Richard Clarida on This Tricky Moment for the Federal Reserve

Summary

Odd Lots Podcast Summary: Richard Clarida on This Tricky Moment for the Federal Reserve

Release Date: November 14, 2024

Hosts: Joe Weisenthal and Tracy Alloway
Guest: Richard Clarida, Former Federal Reserve Vice Chair, Economic Advisor at PIMCO, Professor of Economics at Columbia University

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Introduction

In this insightful episode of Bloomberg's Odd Lots, hosts Joe Weisenthal and Tracy Alloway engage in a comprehensive discussion with Richard Clarida, the former Vice Chair of the Federal Reserve. The conversation delves into the current economic landscape, focusing on the Federal Reserve's monetary policy amidst election uncertainties and shifting inflation dynamics.

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Fed's Current Policy Stance and Rate Cuts

Short-Term Policy Adjustments

Richard Clarida begins by addressing the Federal Reserve's recent decision to cut interest rates by 50 basis points in September and an additional quarter-point the week of the election. He states:

“They are data dependent, but my sense is that the probabilities that you quoted seem pretty sensible to me, not a slam dunk, but I think more likely than not that we get a rate cut in December.”
(04:09)

Clarida explains that the Fed's approach is cautious, emphasizing policy actions based on current data rather than future projections. He highlights the importance of not waiting until inflation fully aligns with targets to avoid potential overcorrections, noting:

“Monetary policy operates with lags. If they had waited to cut rates until inflation fell all the way to two, they might have overdone it.”
(05:15)

---

Balancing Short-Term and Medium-Term Objectives

Dual Timeframe Challenges

The discussion shifts to the Fed's challenge of balancing short-term data dependency with medium-term market expectations, especially in light of the Trump administration's potential economic policies. Clarida explains the complexity of this dual timeframe:

“Right now there's two different timeframes that people are in and people are trying to resolve the two. It makes for some very interesting times in macro.”
(02:13)

He underscores the difficulty policymakers face in reacting to uncertain fiscal policies while maintaining a data-driven monetary stance.

---

Inflation Dynamics and Expectations

Understanding Inflation Trends

Clarida elaborates on the current state of inflation, pointing out that while headline numbers show improvement, the path remains uncertain:

“I take him at his word that it is a bumpy path. Maybe progression could stall.”
(10:23)

He reassures that despite recent positive trends, the Fed remains vigilant, acknowledging the possibility of stalled disinflation without catastrophic price increases.

Sticky Inflation Scenario

Addressing concerns about sticky inflation, Clarida outlines potential scenarios:

“Inflation doesn't get worse, it just doesn't get better. It gets stuck between 2 and a half and 3%.”
(29:20)

He suggests that while not ideal, this scenario wouldn't trigger a dramatic Fed reaction as long as inflation expectations remain anchored.

---

Impact of Trump Administration Policies

Tariffs and Immigration

Clarida discusses how potential Trump-era policies, such as tariffs and immigration changes, could influence the economy:

“A tariff is not really inflationary. It pushes up the price of goods affected by the tariff.”
(36:04)

“Immigration influences the labor supply, with undocumented workers concentrated in sectors like agriculture and construction.”
(36:12)

He emphasizes that the Fed would assess these policies based on their sectoral impacts and overall economic implications.

---

Housing Market and Long-Term Yields

Mortgage Rates and Housing Activity

The conversation turns to the housing market's resilience despite rising mortgage rates, attributed to historically low locked-in rates:

“The magnitude of the gap between the spot mortgage rate and the rate that millions locked in is different in this cycle.”
(19:17)

Clarida notes that this disparity has supported home prices and reduced mobility, a unique feature compared to past cycles.

Financial Conditions

Clarida addresses the apparent ease in financial conditions despite rate cuts:

“Financial conditions are moving in an easier direction, which is okay. But it needs to be a factor in the outlook.”
(20:52)

He explains that while short-term indicators may seem favorable, the Fed considers longer-term trends and sector-specific dynamics in their policy formulation.

---

Scenario Analysis for 2025

Baseline and Alternative Scenarios

Clarida outlines three primary scenarios for the economy by 2025:

1. Soft Landing (Baseline):

   • Gradual inflation return to 2%
   • Modest GDP growth in the low to mid-2% range
   • Fully employed economy

   “Inflation continues to return gradually to 2% in the context of a fully employed economy.”
   (26:24)

2. Sticky Inflation:

   • Inflation remains between 2.5% and 3%
   • Fed may pause or slow rate cuts

   “Inflation doesn't get worse, it just doesn't get better.”
   (30:21)

3. Tough Scenario:

   • Financial conditions tighten leading to a slowing economy
   • Rising unemployment with sticky inflation
   • Least likely but challenging for the Fed

   “If tightening continues, you'll have a slowing economy, rising unemployment.”
   (26:24)

---

Political Influences and Central Bank Independence

Trump's Relationship with the Fed

Clarida comments on former President Trump's public opinions on the Fed:

“Trump opined on interest rates during his presidency, which was not unprecedented.”
(32:18)

He affirms the Fed's independence, emphasizing its Congressional mandate to focus on price stability and maximum employment, regardless of political pressures.

Social Media and Public Perception

In light of public figures like Elon Musk questioning the Fed, Clarida reinforces the institution's commitment to its mandate:

“The Fed is a creation of Congress. They set policy based on achieving their mandate and filter out distractions.”
(33:53)

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Sentiment and Economic Strength

Diverging Economic Realities

Clarida highlights the importance of considering distributional impacts and sentiment alongside aggregate economic indicators:

“The distributional ripples of the economy have been significant, affecting different parts in varied ways.”
(38:32)

He points out that while macro indicators like GDP and employment are strong, underlying disparities influence overall economic sentiment and resilience.

---

Practical Advice for Fed Watchers

Focusing on Key Indicators

Clarida advises listeners to concentrate on Fed Chair Powell's communications for clearer policy insights:

“Listen to Jay Powell. He’s a straight shooter and provides a clear sense of where he is.”
(40:48)

Understanding the Fed's Long-Term Planning

He emphasizes that the Fed plans beyond individual meetings, focusing on long-term economic trajectories rather than short-term fluctuations:

“The Fed looks ahead at least 12 months, if not longer, when developing its policy plans.”
(40:50)

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Conclusion

The episode concludes with a reflection on the complexities facing the Federal Reserve in navigating monetary policy amidst political uncertainties and evolving economic indicators. Clarida's expertise provides listeners with a nuanced understanding of the challenges and considerations shaping the Fed's decisions during this pivotal period.

---

Notable Quotes

• Richard Clarida:

  “Monetary policy operates with lags. If they had waited to cut rates until inflation fell all the way to two, they might have overdone it.”
  (05:15)

• Richard Clarida:

  “Inflation doesn't get worse, it just doesn't get better. It gets stuck between 2 and a half and 3%.”
  (29:20)

• Richard Clarida:

  “Listen to Jay Powell. He’s a straight shooter and provides a clear sense of where he is.”
  (40:48)

---

This episode of Odd Lots offers a deep dive into the Federal Reserve's strategic considerations during a period marked by political shifts and persistent inflationary pressures. Richard Clarida's insights illuminate the delicate balancing act required to steer the economy towards stability and growth.

Transcript

[PGIM Fixed Income]

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[Katie Greifeld]

Bloomberg Audio Studios Podcasts Radio News hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

[Tracy Alloway]

And I'm Jill Wiesenthal.

[Katie Greifeld]

Joe, I feel like it's fair to say there are a lot of weird things that have been going on lately. You know what the weirdest was for me recently?

[Tracy Alloway]

Go on.

[Katie Greifeld]

Having the Fed meeting on a Thursday. Oh yeah, that threw me off for that entire week.

[Tracy Alloway]

I thought you were going to say the weird thing was having a Fed meeting two days after the election. But no, you're right, I was really confused. Just the fact that it was on a Thursday at all. Setting aside the fact that it was an extraordinarily busy week, which was just.

[Katie Greifeld]

Last week, I didn't realize how much of my sense of normality was in fact influenced by having the Fed do something on a Wednesday. But anyway, that threw me too. So we just had a Fed meeting. We are recording this on November 12th and clearly this is an interesting moment for the central bank.

[Tracy Alloway]

Totally. I saw a tweet today. I don't remember who it's from so I can't give proper credit. Or maybe it was a sell side note, I don't know, just words that I saw on my screen at some point. But I think what made this interesting is this moment. Or maybe it was a tomb Dewey note. Whatever it was, this moment where the Fed is still clearly in the sort of short term data dependency. Are we going to see further progress on realized inflation and so forth? Watching the data, plenty of missed signals there. Meanwhile, the market is very seemingly focused on the medium term and thinking a lot about Trump and the new fiscal and macro policies that will emerge under this administration. And I thought that was a really good way to frame it, which is that right now there's two different timeframes that people are in and people are trying to resolve the two. And it makes for some very interesting times in macro, to say the least.

[Katie Greifeld]

Yeah. And I have to say, like, I do not envy policymakers on the FOMC at the moment because they have been emphasizing the data dependency, as you said. But there is all that uncertainty about how the Trump administration is going to unfold fold and what its economic policies will actually look like. It seems really difficult to me to have to react to that from a monetary policy perspective. So basically, there are a lot of questions, lots to talk about, and who better to ask these questions of than a former Fed person? So we are going to be speaking with Richard Clarita, the former Fed vice Chair, now economic advisor at Pimco and a professor of economics at Columbia. Richard, thank you so much for coming on. All thoughts.

[Matt Levine]

I'm glad to be on the show. Big fan.

[Katie Greifeld]

Oh, thank you. So first of all, you know, last week, the FOMC meeting on a Thursday, I gotta ask, when you watch those, are you sort of watching them like wistfully wishing you were there, or are you thinking like, oh, gosh, this is really tough now?

[Matt Levine]

Well, it can be tough. Yeah. I was certainly involved during my four years there in thinking about and prepping for the, the press conferences. But yeah, I watch them as a Fed watcher now. And the chair has become quite polished and experienced in navigating what can be some, sometimes some choppy waters.

[Tracy Alloway]

By the way, Tracy, you didn't say it, but I believe Rich is the perfect guest.

[Katie Greifeld]

Oh, I'm sorry.

[Tracy Alloway]

No, I just want to establish that I believe in this moment we are talking to the perfect guest. And then listeners are like, why didn't you call Rich the perfect guest? So I just want to make sure.

[Katie Greifeld]

That it was truly an oversight.

[Tracy Alloway]

Truly, both Tracy and I consider you to be the perfect guest. So we had that 50 basis point cut in September. Then we had the quarter point the week of the election. As I'm looking at the warp function on the terminal, expectation is for there's 65% chance of a cut in December. So not a slam dunk, but that still seems to be the expectation. Why don't you give us, as a Fed watcher, your current read on the crosswinds that the Fed is going. Let's start with the short term still because then we can get into the medium term, the crosswinds that are happening right now as the Fed looks for the near term path of policy?

[Matt Levine]

Well, they've made some judgments. One, they judge that policy is restrictive, that they've done enough, and so they cut rates. They recalibrated. I think that was the term the chair used in September. Important to note, they've begun to cut rates even though inflation is still somewhat above target. Some of your listeners may wonder why. And the answer is monetary policy operates with lags. And so if they had waited to cut rates until inflation fall all the way to two, then they, they might have overdone it. So I do think it made sense to get the process started. I do take them at their word. They're not on a preset path. The committee is united, unanimous decision to cut rates. And I think importantly, and I'm sure we'll get to this later, you know, the chair's made very clear that he and the committee are not going to be making policy decisions in 2024 based upon what might happen in 2025. And so I think it's important to clarify that. I think they are data dependent, but my sense is that the probabilities that you quoted seem pretty sensible to me, not a slam dunk, but I think more likely than not that we get a rate cut in December.

[Katie Greifeld]

So just on this point, how do you square the proverbial lags in monetary policy with the desire to not be reacting to an incoming administration where policies are not necessarily clear at the moment?

[Matt Levine]

It's a great point. Luckily we have a lot of historical examples because as you know, we have presidential elections every four years and the Fed as an institution and the staff have a lot of experience. And one of the things I learned is, especially in the US System, unlike say the UK System where you present a budget and here there's a whole set of negotiations. And so I do think that the chair gave a good insight into the process that they'll follow, which is that over time they'll learn about the contours of the plans for policy, then what gets enacted? I do think it is a good point. I think initial conditions here are quite relevant. And so in particular with inflation running close to target, if a bit above, I think the general playbook they usually follow makes sense. There is a risk that if they don't start moving now, then for certain scenarios it's too late. But I think given where inflation is, they're making the correct call.

[Tracy Alloway]

So I don't know if economics is really a science or not, but if it is a science, I feel like economists are cursed to never have the pure experiments in the real world that they would like to see. And I'm thinking about that specifically since September, since mid September, early October, we got that 50 basis point cut. Since then, rates at the long end in particular have been rising. Unfortunately from a pure scientific experiment that is around the same time that Donald Trump's odds in the polls also started rising. Therefore it's a little tough to tease out how much of this is okay, we're going to have more reflationary policies in the next administration which we can get to versus you know what, the economy is stronger than we thought, neutral is stronger than we thought, and the terminal rate is not going to be as low as we thought simply due to existing economic conditions. When you look at that rise in the long end, the higher terminal rate and so forth, how do you try to disambiguate the two and what signal, if any, do you read in post September market activity?

[Matt Levine]

Great question and I think the simple answer would be you look at all the above. But I think we can make a couple of informed observations. The first, and if I were back on my old Fed job, I'd be looking at this is longer term measures of longer term inflation expectations either in the TIPS market or surveys, and those are very well behaved. Secondly, we also have had some pretty strong macro data, big revisions to gdp, which in some ways really change in important ways the assessment of where the economy is right now. We got a very soft labor market report, but I think the markets and the Fed are inclined to look through that given, you know, the storm and other related consequences of that. A term perhaps you've used on your show before is also look at the term premium. How much of this move in yields is essentially bond investors saying I want to get paid more in terms of a higher yield given what may happen to fiscal policy, policy or growth. And I think all of the above has been going on. It's been some move in term premium, some stronger data, you know, backward looking data, and probably some repricing of the path for the economy given the election. I would point out that at this stage I think you want to distinguish between a phenomenon where by knowing the election victor, I think we know something about the contours of, for example, tax policy. It's more likely that the 2017 Trump tax cuts are going to get extended more or less intact and that probably would not have been the outcome if we'd had an opposite election outcome. So I think in this early stage it's Hard to determine how much of this is a repricing of the level of markets versus a new trend because I think both could be going on.

[Katie Greifeld]

I feel like I should just mention again, we're recording this on November 12th and there is something happening tomorrow that might have a bearing on this conversation, which is we're going to get the latest CPA CPI reading. When it comes to inflation, obviously there has been improvement on this front. But in the most recent FOMC meeting Powell was emphasizing, you know, really making the point that he expects this to be a sort of bumpy path going forward. When a Fed chair is saying something like that, should we assume that the risk is to the upside on prices?

[Matt Levine]

I don't think so. I don't think that's the message he was trying to convey. I take him at his word that it is a bumpy path. Maybe I'll put something back into that conversation that sort of fell out of favor. There was a lot of talk a year ago about the last mile being tough to navigate. And I would point out that if you look at inflation on a 12 month basis, in December of last year inflation fell to 2.9, the Fed's preferred measure on the core PCE. And that was a big moment. That was the first time in almost three years inflation had, was two point something. It's very likely that this year will end in inflation will end on a 12 month basis anyway at around 2, 8 or 2, 9. So at least by that metric, you know, this is a year when we've not moved backwards. But you could argue that, you know, progress on inflation at minimum has been slow. And so the way I take the conversation from the chair and other members of the Fed is they have a view that disinflation will continue, but they're also open to the risk that it may stall. I don't think necessarily it means inflation is going to go up too to frightening levels. But progress could stall. And I think that they're very attuned and attentive to evidence in the data on that.

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[Marin Sums]

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My child's university fees and living costs? My partner and I have excess savings. So should we overpay on our mortgage or should we put the money into stocks?

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[Tracy Alloway]

So as you mentioned, you know there's a confluence of factors. One of the things that may explain why the market has repriced its terminal rate or the depth of the rate cut cycle this time and you mentioned that we had some pot, we got that strong jobs report, there were some positive GDP revisions that make it look like the economy is in a higher state. The one thing that's been bandied about for years now is this idea that post pandemic like so called R star is higher. I don't know what it is, whether it is higher or not, but if it is higher, what's different? Suppose it is higher. What has changed in your view that would explain a higher neutral rate of interest?

[Matt Levine]

Good point. I think a couple of factors. First of all, why was R Star believed to be pretty low in the decade before the pandemic? Maybe a bit of an anecdote. There was also uncertainty about our star in 2018 when I arrived at the Fed range of views I think from the funds rate maybe two and a half up to three and a half in that cycle the Powell Fed sort of found out where neutral was because when we got the funds rate to two and a half the economy was in a pretty good place. In fact, if anything, inflation began to slow. So it is true that you don't know precisely, but you can sort of have a sense if you're in the right ballpark. So why might it have gone up? Well, there are some positive reasons and maybe some more negative reasons. The positive reason is our star is thought to be related to growth. So if potential growth is higher, either because of innovation or AI. Or list your favorite contributor that could push up R star. It could also reflect demand for capital. We have had some evidence, at least in certain sectors of expanded capital spending. We went through a decade when capital spending was weak. On the other side of the ledger, a lot of the factors that were keeping our star pretty low, if not really change, you know, demographic factors have not really moved and if anything, saving has been moving up. So I think they will find it in this cycle, as we did in the last cycle, by looking at the data and as they get close, you know, rethinking that.

[Tracy Alloway]

Could government spending be a contributor given that deficits as a share of GDP are very high, given where the unemployment rate and resource utilization generally are? Certainly.

[Matt Levine]

And here maybe if I could be a little wonkish, please, for your listeners.

[Tracy Alloway]

Never, never worry about that.

[Matt Levine]

Never worry. I wrote a recent essay in the FT on this topic here. I do think you want to distinguish between the neutral rate that the Fed focuses on, which is really the front end of the yield curve. So where's the funds rate going to end up when inflation gets to target? And right now the Fed thinks that number is around 3%. If you ask me the question where are bond yields going to end up? My own view, and I think the PIMCO view is higher than we saw in the decade before the pandemic. So in other words, we think the front end of the curve may not be all that higher, but long rates could be higher because the curve will be steeper. In other words, markets will adjust not so much because the Fed has to do something different, but because the yield curve will be steeper. It was very flat in the decade before the pandemic. For example, in 2018 when we got the funds rate up to two and a half, 10 year, treasury yields were 3. And so for the reasons you mentioned, deficits and debt, probably in a world with higher, longer yields than we saw in the decade before the pandemic.

[Katie Greifeld]

Hmm. Since we're on the topic of higher long term yields, one of the things we've been speaking about on this show recently is mortgage rates. And even though the Fed has been cutting, those haven't really gone down partly because they are influenced by longer term treasury yields and those are going up. Given that, you know, affecting the cost of housing or the mortgage rate is supposed to be a primary tool in which a central bank actually influences the real economy, does that pose a problem at all for the central bank?

[Matt Levine]

I think it's a reality for the central bank because for the most part, although the Fed has been very active in supporting the mortgage market through the QE programs, its mortgage portfolio is running off. And if anything, Tracy, they've indicated that may well continue even when they stop QT in general, and you are correct, mortgages will tend, yields will tend to move closely, not so much with the funds rate, but the longer end of the yield curve. I would say it's more of a reality as they think about the appropriate stance of policy, they will need to factor that in to what they project they need to do to achieve their inflation and employment target. So I think in the Fed's thinking, it's just a reality of the way the financial markets work and that may call them to adjust policy in one way or another in the future.

[Tracy Alloway]

There was a famous paper that came out saying on the subject of housing called Housing is the business cycle. And one of the things that was interesting was that during 2022, when the, you know, and mortgage rates really started to rocket higher, we did get this freeze in the housing market. Though we didn't see a plunge in home prices, but we really saw, yeah, the market sort of came to a freeze. And there still is a lot of diminished activity and we still see fewer housing starts and we still don't see a lot of sales and all this stuff. Do you think the relationship has changed in some way between the housing market and the broader macro economy?

[Matt Levine]

Great question, because you look at, I've been doing this now for four decades. So you look at business cycle history and there are some common features and then there are always some surprises. And in particular in this cycle, one thing that has been different is the fact that so many folks in the years before the Fed raised rates were able to lock in low rates mortgages, that you've had less mobility. People are less likely to move even if they want to, simply because if they sell their house, they then got to get a mortgage on a much higher rate. Now, this phenomenon is always evident in the data because people can lock in low rates and then rates move up. But what's different in this cycle is the magnitude of the gap between the spot mortgage rate and the rate that millions and tens of millions of people locked in. So I think in that respect, this is a different cycle and it's been a factor that's been supporting house prices even though the Fed's been raising rates dramatically. Typically, you would not have seen that in past.

[Katie Greifeld]

Just related to this topic, the Fed has been talking a lot about how it's necessary to I guess ease up on the restrictiveness of monetary policy and therefore cut rates. And I'm always a little bit confused because when I look at financial conditions on the Bloomberg, they look pretty easy to me. And obviously this has happened post the FOMC meeting. But we have for instance, junk bond spreads getting pretty close to historic lows, equity markets obviously at a record. Where's the restrictiveness actually showing up?

[Matt Levine]

Great point. And I look at the same screens that you both do as well. The Fed, the board of Governors actually about a year ago or so developed its own index of financial conditions and that also shows conditions trending in an easier direction. The chair got a question or two on this in the press conference last week and I'm paraphrasing, but his answer was more along the lines of they try not to get up in high frequency day to day or week to week moves, but they do want to look at longer run trends. I would argue even if you look at longer run trends now, conditions are certainly moving in an easier direction now. You know, that's okay. But it's also important, I think as the Fed communicates through press conferences and speeches, you know, that they clarify what they are looking at because sometimes Fed officials will talk about the funds rate being restrictive relative to inflation and history. And that's, that's true. But the conversation I think also needs to acknowledge what we're looking at in different parts of the, of the markets. Now again, inflation is on the path down to 2%. So an easing of conditions relative to say 2022 when they are very restrictive is not necessarily a problem. But it certainly I think needs to be a factor in the outlook.

[Tracy Alloway]

I'm going to ask sort of, I think it would be a variation on Tracy's question and it came up in also a recent episode we did with Chicago Fed President Austan Goolsbee. When you look at the progress that we've made on inflation since it peaked, given that many financial indices have surged, given that the unemployment rate is still only 4.1%, what's your story for it and what's your story for the connection between the move up in short term interest rates by the Fed and how that Fed through to lower realized inflation.

[Matt Levine]

Well, you know the, in my youth we used to call it the $64,000 question. Maybe the $64 billion inflation has hit hypothetical questions globally. The $64 trillion question. The good news is relative to real time and I can tell you as a fed official in 2021 we had so many conflicting signals. But with the benefit of hindsight and also looking across the globe, I think some pretty clear patterns help to account for this. I should also confess that I was a charter member of Team Transitory.

[Tracy Alloway]

This is where people come up odd lots is a confession. Confession time.

[Matt Levine]

I was a charter member of Team Transitory and obviously it took a while for inflation to get back to two point something. A couple of things. First of all, in retrospect, a lot of the surge in inflation in the US and globally was driven by supply disruptions. It turned out to be more timely and costly to reopen the global economy than it was to shut it down. Secondly, in the US there was a lot of demand support that was flooding the system. The Fed went all in without apology in 2020. We had $6 trillion of fiscal support in 12 months. And so from Econ 101, if the demand curve shifts right and the supply curve shifts left, you're going to get a move up in prices. And that's what we got. There was a lot of uncertainty when the Powell Fed started hiking in 2022 about would they succeed, what would it take to get inflation down. And I think we're all pleased that in fact inflation has come down pretty close to target without a real disruption in the economy. And I think that's due to some of the supply shocks reversing here and abroad. And it's also due to the fact that the Powell Fed did raise rates aggressively. They re anchored inflation expectations. I think if I can editorialize a bit here, I think we're in a world where unlike on your show, we're going to have 30 or 40 minutes. A lot of economics contrary takes place on Twitter and 140 characters. And there are a lot of topics in economics and finance that are really you can't do justice to and in a tweet. And I think this is one of them. So some folks look at this and they say, well, it has to be supply or it has to be demand or it has to be monetary policy. And in fact it was really an all of the above in response to a once in a century shock. And there was also a global phenomenon as, as well. And so I think that's the received wisdom now it was not obvious two or three years ago.

[Katie Greifeld]

I feel like this is my chance to ask you what Powell's burner account on Twitter actually is, but it's probably a long shot. Okay, so speaking of like the overall macro picture and the story that we tell ourselves, Richmond Fed President Tom Barkin was just speaking and he sort of laid out two opposing paths for the economy going forward. And one is a pretty optimistic path where election uncertainty is behind us. And so companies feel more confident in terms of hiring an investment. And so everything stays very, you know, pleasant and the economy keeps going strong. And then the downside scenario is that as prices cool, companies feel more pressure to cut costs in order to either maintain or boost their margins. And that's when you start getting a labor market that is weakening, you know, even further than some of the softness that we've seen in recent months. What's your sort of scenario analysis for, let's say, 2025?

[Matt Levine]

Well, thank you for introducing scenarios, because that's also quite important. So I do think the baseline, what I call the baseline scenario, which is the most likely outcome, is the one the Fed has more or less and really most Wall street economists and forecasters have sketched out. Now, my former colleagues at the Fed won't call it the soft landing, but it looks like I'll call it the soft landing. So inflation continues to return gradually to 2% in the context of a fully employed economy, perhaps a modest downshift in growth from maybe 3% down to somewhere in the twos. But an alternative scenario is what I, and I think this is where Tom Barkin land as well, is what I've called the sticky inflation scenario. Basically, inflation doesn't get worse, it just doesn't get better. It gets stuck at between 2 and a half and 3%. I think that that's not the end of the world, but that's a scenario where probably the Fed is not delivering on the rate cuts that the markets expect. And then I think third and the least likely of the three is one that maybe you also mentioned in the context of Tom's speech, where we've had tightening in financial conditions and policy. It's just taken a while to show up. And when it does, you will have a slowing economy, rising unemployment, perhaps in the context of maybe even some sticky inflation. And that's probably of the three scenarios, the one that is the least friendly and the one that would be the toughest call for the Fed. And so I would think it's, of the three, the least likely, but certainly not a zero. Direct lending has been one of the most dynamic areas of the private alternative space these last few years, having grown massively as a source of capital for both corporate borrowers, but also financial sponsors that have kept going from strength to strengthen and have needed that private capital to foster the growth that they've been experiencing.

[PGIM Fixed Income]

For leading alternative investing insights, listen to Speaking of Alternatives from pjym.

[Marin Sums]

Not everybody likes talking about money. Some people find it awkward. Sometimes they even find it a little embarrassing. I do not. I like talking about money, whether it's the boardroom, the newsroom, the trading floor. I've spent the last 30 years talking about money, writing about money and talking about it and writing about it a little bit more. I'm Marin Sums at Web and every week senior reporter John Stepek and I answer your questions about personal finance and we discuss the best strategies for making the most of your money. Listen in for the kind of insights and explanations everyone can use to help them make better saving and investment choices for themselves and their families. My question is whether you think maxing out my company Pension Match is enough for when it comes to saving for my pension, should I attempt to pay.

[Katie Greifeld]

My child's university fees and living costs? My partner and I have excess savings. So should we overpay on our mortgage or should we put the money into stocks?

[Marin Sums]

From Bloomberg podcasts, tune into Marin Talks Money, follow Marin Talks Money on Apple Podcast, Spotify, or wherever you listen.

[Tracy Alloway]

Some could say that in the 2010s, we sort of had the reverse of that sticky inflation in that for much of the time during that decade, inflation did not. It was missing from the bottom. Yeah, it's a nice problem to have, I kind of think, but it was missing from the bottom. But arguably you could say the Fed tolerated it and the Fed was okay with it, even though technically it wasn't hitting the goal. Talk a little bit more about that scenario in which inflation is running at two and a half percent, as you put it. That's not the end of the world, especially if employment remains robust. But it is technically, you know, it is missing the goal, it is missing the mandate. Talk a little bit more about that sort of not the end of the world, slightly sticky scenario and how the Fed thinks.

[Matt Levine]

Well, and again, I can clarify not the end of the world, you know, comma, so long as inflation expectations remain anchored. And that's why you'll hear Fed officials almost ad nauseam always put in that qualifier. So, you know, once a Fed official, always a Fed official, so long as inflation expectations, because the Fed really does want people to expect inflation to be 2%. And I think I'm glad you brought up the prior decade, because in the prior decade inflation was operating below target. That was oftentimes in the context of a soft labor market as well. Remember, it took like six or seven years for the labor market to get back to where it had been before the financial crisis. And so one of the big differences is we got back very quickly to maximum employment here. So I think so long as people are expecting that inflation will continue to fall if it gets stuck, I don't think that's anything that triggers a dramatic Fed reaction. What it could do, however, is it could mean that the Fed just pauses rate cuts or slows down the pace of rate cuts and doesn't deliver getting the funds rate all the way down to neutral, as many folks thought in September when they cut rates by 50 basis points. Maybe elaborate a bit. You know, the Fed is undergoing on a five year schedule right now or commencing a review of its monetary policy framework. I was there during the last framework review in which we all agreed upon unanimously to reaffirm the 2% inflation target. I get a lot of questions, you know, will the Powell Fed, you know, raise the target? It's an easy question to answer because Powell's been asked that a number of times and he always gives the same answer. No, we will not raise the inflation target. So the Powell fed is targeting 2% inflation. But just as in the decade before inflation was a little bit below two, we operated there. We may operate for some time a bit above 2 as well.

[Katie Greifeld]

So we've been very focused on the macro. But I feel like we do have to ask some political questions as well. And I think you were actually nominated by President Trump.

[Matt Levine]

I was.

[Katie Greifeld]

So I guess, first question, how would you characterize Trump's relationship with the central bank or the way that he views the role of an institution like the Federal Reserve?

[Matt Levine]

Well, I think he's made that clear through his public comments over the years. He certainly opined on interest rates during his time as president. That was not unprecedented. Indeed, if you go back in Fed history, in the olden days, before all of us were active in markets, you had presidents like Truman and Johnson and Nixon opining on the Fed. More recently, really since the 80s and 90s, publicly, presidents have not weighed into Fed discussions, although sometimes their treasury secretaries and their staffs do. More recently during the campaign, he was asked about it, and as I recall, his answer was something along the lines of, I should be able to offer my opinion on policy. So I think it's pretty clear how he thinks about that.

[Katie Greifeld]

But I guess the wild card this time around is it certainly feels like a second Trump administration might be, or at least feel more empowered in certain things. And there's also the involvement of guys like Elon Musk, who is tweeting about ending the Fed. How does that bear on the central bank and policymakers there?

[Matt Levine]

Well, I think the simple answer is the Fed has a mandate from Congress. So the Fed, first of all, the Fed is a creation of Congress. In many countries, the central banks are actually part of the Finance Ministry. The Fed is a creation of Congress. Congress says the Fed's job is price stability and maximum employment. And I can tell you the culture of the Fed, not only the board but the 12 Reserve bank presidents takes that mandate and that responsibility seriously. So I fully expect my former colleagues just to do their job and to set policy based upon achieving that mandate and to filter out, you know, distractions or other such things.

[Tracy Alloway]

Tracy, I'm just going to say, you know, there was that recent mid October interview Trump with Bloomberg editor in Chief John Micklethwait, where he said you show up to the office once a month and you say, let's see, flip a coin. And everybody talks about you like you're a God. Just to be clear, there's no actual coin flip, right?

[Matt Levine]

There is no coin flip. At least in my four years.

[Tracy Alloway]

At least in the four years you never saw a coin flip. At Paolo's most recent press conference, he was asked about some of policy changes that could come under the next administration and how they're always studying and if it looks like something could pass, they run the models, et cetera. You mentioned taxes. And I think there probably is a general consensus that at least on the big things, we're probably not going to see tons of movement because the most likely outcome is some sort of extension of the Tax Cut and Jobs Act. But the two big wild cards, potentially from a macro standpoint, outside of taxes, are tariff policy, which we don't know, but we know that Trump likes tariffs and immigration policy, which could be everything from a harder border to deportations, potentially mass deportations. Undocumented workers are very heavy in both agriculture, residential construction, speaking of housing and so forth. Say these things are coming down the line and the Fed is going to think about modeling changes under the economy under these various scenarios. As an economist, what do these things theoretically mean? And again, I'm aware we don't know the size and scale, but we understand some of the major priorities.

[Matt Levine]

So let's take these in turn. So tariffs, the sort of the textbook way to think about if you're a policymaker, how you think about a one time tariff is it's going to be an increase in the price of those goods to the extent it's passed through. I think Governor Waller was recently quoted as saying, you know, a tariff in and of itself is not really inflationary. It pushes up the price of goods affected by the tariff. I think the temptation at the Fed would be to look through that, and I think in many circumstances that that would be the way to go. It could be a bit challenging this time, you know, because to look through an increase in the price level from tariffs would mean invoking some form of the version of, we think it's transitory. And so that guidance might need to be refined a bit. But I do think that that's largely the way that they would look at it initially. Again, monitoring inflation expectations. And in terms of immigration, there's obviously no. There's both legal and undocumented immigration that does influence the labor supply. As you all know, we had a big revision in Washington's official count of undocumented immigration recently, about a year or so ago, showing much more of that. I do think, importantly that I think regardless of who had won the election, we were probably going to have a flow of immigration a lot less than we had been seeing and maybe comparable to prior periods. So the Fed staff could begin to factor that in. I think, in terms of the details of what the Trump administration will do. Beyond that, I think it's too soon. It's too soon to tell. I do think the sectoral impact that you raised, Joe, is a good one. You know, not all immigrants documented or undocumented, flow evenly across all sectors. They're more concentrated in certain sectors than others. And so I would imagine that when the Fed's doing staff work, it would be looking at that bottom up, sectoral level.

[Katie Greifeld]

There's one other question that I wanted to ask you, and I'm trying to think how to phrase it or how to word it, but the past couple of years, one of the big debates when it comes to the economy has been, I guess, the discrepancy between the hard and the soft data. The vibes. So, you know, a lots of the surveys showing that people aren't very happy with the way things are going, we see that in declining confidence numbers now, the vibes potentially are shifting. But I guess I'm just curious how the Fed thinks about sentiment when it comes to judging the real strength or weakness of the economy.

[Matt Levine]

Well, it's certainly something that the Fed looks at. And of course, there are a lot of different sentiment surveys. And in particular also you can compare, for example, the sentiment of Fortune 500 CEOs versus independent business. Myself, I used to look a lot at the nfib survey data for small businesses. They're often a leading indicator, at least in certain circumstances. Maybe one thing I can weigh in a little bit because I think it has been, it's been an important part of the last several years and it's actually an area where macroeconomists don't do a great job. You know, macro oftentimes is about adding up the economy. You've got gdp, you've got employment. But we have had a period where I do think that the distributional ripples of the way the economy has evolved in the last several years has been relevant. Let me just give a very concrete example. So if you're in the 60% of Americans who live in owner occupied housing and you own stock, last four years looks pretty good. Your portfolio is up, the value of your house is up. But that means there are 40% of folks who actually don't own their own home or don't have a lot of stock. And for them, you know, the big increase in the price level and the erosion in real income was quite relevant. So I do think that macro oftentimes does focus on adding up across and talking about the representative individual. But I think we have been through a period in a pretty compressed period of time when there have been some pretty big divergences across different parts of the economy. And I think that will be relevant going forward. And again, that's certainly something that when I was the Fed, the staff was doing a lot of work on as well.

[Katie Greifeld]

Yeah, the divergences I think are really important and you see it also in corporate borrowing. So if you're a smaller business and you're getting a bank loan, that interest rate is probably pretty high. But if you're a huge company tapping the bond market, it's not that bad. Right now I lied earlier when I said I only had one more question.

[Matt Levine]

Okay.

[Katie Greifeld]

Because I do, in fact.

[Matt Levine]

You're forgiven.

[Katie Greifeld]

Thank you. But you know, you are a Fed person who went to being a Fed watcher. What's your one piece of advice for people who are watching the Fed at this juncture?

[Matt Levine]

Advice? Well, I have two.

[Katie Greifeld]

Your pro tip.

[Matt Levine]

Okay. The first bit of advice is, you know, there are night when the Fed's at full strength, which it is now, there are 12 Reserve bank presidents and there are seven governors including the chair. So that means in any given day there could be 19 speeches or interviews. It can get pretty overwhelming. But in the modern era, which really I define with the Bernanke Fed, Fed chairs are now very much in the public domain. There are now eight press conferences a year. There's Jackson Hole. Chair Powell typically doesn't on the record, sit down three or four other times a year. So almost every month, maybe with the exception of there's one month in there, Chair Powell is out there. And so I think if you want to be a Fed washer, just listen to Jay Powell. He's a straight shooter, he writes his own speeches and so you get a pretty clear sense of where he is. I think the second bit of advice I would get, and it's not a deep point, but it's often forgotten because there are only eight Fed meetings a year. We tend to think about sort of like if you're an NFL fan, there's a game every Sunday. The reality though is that when you're inside the Fed and certainly if you're Jay Powell or my former colleagues and I'm sure current Fed officials, you're really looking ahead at least 12 months, if not longer. The further you go out, the more uncertain you go out. But the idea that each Fed meeting is a meeting by meeting, yeah, there's data dependence and you're not in a preset court. But the Fed also has to develop a plan for a baseline view and an argument for communication and policy. And oftentimes I think commentary on the Fed, it maybe focuses a little bit more on the noise and not so much on the arc or the signal.

[Katie Greifeld]

All right, Richard Clarida, truly the perfect guest for this particular conversation. Thank you so much for coming on off.

[Matt Levine]

Thanks for having me.

[Katie Greifeld]

Joe. That was a great conversation. Really good timing to be speaking with someone like Clarida. I do think I like your framing of like the sort of two track policy right now, the short term versus the long term. I do think there is a tension embedded in that where, you know, clearly the people talk about the Fed being ahead or behind of the curve. Right. And Richard brought up the long and variable lags. I do think there is a DES to get ahead of some things. But at the same time, you know, they've emphasized that data dependence for so long and the future is so uncertain at this current moment in time. I don't know how they square those two things.

[Tracy Alloway]

It's tricky. By the way, I do want to give I confirmed a specific shout out to Tim Dewey past odd lots guest at SGH Macro. The first line of his note this morning was the Fed's near term focus remains on the data while market participants continue to digest the economic implications of Trump's victory. Last so that point about the dual Timeframe.

[Katie Greifeld]

I like that you care about attribution.

[Tracy Alloway]

Absolutely. I came up in the age of blogging and linking, so this is like before people used to just steal stuff. But I do think that from Tim, which I then transmitted, is a very useful way of explaining why this moment seems so complicated. And as I mentioned and we talked about with Ridge, it's arguably been very complicated ever since simultaneously Trump's odds started rising in the polls and we got that huge September jobs report which as Rich mentioned, sort of caused this rethink about how strong or how weak the economy really was when they cut 50 basis points. And so for both you and I.

[Katie Greifeld]

Differ a little bit on this point because I think it is becoming clearer that a lot of that reaction in long term yields is to Trump and his policies. What I will say is we have CPI on Wednesday. By the time this episode comes out, we'll have gotten that number and we will have seen the market reaction to it. I think that might be an interesting one to watch to try to further settle this question.

[Tracy Alloway]

Tracy?

[Katie Greifeld]

Yes.

[Tracy Alloway]

Nothing is ever settled.

[Katie Greifeld]

Yeah.

[Tracy Alloway]

How do you enter? After how many years will you. When will you stop believing that any question in economics could ever possibly believing.

[Katie Greifeld]

That there are in fact answers that will never.

[Tracy Alloway]

You have to give that up at some point. We will never have answers, only new questions.

[Katie Greifeld]

The nice thing is I've already given into this idea, even if I'm personally disappointed by a lack of answers. Having a continuous stream of questions means we have never ending content for this podcast.

[Tracy Alloway]

No, it's great. It's great.

[Katie Greifeld]

Always something to talk about.

[Tracy Alloway]

Absolutely.

[Katie Greifeld]

Okay, shall we leave it there?

[Tracy Alloway]

Let's leave it there.

[Katie Greifeld]

This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at TracyAlloway.

[Tracy Alloway]

I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our guest Richard Clarda. He's to. I don't know if he posts there very much, but he has. Follow our producers Carmen Rodriguez at CarmenArman, Dashiell Bennett at Dashbot and Calebrooks at Calebrooks. Thank you to our producer Moses Ondam. For more Odd lots content, go to bloomberg.com oddlots we have transcripts, a blog and a new daily newsletter that you should sign up for. And if you want to chat about all of these topics, especially macro, check out our Discord Discord GG Odd Lots.

[Katie Greifeld]

And if you enjoy Odd Lots, if you like it when we talk about the Fed with a former Fed Vice chair, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, in addition to getting that new Daily All Bots newsletter, you can also listen to all of our episodes absolutely ad free. All you need do is find the Bloomberg Channel on Apple Podcasts and follow the instructions there. Thanks for listening.

[Marin Sums]

Not everybody likes talking about money. Some people find it awkward. Sometimes they even find it a little embarrassing. I do not. I like talking about money, whether it's the boardroom, the newsroom, the trading floor. I've spent the last 30 years talking about money, writing about money and talking about it and writing about a little bit more. I'm Marin Sums at Webb and every week senior reporter John Stepek and I answer your questions about personal finance and we discuss the best strategies for making the most of your money. Listen in for the kind of insights and explanations everyone can use to help them make better saving and investment choices for themselves and their families. My question is whether you think maxing out my company Pension Match is enough for when it comes to saving for.

[Matt Levine]

My pension, should I attempt to pay.

[Katie Greifeld]

My child's university fees and living costs? My partner and I have excess savings, so should we overpay on our mortgage or should we put the money into stocks?

[Marin Sums]

From Bloomberg podcasts, tune into Marin Talks Money. Follow Marin Talks Money on Apple Podcasts, Spotify, or wherever you listen.