Recession can be characterized by ‘a loss of faith’ amid unemployment spike: Economist

Moody’s Analytics Chief Economist Mark Zandi examines the Fed's rate hike outlook while maneuvering through recession worries, wage demands, and concerns in the labor market.

Video Transcript

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SEANA SMITH: Stocks selling off today in fear that the Fed is going to stay aggressive and keep raising rates until the economy falls into a recession. Here to discuss where things stand from his point of view, we want to bring in Mark Zandi. He's Moody's Analytics Chief Economist.

Mark, it's great to have you back here on Yahoo Finance. Let's talk about some of the recent data points that we got. We got the jobs report last Friday, the ISM services number out this morning. "Wall Street Journal" now reporting that 50 basis points could be on the table at the Fed's next two meetings. What's your big takeaway?

MARK ZANDI: Well, I think the economy is resilient, but its growth rate is moderating slowly but steadily. And I think it will continue to moderate under the weight of the higher interest rates. I think that the Fed will continue to raise rates, terminal rate get at least to 5%.

But given the broader resilience in the economy, consumers, businesses hiring, I think we can navigate through-- we've got a fighting chance of navigating through the next 12 to 18 months without actually going into recession. It'll be tricky. And under any scenario, it's going to be a bit uncomfortable. But I think recession is not inevitable.

DAVID BRIGGS: Primary concern of that latest jobs number being wage growth. How concerned were you?

MARK ZANDI: Yeah, I mean, if I were going to write it on a piece of paper and say, hey, what would I like to see, it wouldn't have been 5 percent-ish. That's kind of the underlying rate of wage growth as measured by average hourly earnings in the report. We need something closer to 3 and 1/2%.

But I think all the trend lines suggest we're headed in that direction. I mean, job growth is slowing quite significantly. Underlying job growth is 250k per month. We were at 600k per month at the start of the year.

Other indicators suggest that we're going to see further slowing in job growth, hours work decline. The number of people working in the temp help industry weakened. That's a leading indicator of future job creation.

The other survey of employment, the household survey, I mean, all these numbers, the 250k's, survey businesses. But you look at household-- the household survey, another window on what's going on the job market, that's been meaningfully weaker, and that may be also a leading indicator. So job growth is steadily slowing.

And the other thing I'd point out is labor force grows-- labor supply is OK. It's not too bad. Unemployment stopped declining. The employment-to-population ratio stopped rising. So all the trend lines kind of suggest that we're going to get to a place where things cool off and wage growth begins to moderate, not next month, not next quarter, but by this time next year.

SEANA SMITH: Mark, and I know you're also keeping a close eye on gas prices, how that's factoring into inflation, another important thing to keep an eye on when we're talking about wage growth and its effect on inflation. I guess, talk to us just about how important of a factor that is, and especially to how consumers are currently feeling about inflation.

MARK ZANDI: Yeah, that's a great point, Seana. So I do think that one of the key reasons why wages took off here this time-- beginning this time last year was the jump in oil prices, gasoline prices related to the Russian invasion of Ukraine. And gasoline prices, oil prices, they play a central role in people's thinking about inflation.

That means the price that they observe every day that they go to work. They pay it at the pump once a week. So they see it. They feel it. It really is what's key to driving inflation expectations. So when oil, gasoline prices surged to record highs-- I mean, back in June of this year, we were paying $5 for a gallon of regular unleaded, a record high.

I think that's when workers said, hey, you know, Mr. Employer, you need to pay me more to compensate the-- and that's why we've seen this inflation metastasize. But now with oil prices and gasoline prices coming down-- we're at $3.50 for a gallon of regular unleaded, headed lower-- if nothing disturbs that, obviously a lot of risk around that, but if nothing does, then I think wage demands will moderate as people's-- consumer's inflation expectations moderate along with the lower oil prices, gasoline prices.

DAVID BRIGGS: Of course, you have been watching the housing market, the first indicator of Fed success, or lack thereof. Do you see prices leveling out? Or are we talking about a major 20% type of correction some are still predicting?

MARK ZANDI: Yeah, somewhere in between, David. So not zero, not 20. If you told me down 10 peak-to-trough, that sounds about right to me in the context of mortgage rates that are sitting-- fixed mortgage rates are 6 and 1/2 percent-ish. If we hang there, and that feels like we will, that's hammered affordability and crushed demand. Home sales are way off.

So I do expect prices to weaken here. I don't expect them to go down 20 or collapse because in part, I don't think we're going into recession, in part because the borrower-- the quality of the borrower since the financial crisis is actually quite good. Credit scores have been very high, and they're getting plain vanilla 30-year, 15-year rate mortgages, nothing weird or exotic like what we saw before the financial crisis, two years subprime ARMs, neg am loans, that kind of thing.

So I think we're in a spot where we are going to see a correction in price, just because we have to-- the housing market has to restore affordability. The market's just not affordable at this point for most potential buyers. But I don't think we see a crash, which would be kind of a 20% decline.

SEANA SMITH: Mark, another important indicator that many on the street closely follow, the CEO optimism survey from the Business Roundtable. That was out this morning showing that optimism is declining. There certainly is a bit more pessimism when you're taking a look at what CEO outlook is into next year. But it's not falling off a cliff. I guess, your broad takeaway on that and just in terms of what that signals to you.

MARK ZANDI: Yeah, it's bizarre, isn't it? I mean, I've seen many business cycles, many recessions. I've never seen kind of this broad-based pessimism, particularly among CEOs of companies. They're generally, you know, glass half full kind of people looking on the upside. So it is surprising.

One possible takeaway from that, though, is you actually need business people to be cautious for the economy to slow sufficiently to quell the inflationary pressures. So if businesses run by CEOs that are very nervous about the economic outlook begin to pull back on investment and hiring, and that-- that's kind of what we need. So that may help forestall recession.

The other thing I'd say is the key to recession, though-- and by the-- at the end of the day, a recession is a loss of faith. It's business people losing faith that they can sell whatever they produce and they start cutting jobs. There's the loss of faith of consumers that they'll hold on to their job and they stop spending.

So it's really the change in sentiment that really matters. And people can feel blue and not great and ugly but that doesn't collapse, then I think we can avoid an economic downturn. But if sentiment really starts falling very rapidly, that means people are losing faith, business people, consumers are losing faith, then that would be a tell that we, in fact, are going into recession in the not-too-distant future.

DAVID BRIGGS: As for that consumer, Mark, it's been another confusing dynamic where savings continue to plummet and credit balances continue to skyrocket, increasing more than they have in some 20 years. How long can this dynamic hold up?

MARK ZANDI: A while. That decline in saving rate represents all that extra savings that people did during the pandemic. I mean, they're drawing that down now because of the high inflation, but they have significant amounts of cash sitting in the bank account that they saved during the teeth of the pandemic. And they're now using it.

So the savings rate, the measured saving rate, is low, but they're able to supplement their income with-- their purchasing power with that excess savings. So that's a good thing. Of course, low-income households, that's not the case. They have-- they have drawn down their excess saving and then some, and now they are turning to credit cards and unsecured personal loans to help supplement their income. And that can't continue for very long. At some point, they're going to be tapped out with that.

But at the end of the day, the folks in the top third of the distribution of income account for over 2/3 of consumer spending. So it's not great. The economy is not going to thrive. Again, it's not going to be-- it's going to be a struggle over the next 12 to 18 months, but the economy can continue to move forward as long as that top third of the distribution keeps spending. And right now, they've got a ton of cash.

SEANA SMITH: Guess that's a glimmer of hope there. Mark Zandi, Moody's Analytics Chief Economist, always great to have you. Thanks so much for joining us this afternoon.