Is Pandemic-Era Borrowing Painting a Precarious Picture?

In a world of fluctuating economic landscapes, nuanced discussions on indicators like the Core CPI, OER, and consumer credit card debt are invaluable. With recent predictions and data driving a torrent of speculation, we spoke to Morgan Slade, a renowned expert on global economic trends from CloudQuant, to break down the currents shaping the future of the American economy.

Gary Drenik: Morgan, diving right in, the upcoming BLS data has many on edge and anticipating a slowdown in the contraction of Core CPI. Your forecast shows a notable drop in Core CPI – moving from 4.7% down to 4.3%. Can you expound on the underpinnings of this?

Morgan Slade: Absolutely, Gary. The American economy is an intricate web of indicators and drivers. The uptick in consumer credit card debt, highlighted in data from Prosper Insight & Analytics, coupled with considerations like the Owner Equivalent Rent (OER), has caused a substantial drag on core CPI. The emphasis on OER is particularly pronounced; if excluded, we’d observe a marked dip in year-over-year inflation rates. With the YoY drop in home prices in May we should continue to see OER exerting downward pressure on Core CPI; however, month-over-month home prices have been increasing since the start of this year. Due to the lagged relationship of home prices to CPI, we wouldn’t expect to see the effect of the increases for potentially another year.

Drenik: The emphasis on OER in these discussions seems disproportionate. Do you believe its role in shaping CPI has been overstated or misinterpreted?

Slade: It’s not so much about being overstated as it is about understanding its mechanics. The weight OER holds in both CPI (25.5%) and PCE (11.2%) is undeniable. Yet, it’s more symbolic—a notional value tied to the concept of homeownership. For this reason, our European counterparts favor a different metric – the Harmonized Index of Consumer Prices (HICP). It’s a very similar metric to CPI, but it excludes the prices of owner-occupied housing. If you look at the HICP for the U.S., its YoY growth of 1.7% is under the Fed’s target inflation rate of 2%.

Drenik: How does the Fed interpret these conflicting metrics?

Slade: Jerome Powell and the Fed are aware of the many different lenses you can use to view inflation. They give insights into the categories that are currently causing the most inflationary stress. In the case of the Fed, they can’t do an incredible amount to control the prices of food and energy which can move wildly due to supply chain shocks. They understand this and can look to the “Core” metrics for CPI and PCE that exclude those categories to get a sense of how well they’re controlling inflation. PCE is used as the Fed’s primary inflation gauge, and while it doesn’t exclude OER like HICP, it does give it considerably less weight than CPI does.

Drenik: Switching tracks to the complex realm of consumer debt, there’s an evident contrast. On one hand, we’re seeing a 30% spike from 2019 averages in savings and checking balances. On the flip side, delinquency trends, especially in credit card and auto loans, are alarming. How do you reconcile this duality?

Slade: It’s a juxtaposition that’s telling of our times. The pandemic, while elevating savings for many, has also exacerbated vulnerabilities. Americans, by and large, haven’t exhausted their pandemic savings. But the spike in late payments and delinquencies, especially among those with compromised credit scores, hints at deeper economic fissures. We’re seeing an increase in adults with monthly credit card debt greater than $12.5K, and adults across all income groups have reported increased budget consciousness.

Drenik: Could the looming shadows of gas and food prices compound this?

Slade: The energy and food sectors are always subject to volatility. While geopolitical events and supply chain disruptions, like Russia’s recent postures against Ukraine, contribute to price fluctuations, these are often ephemeral. Short term, it’s likely to see price spikes in certain food items as Russia hinders Ukraine’s grain exports. Nonetheless, it’s crucial for institutions like the Fed to base interest rate decisions on Core CPI metrics that discount such transient price movements.

Drenik: With speculation rife around interest rate movements, the CME FedWatch tool is reporting an 85% probability of rates remaining unchanged. Your take?

Slade: It’s a balancing act for the Fed. Current data, from the potential decline in shelter’s contribution to CPI to the challenges posed by high-interest rates in sectors like apartment real estate, makes a case for rate stability. The big question right now is whether or not the Fed thinks inflation is declining fast enough; rate hikes would speed up the process, but also increase the probability of a harder landing. Decisions now will have long-term implications, so the approach must be judicious.

Drenik: Touching upon the real estate sector, the looming $1 trillion in multifamily housing debt due between 2023 and 2027 is causing ripples of concern. Coupled with the 14% dip in foreign purchases of U.S. homes, are we courting danger?

Slade: It’s certainly a confluence of challenging scenarios. The pandemic-era borrowing, particularly in the apartment segment, paints a precarious picture. The retreat of foreign buyers, driven away by high-interest rates and a strengthened dollar, adds another layer of complexity. A large part of the concern comes from the type of loans used during the pandemic for the purchase of apartment buildings. Typically, these would be fixed-rate, long-term loans, but during the pandemic, investors were borrowing upwards of 80% of the value of the building and opting for shorter-term, floating-rate loans. With apartment rents starting to stagnate, this could quickly become a problem for investors.

Drenik: The labor market has seen an influx, particularly of prime-age workers. How does this weave into the broader economic canvas?

Slade: The re-entry of prime-age workers is a silver lining as it mitigates the effect of the Baby Boomer generation leaving the workforce. It offers the Fed some leverage in navigating wage growth through supply and demand. However, emerging data from LinkUp around the extension in the job posting durations, an indicator for decreased hiring velocity, suggests potential bottlenecks. The Fed is predicting an increase in the unemployment rate to 4.1% by the end of the year, so we’ll keep a close eye on the data. The labor market is dynamic, and we might be bracing for more shifts by year’s end.

Drenik: Wrapping up with GDP growth—it’s outperformed expectations recently. Are we navigating away from a recession?

Slade: The accelerated 2.4% GDP growth is a beacon of optimism. The general consensus seems to be that we now have about equal chances for a soft landing as a hard one, whereas the past few months have leaned towards a pullback. But the economic milieu remains delicate. While the balance currently teeters between recession and stability, policy decisions in the coming months will determine our trajectory.

Drenik: Morgan, your insights have been enlightening. Thank you.

Slade: The pleasure is mine, Gary. The economic journey ahead is intricate, and discussions like these are imperative.