Inflation is 'close to peaking,' according to Economist Mark Zandi

Moody's Analytics Chief Economist Mark Zandi joins Yahoo Finance Live to discuss how the pandemic affected the global supply chain, causing inflation and higher prices.

Video Transcript

- We're keeping an eye on what's happening in these markets right now. Let's pull up where we stand right now. The S&P 500 is up about four almost five points. It was down earlier today. NASDAQ is also up 28 points. But we've got the Dow now off about 51 points.

Let's talk about all of this with Mark Zandi. He is Moody's analytics chief economist. It's good to have you here as always. One of the things that people in my industry keep talking about is inflation and the impact inflation may have on investors.

In your most recent note, or actually it's a column that's online, you talk about hair on fire. And I think perhaps you've got my industry called out correctly. So, is inflation actually as bad as we keep talking about it every day and investors seem to be worried about it?

MARK ZANDI: Well it's bad. I mean, it's high. It's over 6% on the consumer price index. But in my view, it's close to peaking. You know, probably not this month. Maybe not in December. But by early next year.

And I think by this time next year, inflation will be at a place that we're really not talking about it. You know, I think it goes to the diagnosis of what's going on. I think the pandemic, particularly the Delta wave of the pandemic, ignited this inflation because it scrambled supply chains around the world, messed up the labor market, caused consumers to shift back to spending on stuff and away from services.

And that has created these inflationary pressures. So if that diagnosis is correct, then as the pandemic winds down and hopefully it does going forward, I think these pressures will abate and inflation will moderate. So a year from now, know still be on the high side of what the Federal Reserve would like to see. But close enough that I don't think we'll be talking about it.

- Mark some out there have been critical of the Fed saying that they're behind the curve. They need to become a little bit more aggressive right now even though they have begun tapering. Do you think there's any merit to that argument or are they right where they should be just in terms of policy?

MARK ZANDI: Well, if I were them I think I'd allow investor expectations to start pulling forward the normalization of policy. I mean the Fed's kind of laid out a script for winding down its bond buying, its quantitative easing, and starting to raise short term interest rates. So that's what's kind of embedded in markets and what investors think. So given the strength of the economy, you could see it in the data today, given that inflation is high.

And you know even I think a year from now, it'll still be on the high side, I'd allow investors to start believing that I'll taper QE, quantitative easing, a little bit more quickly. Maybe start raising rates a little sooner next year. Maybe instead of two quarter point hikes in the federal funds rate next year, maybe three, something like that.

Take a little bit of-- if I were looking at the bond market and I saw lower interest rate, long term rates start today, and I'd say they were up a quarter point a half a point from where they are today, I'd say that's probably going to be therapeutic for the economy. So I don't think they're far off where they should be. But if I were them, I'd start allowing investors to believe that I'll be a little bit more aggressive here going forward.

- And then, Mark, I want to draw your attention to the labor market. So the unemployment numbers came out today. They were pretty good, 199,000 first time unemployment claims. So what happens to the labor market next year? Where does full employment look like and when do we get there? Is it 3 and 1/2%? Is it 4%? And then does the labor market still need more support at this point from the Fed or does the Fed really need to make this pivot now and consider inflation?

MARK ZANDI: Yeah, I think we still have a lot of slack in the labor market. I mean, the unemployment rate is 4.6%, because prior to the pandemic, it was at in the mid 3's and the economy seemed to be navigating that pretty well. Inflation was tame and low. So I think we have at least a point to go on unemployment.

And then we've got several million people who have stepped out of the workforce all together during the pandemic, and therefore are not counted as unemployed. But I think they'll come back in as the pandemic recedes and they get back to health and they're less fearful of getting sick and they don't have to take care of children who are at home because they can't get care.

So you know, if you add all of that up, I think there's still a lot of room to maneuver here before the economy is at full employment and we get the kind of pressures that would I think force the Fed to normalize rates more quickly than they plan right now. So you know, I think there's still some room to navigate here for the labor market and then for the monetary policy.

Does that room to navigate include something that you're warning people about? You said, quote, "it would not be surprising if there's a significant correction in stock, bond, and real estate prices in the coming year." What does that look like in the real world for those of us who worry about home prices and worry about our investments?

MARK ZANDI: Yeah, you know, for most people they should look through it, right? I mean, you should have a longer term-- if you're invested in the stock market, you should have a longer term investment horizon. You know, not next year maybe not even the next five years but over the next decade.

So the ups and downs and all arounds in the market really, you shouldn't be focused on. And also for your home, you know, most people aren't looking to sell their home next year or two years or even three years from now. So you have a long term horizon, you should look through these ups and down and all arounds.

But, now having said that, stock prices are very high relative to earnings. Multiples are very, very wide. And in the housing market, house prices are very, very high relative to rents and incomes and construction costs, the kind of fundamental things you look at to value housing.

Now, valuation should be high because interest rates are very low. But as interest rates normalize as the Fed starts to ease up on its support for the economy and interest rates start to move and long term rates rise, that's going to make these valuations a bit look a bit stretched. And I think we will see at best, for the year, basically stock prices, housing values go flat.

And there could be a period between now and the end of next year when we see a correction in prices prices, stock prices down 10%, 15% from where they are today. And in housing values in some markets that are down from where they are today.

- Mark, how are you looking at the rising COVID cases. The national average daily national average now isn't too far from 100,000. It seems like we're headed in the wrong direction. The numbers continue to increase as we head into the winter months. I guess how big of a risk do you see this being to the recovery? And are you revising your outlook, your growth outlook at all as a result of this?

MARK ZANDI: It is a risk. I am very nervous about it. I mean, I do think the Delta wave did a lot of the pandemic that hit back in the summer. It did a lot of damage. It slowed growth. And it's again, behind the surge in inflation. So another wave of the virus, that'll do damage too.

Now I'm hopeful. And I think this is reasonable, that each new wave of the virus that we suffer through, and I think at this point, we have to count on more waves in the future. But each new wave of the virus is less disruptive to the health care system, to the economy, than the previous wave.

So if that's kind of the script that's before us, you know, I think the economy will-- it's not going to be a straight line. It never is. But the economy is going to steadily continue to recover. And inflation is going to steadily moderate. And a year down the road, we're going to be feeling a lot better about things.

But having said all of that, we're talking about this pandemic and hard to know what path that's going to take here. So a lot of risk around anything I'm saying. And then, Mark, I want to ask you about valuations because they're sky high, right, in several sectors. So when does everything sort of come down to the ground and reality starts to sink in and some of the froth starts to you be eradicated from the market?

MARK ZANDI: Well, I don't know precisely when. But I do think between now and the end of 2022, I would not be surprised that there's a period where we see markets take stock of these high valuations in the context of rising interest rates, short term interest rates, long term rates, and say, hey, these valuations don't make a lot of sense in the context of higher rates and we see a repricing.

But as you know, markets, they're fine, they're fine, they're fine, and then they're not fine. They move very, very quickly. And I suspect that's the kind of experience we're going to have to navigate through in 2022 at some point.

Whether that's in February or June or next October, I don't know. But all the preconditions for a correction in prices, equity prices, bond prices, are in place right now.

- It's kind of like when a dog sees a squirrel, and then squirrel, squirrel. Everything's good until the markets are like, oh, problem. Mark, I just want to ask you real quick, looking ahead to December we have the final FOMC meeting of the year. What should investors pay attention to? And the statement we'll get as well as all of the data that they'll release in December, it's one of those dot plot meetings.

- Yeah, it's going to be an important meeting because it's all happening after these this hair on fire kind of inflation statistics. And they need to be focused on it. So I'm sure we'll get a lot of information about how they're thinking about things at this meeting. And you know one thing to watch is the pace of their tapering of quantitative easing.

Right now kind of the expectation is they're going to every month reduce the amount of bond buying by about $15 billion a month. Are they going to accelerate that process? In their dot plot forecast, this is the forecast that they do, they give us dots, give us a sense of where they think policy is headed in terms of short term rates.

Are more people starting to think we're going to get rate increases this year. And instead of I think right now, the last dot plot had a couple quarter point hikes. In late 2022, will there be three? Will there be four? So those are two things. There's lots of things to look out for. But if you're reading the tea leaves, those are the two key leaves to be looking at.

- I think my colleagues are all going to be talking about inflation expectations. We're going to be putting expectations at the end of the word inflation as we go forward. Mark Zandi, thank you so much. Mark, by the way, is the Moody's analytics Chief Economist.

You can read his column about inflation, I believe if you Google Mark Zandi, CNN, you can see that. He talks very honestly and succinctly about where we're headed. Mark, all the best to you.