Economic Outlook: Fasten Your Seatbelts

Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.

Chris Mukhai (00:08):
Thank you, Andy, for the warm reception. One of the nice things about being a banker in the California public finance market for the entirety of my 34-year professional career is that I've had a chance to meet and get to know many of you in the audience today. My career almost coincides with the life of this conference as well, so that puts an age on me. For those who don't know me, I'm Chris Mukhai, currently head of Raymond James Public Finance Banking Efforts in the Western United States. Raymond James continues to grow and expand its presence in public finance, particularly in California, and has quickly become one of the top underwriters nationally. We're very proud to support our California clients, the California Muni Bond Market, and the California Bond Buyer Conference. Today, I'm very honored to have the opportunity to introduce the keynote speaker for the conference, Beth Ann Bovino, the Chief Economist for US Bank.

(00:56):
Because there's absolutely nothing in the world going on around us today, I'm really happy that the Bond Buyer brought Beth Ann in to give us some investment advice, hot tips, and even tell us where interest rates are going. Well, not really. Of course, these days we are inundated with a lot of things: talk about tariffs, inflation, immigration, federal shutdowns, national debt, the debt ceiling, rate cuts, and dot plots. If you were here earlier and heard Treasurer Ma speak, even more of those things are impacting California. Fortunately, few are better at explaining what all this stuff might mean for us than Beth Ann. Beth Ann's career spanned nearly three decades supporting several government, finance, and information organizations. Prior to US Bank, she was a managing director and chief North American economist at S&P Global Ratings. In this role, she managed the forecasting operations for the North American economy.

(01:48):
Her insights and commentary on topics ranging from labor and wages to housing and income inequality regularly appeared in national media. Prior to S&P, Beth Ann was an equity strategy research analyst at SunGard Institutional Brokerage and served in similar roles at UBS Warburg and the Federal Reserve Bank of Atlanta. She received her bachelor's in economics from the Wharton School, her master's in international economics from Yale, and a doctorate in economics from Columbia University. But most importantly, she's also an amateur pianist and will be doing her best Norah Jones and Lady Gaga impersonations tonight at the piano bar. So with that, let me introduce Beth Ann Bovino, our keynote speaker today.

Beth Ann Bovino (02:38):
I shouldn't use up my time because I know we only have a little bit, but the truth is I did pick up piano because when I was about 10 years old, my grandpa died and he gave me his piano. I loved that piano and played all the time for a whole year, but then my family moved and my mom told me that the piano didn't go with the home. My career as a pianist was crushed at an early age. Then came COVID; I was working from home and that's when I decided I'm ready to start now. I forgave my mom, but I clearly haven't gotten over it. Anyway, why don't we get onto more rosy topics: the US and world economy. Economic outlook—fasten your seatbelts. I don't know if many of you folks have seen the old movie with Bette Davis called All About Eve.

(03:46):
There was a point in that movie where Bette Davis was miserable because someone was trying to take her spot in theater. She invited all these people over to her house and was drinking way too much. She turned to the crowd and said, "Fasten your seatbelts because it's going to be a bumpy ride." That reminds me of where we are today. Going back several years now, it seems like the uncertainty doesn't seem to go away. What do I expect for the US economy going forward? Economic activity before the shutdown already indicated softer momentum. The shutdown now amplifies that economic uncertainty which is already strained by trade, immigration, and many other things going down the pipeline.

(04:49):
We're still in a place where we have sticky inflation and a weakening job market, which leaves little cushion for the US economy to manage through these hurdles. This leaves us in a tough place. That said, at US Bank, we still expect a soft but bumpy landing. Unfortunately, "soft" means lower growth, a higher unemployment rate, and sticky inflation until the Fed gets it under control. When we think about what the Fed is going to do, we think they have pivoted to their other mandate—the jobs mandate—and have cut rates now two times. That is giving a little support for the US economy. However, inflation remains well above its 2% target.

(05:56):
The worry the Fed has, and certainly I have, is: did they move too soon? Will inflation be under control with these moves? Keep in mind that markets have priced in a December cut, but I wouldn't be so sure just yet. There's a lot of pressure right now. From alternative numbers, the economy is still holding up and the tariff pressure has still to feed through the inflation readings.

(06:36):
One of the big things President Trump brought to the world economy was the tariff plan, called "Liberation Day." The tariff war has put pressure on inflation. Inflation is now over 3% on a year-over-year basis and has put weight on growth. If you look at the right-hand chart, look at the swings there. In the first quarter of this year, we saw a negative reading down about 0.6%. The big driver there was imports. Imports are a negative on growth because we're buying stuff from around the world rather than here.

(07:38):
Those dark gray bars represent net exports. Huge drop. In the second quarter, since businesses and households had already filled up on the imports they needed pre-tariff, they didn't need to buy them again. So you saw a big boost driven by the swings in imports. Looking again at that right-hand chart, the light gray bars represent inventory. If you're buying a lot of imports as a business, it goes into your inventories, which grows the economy. However, in the second quarter, as businesses sell those items to consumers, the inventories get depleted.

(08:42):
With inventories depleted, businesses are going to have to go back to the trough and buy imports again—this time with a higher price tag because of tariffs. Why is it that the US economy isn't yet feeling a recession? Look at that left-hand chart looking at trade as a percentage of GDP. The reason we aren't in a recession is because US economic activity is largely domestically driven. In that chart, the bottom blue line is the US, where trade as a percentage of GDP is just 25% or so.

(09:48):
Compare that to the rest of the world, where trade is 60% of GDP. That's why the rest of the world buckled when these tariffs came down. In the middle chart, you can see the shock: the effective tariff rate in the US is now about 16%. That's the largest effective tariff rate since 1909. In 2024, it was just 2.25% or 2.5%, so that is a huge jump.

(10:49):
However, is there a tipping point? What kept me up at night was the retaliation between the US and China, with talk of 100% plus tariffs. That would push the effective tariff rate over 25%, which to me would be the tipping point. Things have stabilized for now, but as we know, things change on a dime. Now, what about the impact on households? Inflation reached a 40-year high in 2021 and 2022.

(11:55):
It was over 8%, or four times what the Fed wants it to be. When it started to come down, economists thought things looked good, but households didn't feel it. People at the grocery store were feeling the pain and were angry. The left-hand chart shows why. The price growth of essential products like shelter, gas, and food was well above the growth rate of wage gains represented by that dark black line at the bottom.

(12:58):
This is where the pain was. Real wages were negative for 24 consecutive months and are only slightly positive today. This chart doesn't even capture the tariffs yet. The tariff tax makes it much worse. Looking at the right-hand chart, the dark blue represents the cost of tariffs per household income by segment. High-income households will take a hit—losing over $1,000—but as a percentage of their income, it is small.

(14:03):
The average middle-income household is going to lose over $3,000 a year because of these tariffs. Tariffs are a regressive tax. Lower-income households lose the most on a percentage basis. While they "only" lose $1,700, as a share of their income, the cost is over three times as large as it is for high-income households. That is the pain you are hearing about in California.

(15:28):
The Fed has two mandates: inflation and jobs. They want stable prices and maximum employment. Regarding the inflation mandate, consumer prices are still high. It has come down from the 8% highs of 2021, but it is still too high for the Fed. We think more tariff pressure is coming. When I look at producer prices, specifically margin prices, they are shrinking.

(16:35):
That sounds good, but shrinking margins means profit margins for retailers and importers are being squeezed. Businesses are currently squeezing margins to hold onto customers, but eventually, they have to give. The right-hand chart suggests that will be soon. Consumer surveys for manufacturers were disappointing today, and service industries plan to push price increases forward to the consumer.

(17:40):
Now for the other mandate: jobs. This is another area where the Fed is challenged. Look at the left-hand chart; job creation has hit the skids. We're looking at job gains of just 29,000 a month on a three-month average. A year ago, it was over 150,000. We've seen a big drop.

(18:44):
The unemployment rate has ticked up to 4.3%. That is historically low, but there are reasons underneath the surface. Businesses are pulling back on hires, and the labor supply is shrinking because of tighter immigration. On the right-hand chart, while businesses are holding onto workers, they aren't looking to hire more. Job openings have dropped considerably.

(19:44):
This tells me we are in a "low-hire, low-fire" environment. This makes the labor market brittle and at risk of a sharp move in the unemployment rate should layoffs occur. The Fed is challenged: inflation is at 3% (above the 2% target), but the jobs market is looking fragile. This is the big question they are struggling with.

(21:22):
Regarding the tension between the Fed's mandates, there is a huge divide. In the last FOMC meeting, while they cut by 25 basis points, it was very divided. It was the first time since 2019 that we saw a dissent for both more rate cuts (by Governor Moran) and a dissent for no rate cuts (by a Fed president).

(22:30):
This makes a possible cut in December challenging. The left-hand chart shows the "dot plot" of projections, highlighting the spread among members. On the right-hand side, the yield curve has finally steepened. You would think that is a positive sign that markets anticipate growth, but I question that.

(24:03):
This could instead signal concerns about inflation or the growing federal debt. Normally, a steeper curve means growth, but given the weak job market, my concern is that this signals worries over stagflation down the road.

(25:01):
Regarding immigration, in 2024, it seemed there was a miracle happening. On the left-hand chart, we saw a huge increase in labor force projections. The CBO found about five million more workers than they knew about before, based on deep-dives into immigration studies.

(26:05):
The middle chart shows that most of this labor supply came from immigrants of working age. If you have more workers, you have more productivity and the economy grows. The right-hand chart shows that the CBO's potential growth projection went up to over 2.25%.

(27:07):
This inflow meant the economic pie would grow by over $7 trillion through 2034. Chair Powell attributed the 3% plus growth in 2023 and 2024 to immigration. Now that things are slowing, one of the factors is less immigration.

(29:24):
Looking at the right-hand chart, government shutdowns are not a solution. We are approaching the longest-running shutdown in history. For every week the government is closed, it shaves about 0.1 percentage point off growth. The CBO said it could take $14 billion from the economy if it lasts through November. While some growth might come back, we lose the productivity of furloughed workers.

(31:19):
On the left-hand chart, regarding the "big beautiful bill," the CBO doesn't think it will pay for itself. Federal debt held by the public as a percentage of GDP is already going in the wrong direction, reaching about 115% by 2024. With the bill, it goes up to over 123%. It's going to cost the taxpayers.

(32:27):
Before I came to US Bank, I was the chief US economist at S&P Global Ratings. When we were preparing to downgrade the US government, I couldn't tell my mom because it would be illegal insider information. Her response was, "You could have used a payphone!"

(34:35):
To give you a sense of US debt, it's rising everywhere. Japan is the largest in terms of debt-to-GDP. Why? Because we're all getting old. The right-hand chart shows the number of retirees as a percentage of the total population. By 2050, it's going to be over 20% in the US.

(35:45):
Issues like immigration, Fed independence, tariffs, and trade are all tied to policy. While there is trouble ahead, the resiliency of the US economy is impressive. Every time we meet these challenges, we somehow overcome them. The heightened policy uncertainty is a big threat, but the US economy has managed as best it can, and I think we will again. Thank you.