Morgan Stanley Chief Global Economist Seth Carpenter joins Yahoo Finance Live to discuss the state of the economy as Fed Chair Powell testifies before Congress, inflation, energy, food, and Fed policy.
Video Transcript
BRAD SMITH: Just as the Fed attempts to counter rising inflation by raising rates in hopes of staying away from a recession, Fed Chair Jerome Powell is testifying before Congress this morning. And joining us now to break it down, we've got Seth Carpenter, who is the Morgan Stanley chief global economist, here.
A ton to really dive into here. What most notably are you going to be looking for, for Fed Chair Jerome Powell, who's already put his comments out there, at least his remarks out there? And we're kind of latching on to the fact that he sees compelling evidence that the economy can support additional tightening from this point forward.
SETH CARPENTER: I think Chair Powell is in a very challenging circumstance. I mean, the Congress clearly are out to criticize the Fed for letting inflation get out of control. The different political parties have their own interests. And so he's got to try to figure out how to steer the narrative that the Fed is on the case. The Fed wants to rein in inflation in that they're not going to have a repeat of the 1970s. He's in a difficult circumstance in terms of the narrative.
But he's also in a very difficult circumstance when it comes to the economics of it, because they don't know right now where the neutral funds rate is. They're going to keep raising rates until they feel like they've got traction on the economy to bring inflation down. But the challenge is going far enough to slow the economy enough that inflation pressures go away, but not so far that they actually cause a recession, because if you think they're getting criticism now for inflation being high, you can only imagine the criticism they'll receive if they, in fact, induce a recession.
JULIE HYMAN: There's also-- hey, Seth. It's Julie here. There's also some questioning for the Fed chair from the likes of Elizabeth Warren in the hearing about the Fed's lack of effectiveness against some types of inflation. And that's something that Chair Powell has talked about himself, namely when we're talking about energy prices and food prices, that the Fed-- it's not-- just not as powerful with that type of inflation.
So you have here the problem of the Fed tightening, those things that exist somewhat outside the Fed's purview, and that also complicates the issue quite a bit as well, doesn't it? I mean, what's going to happen to those food and energy prices?
SETH CARPENTER: Oh, my gosh. It completely complicates the issue. And it also raises that much more possible criticism for the Fed. The Fed has a very, very blunt tool. They influence financial conditions primarily through short-term interest rates. That tool by itself can't directly affect food prices, cannot directly affect energy prices, and in fact, can only affect the so-called core inflation by slowing overall economic growth in order to reduce overall demand for goods and services across the economy to eventually bring down inflation.
So what that means is a slower economy almost surely has to mean less job creation probably less wage inflation. We've already seen average hourly earnings start to come down over the past few months. To have that happen against the backdrop of food prices, energy prices, which, a lot of times, economists like me like to exclude because they're not part of the core measure, but real people every day spend so much of their money on food and energy.
It's going to be painful for a while, potentially, to have slower job growth, slower wage growth, and while we're still waiting for the food and energy inflation to start to come down. So it is a very difficult economic position the Fed finds itself in.
BRAD SMITH: Seth, on that conversation of declining demand and some of what the Fed policy is going to do to try and kind of tamp-- dampen, excuse me, that demand, we were actually speaking with our own Brian Cheung. He was able to speak with the Philadelphia Fed president earlier today, Patrick Harker. I want to play for you a quick comment from Harker earlier this morning.
PATRICK HARKER: If we start to see demand soften-- and we are seeing some signs that demand is starting to soften in certain sectors of the economy. And if it's softening quicker than I anticipate, then it may be appropriate to go with a 50. If it's not, then it's probably appropriate to go with the 75. Let's see how the data turns out in the next few weeks.
BRAD SMITH: And so on the back of that, with the policy that the Fed has rolled out to this point in time, how much quicker do you expect some of that demand to start to soften?
SETH CARPENTER: There is always a lag between policy tools changing and financial markets, and then from financial markets to the economy. We already see some slowdown in the housing sector. Now housing is always the most interest rate sensitive part of the economy. And we are seeing that. And we've just got some home sales data this week that confirms the turning over, to some extent, of the housing sector.
Will we see it show up, for example, in consumer spending numbers? We did get the last retail sales report that showed a little bit of softening. I think there's always the chance that we get more data that confirm the deceleration in the economy. Getting enough of it between now and the July FOMC meeting, especially given how much Chair Powell pointed to inflation and inflation expectations data as pushing in favor of 75 versus 50, that's going to be hard for us to see, which is why my colleague, Ellen Zentner, who runs our US team, has, as a baseline, another 75 basis point rate hike in July.
After that, the data should accumulate, showing more slowing in the economy and, we think, having shown a peak in inflation. And then the Fed can step down to 50 basis points. And then eventually, we think by Q1 of next year, they'll probably reach the peak of their rate hiking cycle.
JULIE HYMAN: Yeah, Seth, that's a good reminder that you look globally versus exclusively at the US. But, you know, your counterparts all across Wall Street are all playing the probability game right now. What is the probability we will enter a recession in the next 12 months? How are you guys thinking about that for the US? And also, how are you thinking about it for the other major global economies?
SETH CARPENTER: It's very challenging. I think there's no question whatsoever that recession risks are elevated. They're probably not uniform across the globe. We were just talking about Chair Powell and the Fed and the very difficult economic circumstances they face. If we go across the Atlantic to Europe, the ECB is facing similarly difficult challenges.
What's different, though, in the Euro area is, headline inflation in the two economies are very, very similar-- 8, call it 8 and 1/2, give or take a few tenths, depending on how the different economies measure inflation. But core inflation is much lower in Europe relative to the United States. Or put differently, food and energy are driving so much more of the inflation in the Euro area that they are that much more bound by the criticism, I think, that Chair Powell was receiving from Senator Warren.
So what does that mean for them? As the economy slows and we think growth in the Euro area is going to slow appreciably in the second half of the year and in the fourth quarter, barely be above 0 on a quarter on quarter basis, the ECB is going to be confronted with the fact that they have high inflation to battle. They're going to be raising rates to try to bring that down at a time when we see the Euro area economy slowing.
If economy is at risk, I would say the Euro area economy is at great risk because the ECB's just that much more stuck by needing to slow the economy to slow down inflation. But so much more of their inflation is being driven by components that they just don't have as much direct control over.
BRAD SMITH: And one of those components is the supply chain, quite frankly, as well. And I mean, that just comes as a constant reminder, even Fed Chair Jay Powell putting that within his commentary and the current economic situation and outlook and how their policy is also hinging on the supply chain. Do you expect that to also alleviate some of the pressures in lockstep with the Fed's policy?
SETH CARPENTER: I do. I do. We have a couple of different measures of supply chain tensions around the world. And one just looks at pure supply factors. The other one looks at the intersection between supply and demand factors. And what's clear is, both of those are in slightly better positions than they were at the end of last year. But there's really been a stall in just the supply side of the global supply chain. So things have stopped getting better since about February or March.
However, if you consider how demand interacts with the supply factors, we are continuing to see some easings. Part of what happened was we had this surge in demand. We saw something like a few years of purchases trying to get shoved down into just a few months or a couple of quarters. And the supply chain wasn't able to handle that.
As demand starts to soften, it's going to make it easier for supply chains to keep up. And we think that's going to end up translating into lower goods inflation. But the two do work together. So central banks cannot affect supply chain directly, but they can rein in demand. And by reining in demand, it means that those acute supply pinches get a little bit less severe.
BRAD SMITH: Seth Carpenter, Morgan Stanley chief global economist, thanks so much for the time today. Seth, appreciate--