling is a much more severe risk than a shutdown because even the threat of missed Treasury payments could destabilize global financial markets. State governments may become the main arena for policy experimentation because unified control makes it easier to pass laws and test competing approaches. Political and demographic sorting may be increasing, but factors like remote work, housing constraints, and age composition make it hard to isolate ideology as the main driver.

Data Points: Headline CPI (year over year): 7.7% - October CPI report, down from 8.2% in September and below the June peak of 9.1%. Core CPI (year over year): 6.3% - October CPI excluding food and energy. Core CPI (month over month): 0.3% - October core inflation, down from 0.6% in September. Used car prices (month over month): -2.4% - A major contributor to the cooling in CPI. Health insurance component (month over month): -4.0% - BLS methodology made health insurance appear to fall sharply, lowering core CPI. Shelter/rent growth (month over month): 0.7% - Rents moderated slightly from 0.8%, though housing inflation remained elevated. New vehicle price inflation (month over month): 0.4% - Still rising, but slower than prior months; expected to flatten as supply improves. Dow Jones Industrial Average reaction: +1,200 points - Market rally following the CPI report. Fed expected December hike: 50 basis points - The weaker CPI shifted market expectations away from a 75 bp move. Likely terminal fed funds rate: 4.75% to 5.0% - Discussed as the expected peak range for this hiking cycle. Recession probability (Chris): 67% - Chris lowered his subjective recession odds after the CPI report and Phillies loss. House control threshold: 218 seats - Needed for a majority in the U.S. House of Representatives. October Treasury net interest paid: $43.4 billion - The first month of the fiscal year showed rising federal interest costs. Net interest increase vs. last October: 1.5x - Dan noted the October interest bill was about 50% higher than a year earlier. Debt-ceiling default risk: ~10% subjective probability - Dan estimated the chance of a default-type event as low but nontrivial.

Pivotal Quotes: "good news was good news" — Chris: He described the CPI report as a clearly positive inflation release that markets welcomed. "the debt ceiling is the dumbest thing that we have in all of government" — Dan: Dan criticized the debt ceiling as an archaic and dangerous mechanism that risks a U.S. default. "we're all happy at the end of the day" — Mark: He summarized the department's culture of debate and forecasting disagreement as productive rather than divisive.

Implications: Inflation is easing, but the Fed likely still needs restrictive rates. A narrowly divided Congress means fiscal inertia, with shutdown and debt-ceiling risks the main policy threats. States may see more action than Washington.