2 + 2 = ? In the world of economics—a lot of variables may mess with the answer.
Two sessions early in the agenda at Commonfund Forum 2024 brought into focus the range of scenarios in play for trustees and investment committees navigating their way in today’s economic environment. At the macro level, James Bullard, former President of the Federal Reserve Bank of St. Louis, shared insights into key policy decisions of the Federal Open Market Committee (FOMC). A panel, moderated by Steve Liesman, Senior Economics Reporter for CNBC, focused on the risks and opportunities they see ahead for the economy and financial markets. The panelists were Dana Peterson, Chief Economist, The Conference Board; Julia Pollak, Chief Economist, ZipRecruiter; and Deborah Spalding, Chief Investment Officer, Commonfund OCIO.
What’s in store for the U.S. economy: soft landing or hard? James Bullard believes that if the Federal Reserve achieves its targeted 2 percent inflation plus 2 percent GDP growth it will likely add up to the desired soft landing. As to the question of the moment—when the FOMC may initiate reductions in the fed funds rate—Bullard said, “the policy rate has to be lower than it is currently when you hit that soft landing, so the rate has to start coming down soon.”
In another session a Forum panel discussion brought to light some of the variables that may—or may not—get in the way of that soft landing. Where investors are concerned, said Deborah Spalding, there are risks that can be priced, like sticky inflation, increases in unemployment or weaker consumer confidence. She is chiefly concerned, however, about risks that can’t be priced, including the U.S. presidential election, China-Taiwan tensions and the implications of the Russia-Ukraine war.
The war reference related to a point Bullard made in a Q&A session following his remarks. He pointed to COVID-19 and likened it to a war: “It’s not a conventional war, but it’s a war, nonetheless. Like other wars, this one brought social upheaval and the scramble to borrow a lot of money. The monetary policy makers kept interest rates low to help the war effort. Throughout history in very different times and places this has consistently caused inflation. To get out of inflation, you have to reverse both the fiscal and monetary policies.”
The drama behind the scenes even reflected a war mindset. “In 2022, it looked like the Fed was going to lose control and inflation expectations could become unmoored,” Bullard recounted. “I was at the Fed’s annual Jackson Hole Symposium in August that year and I would cite Fed Chair Jerome Powell’s speech as a great moment in central banking history. Powell got up to give the customary speech but after just nine minutes he stopped and sat down. I thought something had gone wrong but, no, he just truncated his speech to emphasize the key point: the Fed was committed to bringing inflation back to target.”
Since then, the inflation rate has moved closer to target, but not reached it. One factor standing in the way: a strong labor market. In the panel discussion, Dana Peterson cited labor “hoarding.” She said Conference Board surveys ask CEOs about their plans for hiring and wages and have found that many are hoarding labor—that is, not hiring but instead raising wages to retain workers. “That’s placing upward pressure on incomes and acts as a resistance level for the Fed’s plans to bring inflation down to target,” Peterson said. From her perspective at ZipRecruiter, Julia Pollak said she senses some slack in the labor market. “Applications per job posting have risen about 30 percent over the past year, and about two-thirds of that is due to a decline in openings and one-third to increased job search,” she said.
Longer term, the panel cited structural changes in the economy as a dynamic to be reckoned with. The exit of Baby Boomers from the labor market will leave a younger, less experienced work force. At some point, the credit markets can be expected to punish the U.S. for its mounting national debt. The U.S. has a housing shortage, especially for affordable housing, meaning that prices will remain elevated. Defense spending will likely increase and stay higher in response to threats around the world.
Productivity, largely driven by artificial intelligence, may be a major offset. “I’m astounded when I ask CEOs about the extent to which their businesses are already using AI and the results they are achieving,” Pollak said, noting that one company’s 2,000-strong customer support staff had increased productivity by 30 percent. Panelists also observed that while investors are currently rewarding chip makers in the future, they will recognize the productivity benefits flowing to users of AI.
One cautionary area that has caught Deborah Spalding’s attention is the vulnerability of mid-size banks to declining valuations in commercial real estate, chiefly office buildings, owing to remote and hybrid work arrangements. She said the largest U.S. banks have already made provision for bad loans and the smallest banks have relatively little exposure to this market. “It’s everything in the middle that concerns me,” she said. “There are hundreds of these regional banks that have not stepped up to the problem. Between the FDIC, the Fed and the Treasury we do not have the capacity to rescue all of these banks so some of them are going to fail.”
On paper, the Fed’s methodical pursuit of 2 percent inflation plus 2 percent GDP adds up to a sound economy. After that it’s a matter of solving for the X factors.
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