The Economy's Highs and Lows

Episode Summary

Executive Summary: The episode argues that U.S. inflation is effectively back near the Fed’s target, while growth remains resilient thanks to consumer spending, but housing is still deeply constrained by affordability and limited inventory. The hosts also discuss labor-market data credibility, expectations for a September Fed rate cut, and Emily Mandel’s state fiscal stress test showing most states are well prepared for a recession.

Main Topics: Inflation has largely returned to target (Priority: 5/5): Chris argues the Fed’s preferred inflation gauge is close enough to target that policy should shift toward broader economic conditions. The group discusses owner’s equivalent rent as a lagging measurement issue that still masks underlying softness in inflation. Growth remains solid, but potential output may be higher than assumed (Priority: 5/5): Marissa and Chris note that revised Q2 GDP growth of 3% and strong consumer spending suggest the economy is holding up well. They debate whether current potential growth is closer to 3% or even 4% because of strong labor-force growth and productivity. Fed rate cuts are now widely expected (Priority: 4/5): The conversation centers on the near-certainty of a September rate cut, likely 25 bps, with a debate over whether a weak enough labor report could justify 50 bps. They also discuss how market expectations may be ahead of the Fed’s likely path. Consumers are still spending, but sentiment is mixed (Priority: 4/5): The hosts highlight the Conference Board consumer confidence reading as a sign that households are relatively stable and improving in expectations, even as the University of Michigan survey remains weaker. Personal spending data also supports this resilience. Housing remains the weak spot (Priority: 5/5): Pending home sales fell sharply and hit record lows, reflecting affordability pressures, high mortgage rates, and limited inventory. Even with some rate relief, the market is still far from normal, though new home sales have held up better due to builder incentives. State fiscal conditions are strong despite tax cuts (Priority: 4/5): Emily Mandel explains that most states can withstand a recession thanks to built-up rainy-day reserves, though states with permanent tax cuts or higher spending commitments are more vulnerable. Pennsylvania is highlighted as fiscally sound, while Arizona is a notable stress case. Trust in economic statistics is under pressure (Priority: 4/5): Marissa flags conspiracy theories around BLS revisions as part of a broader decline in trust in public data. The hosts connect this to polarization, social media, and the difficulty of communicating economic reality to the public.

Key Arguments: Inflation is no longer the dominant macro risk; the Fed can focus more on growth and labor-market conditions. Measured inflation may still be distorted upward by lagged owner’s equivalent rent, implying underlying inflation could be at or below target. GDP growth of 3% alongside a rising unemployment rate suggests potential growth may be above the traditional 2% estimate. Strong labor-force growth from immigration and participation, plus productivity gains, could push potential growth closer to 4%. A September rate cut is now effectively baked in, with 25 bps the most likely outcome unless employment data deteriorates sharply. Consumers remain comparatively healthy: spending is solid and confidence is near long-run averages, especially in expectations. Housing weakness is driven less by demand collapse than by constrained supply, high prices, and buyers waiting for better mortgage rates. State governments have generally rebuilt reserves and can absorb recession stress, but permanent tax cuts and ongoing spending pressures create long-run fiscal risks. Conspiracy narratives around the BLS damage trust in data and make economic communication more difficult. The Fed is unlikely to restart QE for mortgage-backed securities because that would look too much like targeted fiscal support and would be politically and operationally unattractive.

Data Points: PCE inflation (headline, year over year): 2.5% - Used by Chris to argue inflation is essentially back near target. PCE inflation (monthly): 0.2% - Monthly increase cited as evidence of cooling inflation. PCE inflation, non-owner’s equivalent rent: about 1.5% year over year - Used to show underlying inflation may be below target once lagged housing costs are removed. Q2 real GDP growth (annualized): 3.0% - Revised second-quarter growth cited as evidence the economy is not slowing sharply. GDP growth, year over year: 3.0% - Mark notes second quarter 2023 to second quarter 2024 GDP growth was about 3%. Average GDP + GDI growth: 2.1% year over year - Marissa argues averaging output and income measures suggests slower underlying growth than GDP alone. Unemployment rate change: up almost 1 percentage point - Used to question whether potential growth can really be only 3%. Conference Board consumer confidence index: 103 - Mark cites this as consistent with long-run average sentiment. Average Conference Board confidence historically: just under 100 - Used to show current confidence is not unusually weak. Pending home sales: down 5.5% in July - Chris uses this as the clearest sign of housing weakness. Pending home sales level: lowest level ever in the history of the data - Illustrates severe housing-market stress. 30-year fixed mortgage rate: about 6.4% - Used to explain why housing affordability remains difficult despite some easing. Existing home sales: about 4 million annualized - Described as extremely low by historical standards. Personal savings rate: 2.9% - Mark points to this as a warning sign that consumers may be drawing down savings to support spending. State stress test result: 41 states passed; 9 failed - Emily’s stress test found most states have enough reserves to withstand a severe downturn. Tax policy trend: most states have passed tax cuts since 2021 - These permanent cuts are a key reason some states are more exposed fiscally. Arizona tax policy: flat income tax rate adopted in 2021 - Highlighted as a state with added fiscal stress from tax cuts and spending growth. Federal support to state/local governments: about $500 billion from the American Rescue Plan - Discussed as a major source of fiscal cushioning for states. Potential Fed rate cut in September: 25 basis points most likely; 50 bps possible if data weaken - The panel agrees the market expects a cut, with debate over size. Market pricing for September Fed decision: roughly two-thirds probability of 25 bps, one-third of 50 bps - Chris cites futures pricing and market expectations. Fed funds rate path in markets: about 100 bps lower by year-end - Markets expect a faster easing cycle than the hosts do.

Pivotal Quotes: "I think I have to go with the PCE, the personal consumption expenditure indicator of inflation. The Federal Reserve's preferred measure looks good." — Chris Dorides: Chris explains why disinflation is the most encouraging macro development. "The state that I'd probably highlight here is Arizona. They passed, they moved to a flat income tax rate back in, I believe, legislation passed in 2021." — Emily Mandel: Emily identifies Arizona as a state where permanent tax cuts and spending growth create fiscal stress. "The economy is not in a recession." — Mark Zandi: Mark pushes back on public perceptions shaped by inflation and housing frustration.

Implications: Listeners should expect a September Fed cut, ongoing housing weakness, and continued resilience in overall growth. State budgets are mostly prepared for a downturn, but trust in data and politics may remain a major risk to public understanding.