In this episode of The SIFMA Podcast, SIFMA President & CEO Kenneth E. Bentsen, Jr. sits down with Lindsey Piegza, Ph. D, Chief Economist and Managing Director for Stifel Nicolaus & Co. and Chair of the SIFMA Economic Advisory Roundtable, to discuss the outlook for the U.S. economy and results from SIFMA’s recent survey of chief economists from 27 global and regional financial institutions.

From the Survey

The Federal Reserve waited too long on raising rates leading to increased inflation, agrees 93% of the SIFMA Economic Advisory Roundtable in its latest survey. They are split, however, on the timing and likelihood of recession.

A 50 basis point rate hike is unanimously expected in June; 54% of respondents expect the Fed to raise the target Federal Funds rate by less than 200 basis points by year-end, followed by 38% expecting a 200 basis points hike. All respondents expect the size of the Fed’s total balance sheet to drop down to $7 trillion by the end of 2022, and 69% expect it to stay over $7 trillion by the end of 2023.

“We are seeing clear signs of improvement, reaching that light at the end of what has been a very long and very painful tunnel. At the same time, many of last year’s risks still remain, complicating the outlook for the domestic recovery: policy risks, inflation risks, supply distortions, an ongoing labor supply shortage, and more recently international conflict and more aggressive monetary policy, just to name a few,” said Dr. Lindsey Piegza, Ph.D., Chief Economist and Managing Director at Stifel Financial Corporation and Chair of SIFMA’s Economic Advisory Roundtable.

Economic Forecast Highlights

• Unemployment rate forecasted to end 2022 at +3.5% and remaining at +3.5% in 2023 (4Q average).
• 2022 GDP growth expected at +1.5% (median forecast, 4Q/4Q); 2023 expected at +1.7%; long-term potential GDP growth rate of 1.5-2%.
• The main factors impacting economic growth include inflation, U.S. monetary policy, and tight labor market for both 2022 and 2023.

Inflation Forecast Highlights

• 93% of respondents believe we are at peak inflation levels (in terms of PCE).
• 33% of respondents expect inflation will begin to noticeably decline back down towards the Fed’s preferred 2% target by 1H24, followed by 27% replying 2H23.
• 56% of respondents believe inflation is largely a supply driven problem and 44% demand driven; 50% of respondents expect supply chain disruptions to dissipate by 2H22, followed by 29% replying 1H23.

Download the full survey for insights on Fed actions and life after COVID, and more.

Transcript

Ken Bentsen: I’m Ken Bentsen, President and CEO of SIFMA. Welcome to The SIFMA Podcast.

Good afternoon and thank you for joining for a discussion on the midyear US Economic Survey of SIFMA’s Economic Advisory Roundtable. SIFMA’s Economic Advisory Roundtable is comprised of the chief US economist of 27 global and regional financial institutions. The survey reviews the roundtable economists’ forward-looking expectations for macroeconomic trends including GDP, unemployment, and labor force participation, interest rates, inflation, and monetary policy. The survey also considers various externalities that may impact these trends.

The first half 2022 survey is the fifth survey we have conducted since the onset of the pandemic, which is remarkable to think about. While we may not be totally done with COVID or it with us, we certainly are experiencing a definitive trend toward return to normal, albeit with some lingering and permanent impact. At the same time, we are experiencing the highest inflation, hawkish monetary policy, and geopolitical instability not seen in at least a generation. So this is a good time to discuss what the future may hold for the next year. This year, the midyear survey was conducted between May 9 and May 23.

To dig deeper into the report findings, I’m delighted to be joined by Lindsey Piegza, Chair of SIFMA’s Economic Advisory Roundtable and Chief Economist and Managing Director at Stifel. Thank you for joining us today, Lindsey, we really appreciate getting your insights.

 

Lindsey Piegza: Thank you for having me, Ken, it’s a pleasure to be here today.

 

Ken Bentsen: Great. So, there remains a considerable amount of uncertainty around where the economy is headed. As I noted, according to the survey, 2022 GDP growth is forecast at 1.5 percent for 2022 and 1.7 percent for 2023. To focus on the near-term first, how do you see the economy faring through the summer, and longer-term what do you see as the key factors driving GDP forecast as well as upside and downside risk?

 

Lindsey Piegza: Well, I think it’s fair to say that the economy is already showing signs of weakness, cracks in the armor if you will — still positive, but slower pace of production. We’re seeing reduced consumer spending, even the housing market, activity in the housing market has slowed.

So, you add on lingering high elevated costs, and both household and corporate balance sheets will increasingly struggle. They’re already struggling. So, while I do expect growth will remain in positive territory through the summer, the average growth rate over the first nine months of the year is likely to be near 1 percent — so, a bit below the survey expectations. Still about half, however, the pace of pre-pandemic growth.

Longer-term, I think the economy is going to again continue to struggle, with significant monetary and fiscal support no longer in the picture. And this has become really so ingrained in the market over the past decade, so the loss of that monetary and fiscal support is going to act as a sizeable drag.

So in fact, I would argue that unless inflation fades in a meaningful way, resulting in positive real wage growth, confidence, consumption, investment, these are all likely to continue to dissipate.

Now, as far as the upside and downside risk, to your question, I would point to the Fed and the Fed’s pathway for rates as one of the largest if not the largest wild card to growth. The Fed is struggling to raise rates enough, as we know, to control inflation, but at the same time they don’t want to raise rates enough to undermine the recovery entirely.

So, a presumably more aggressive pace of rate hikes will result in slower activity — this is your downside risk — while on the other side a more dovish pathway could be a welcome support, an unexpected support to positive growth. So, that’s really how I see the upside potential risk to growth going forward.

 

Ken Bentsen: I want to come back to inflation, but maybe before I do, our survey respondents were all over the map sort of on timing or expectations of the economy tipping into a recession. Almost equal responses for it happening in the second half of ’22 to somewhere beyond 2025, regarding the timing. And a minority share actually believed there would be no recession. What’s your perspective here?

 

Lindsey Piegza: I think this goes back to your earlier question regarding the risks to the outlook: should the Fed recognize the material reduction in momentum and be willing to pull back on the pace of rate hikes, moving for example at 25 basis points in the second half of the year instead of continuing at a 50 basis point clip?

I think the Fed is increasingly likely to avoid an outright recession. Now, that being said, even if we do see the Fed move to a more reduced pace of policy action, I don’t think the Fed will be able to entirely avoid negative growth, and I do expect to see at least the first negative GDP print by the first quarter of 2023. And I say the first quarter of negative growth excluding the first quarter we saw this year, which was primarily a reflection of trade and inventory.

On the other hand, if the Fed does continue along with this more aggressive approach to rate hikes, meaning continuing at these half-point steps or maybe even larger, a recession is in my opinion likely to occur by the end of this year, 2022, or at the very latest 2023.

Now my base case for growth going into this year — so, turning the corner into 2022 — was a relatively benign, some may call it a disappointing, 2 percent growth rate, so returning to pre-pandemic levels of activity. But the more aggressive the Fed, the slower I do anticipate growth to become in the coming quarters.

So essentially, the rising risk of recession is greatly linked if not entirely linked at this point to the committee’s persistence to raise rates at larger intervals into the second half of the year.

 

Ken Bentsen: So with inflation being the lead story these past several months, maybe let’s dig in a little bit further. Our survey respondents expect the Personal Consumption Expenditure Index to end 2022 at 5.1 percent, down from the April reading of 6.3 percent but still far ahead of the Fed’s 2 percent long-term target. The respondents overwhelmingly believe, 93 percent, that the Fed waited too long to act, allowing inflation to get out of control. What’s your perspective there?

 

Lindsey Piegza: First off, of course we all know the benefit of hindsight, but I think we do have to remember that for much of 2020 and through most of 2021, the Fed was convinced that rising price pressures were or would prove to be transitory, thus rendering the need for a removal of accommodation essentially unnecessary.

Now of course, by December of last year it became clear to the Fed — I think the market was well ahead of the Fed’s acknowledgment — but by the end of last year, it did become clear that price pressures were becoming more ingrained in the economy, and that policy action, a reversal of policy action, was required.

It was also clear by this point that the Fed was behind the curve, that we needed to see more aggressive action because they had waited so long.

So two things: first, I think we need to recognize and almost applaud Fed officials for recognizing their error and moving swiftly to rectify that error in judgment by raising rates, and raising rates at a faster clip than they would’ve otherwise initiated had they begun this process earlier.

But two, I think it’s important to note that had the Fed been correct in their assessment that inflation was transitory, I think you can make the argument that their decision to remain on the sidelines would have arguably proven correct, or been the appropriate pathway for policy under those transitory conditions.

But in the end, we have to be realistic — that wasn’t the right decision, they were wrong, and now they’re very much playing catch-up.

 

Ken Bentsen:  And over the last year, many have cited supply chain constraints as the primary driver of inflation — in fact, 56 percent of our respondents believe that’s the case. But, 44 percent believe it’s more demand-driven. How do you think about the differing drivers of inflation, and in addition to supply and demand, how does labor fit into this?

 

Lindsey Piegza: Well, this is one of the factors that’s complicating the issues in the marketplace for the Fed right now. As we assess the market, the vast majority of price pressures are stemming from the supply side of the equation. Now, we do have some demand pull pressures mixed in there thanks to extraordinary stimulus from the federal government to the tune of $6 trillion, much of which was in the form of direct payments to consumers. But again, the majority of these price pressures do stem from the supply side.

So essentially, while the rest of the world is also feeling the pinch from these supply side constraints and higher prices, prices are higher in the US than most anywhere else in the world, because not only do we too have these supply side price increases but we’ve exacerbated the situation with the demand side, adding in demand pressures as well.

That being said, the Fed raising rates will better control demand side pressures, and to your point, this is where the labor market fits in: raising the cost of capital can reduce investment and reduce consumption, resulting in a slower economy and more benign inflationary pressures, essentially then reversing the wage price spiral, whereby higher costs lead to higher wages, which in turn lead to higher costs, higher wages, et cetera, et cetera.

But the real conundrum for the Fed, the real conundrum comes as raising the cost of capital does little if anything to address price pressures stemming from supply side constraints or disruptions or dislocations in the aftermath of the COVID-19 crisis or more recently as a result of international conflict.

In other words, because the vast majority of inflationary pressures are coming from the supply side, this is going to render traditional policy metrics — i.e., raising the cost of capital — less effective in fighting these price pressures.

So, the bigger concern that I have is that the Fed continues to raise rates all in an effort to fight inflation, but because the vast majority is stemming from the supply side, this leads to a period of stagflation whereby prices are still elevated, but now we must contend with the effects of a weaker economy as well. So, really producing a double whammy for the average American.

 

Ken Bentsen: Yet another not seen in a generation or more situation. And what do you see is the trajectory of inflation? Our survey consensus is that after finishing the year, CPI finishing the year at 6.3 percent, it would fall to 2.5 percent, similarly with core. That would show a trajectory, at least in ’23, getting back closer to the Fed target. What do you see there?

 

Lindsey Piegza: Well, I think the market is very anxious to call peak in inflation, I think that much is clear. However, when we look at the latest numbers, that latest slowdown that we saw in April, it’s likely a reflection of improvement that we saw at the start of the year before Russia invaded Ukraine and before the second and third and even fourth round of lockdowns in China this year.

It’s important to remember that it takes time, in some cases months, for the effects of policy to filter down into the numbers. So, the full effect of the latest conflict and the latest policy decisions we’ve seen overseas, this has not yet been fully felt in the figures. So, I’m very hesitant to call a peak in inflation just yet.

That being said, it does appear that we are maybe somewhat splitting hairs, because whether or not we rise above earlier levels or not, the important takeaway is that inflation is likely to remain elevated for some time until we see, one, balance restored to the international markets, and two, resolution reached overseas.

But as far as returning back to the Fed’s near 2 percent target range, to answer your question, I think this is likely several years away. That’s not to say we won’t make significant progress along the way, but returning to the structural fluidity of the global marketplace we were used to pre-COVID resulting in much more benign price pressures, I think this is still likely several years out. So, a bit more of a pessimistic take relative to our survey results.

 

Ken Bentsen: So, let’s shift to the Fed policies. You’ve referenced them quite a bit, but the Fed’s already raised rates earlier this year, and the consensus is they’re going to raise another 50 basis points in June. On top of that, they’ve announced the inaugural drawdown of the balance sheet beginning in June, and ramping that up into September, both in the Treasury and MBS holdings they have. What did the survey tell us on rate hikes in June and for the rest of the year?

 

Lindsey Piegza: I think there’s a general acceptance that the Fed will continue to raise rates at a half-point clip for at least a few more meetings, meaning June, July. However, come September, the opinions begin to vary widely, not only among our survey respondents but among policymakers themselves.

As we’ve recently heard from some officials, the Fed may want or need to take a pause in September in order to assess the true underlying conditions of the economy and also allow the Fed to assess the impact of earlier rate hikes. But others have said a pause simply doesn’t make sense. And some other Fed officials have even proposed larger rate hikes once we’re past the summer.

So, at the very least this varying array of opinions, again both among survey respondents and Fed officials themselves, reminds us that the market is still very unclear as to the appropriate pathway for policy, and that the pathway for policy is far from certain, or far from a predetermined pathway.

 

Ken Bentsen: So, given that variations in views and obviously as hard as it is to guess forward as opposed to looking backwards, what’s your view on the level of peak Fed Funds Rate, and the timing to get there?

 

Lindsey Piegza: I think the Fed has been very clear that they will hike 50 basis points in June and again in July. After that, however, I do expect the Fed to at least consider reducing rate hikes to 25 basis points, so cutting that in half at least for the remaining three meetings of the year, which would still take the Federal Funds Rate target just shy of 3 percent by the end of 2022.

Of course, this expectation of a reduced pace of still ongoing rate increases is predicated on the Fed’s desire to avoid a recession. But at this point, with the Fed hyper-focused on inflation and arguably solely focused on inflation, that is somewhat of a bold assumption at this point. So, we need to have more of a wait-and-see, more of an open expectation for Fed officials to be able and willing to assess the underlying weakness in the economy.

But if they go into the second half of the year with eyes wide open, I do think there will be at least some Fed officials pushing for a slower pace, a more benign pace of policy reduction.

 

Ken Bentsen: Related to that, as you noted, the Fed’s begun paring down its balance sheet. All of the respondents believed that the balance sheet would end the year at greater than $7 trillion, and only a minority share really saw it dropping below $7 trillion in 2023. Do you expect the Fed to accelerate the pace of reductions in the balance sheet, or again more steady and wait and see?

 

Lindsey Piegza: No, I think the latter, I don’t expect the committee to accelerate the pace of reductions in 2022. However, that just like the pace of rate increases will also depend on the evolution of the economy, the evolution of policy. And maybe in 2023, I could see that iteration, but as far as 2022 I think at this point the market has digested and accepted the proposed pace of reductions, and deviating from that pathway would cause unnecessary volatility in financial markets.

 

Ken Bentsen: So, let’s shift to COVID, or life after COVID. Important contributing factors to economic forecasts or how businesses and consumers are thinking about life after COVID: it looks like we are pretty rapidly returning to normal lie, at least as it relates to most things, but not necessarily all. Do you expect the labor force participation rate to return to the average 63 percent pre-COVID, and what do you think the timing of this would be if you do, and what’s holding it back?

 

Lindsey Piegza: I think to answer the question of when will workers return, we have to understand first why they left. And unfortunately, it’s not an easy answer. There’s several factors that contributed and continue to contribute to millions sitting on the sidelines.

For some it’s, as you can imagine in the aftermath of the pandemic, fear of contracting of spreading the virus. For others, it’s lingering issues with child care or elder care. And for others, it’s more of a financial variable, as many are still eating through existing wealth or accumulated savings they were able to stockpile during the pandemic and after as a result of both a nominal change in spending habits as well as fiscal stimulus and spending programs at the state, local, and of course federal level.

So with that in mind, the answer to the question, we may never return to pre-pandemic levels of participation, particularly if those two earlier categories result in a permanent departure from the labor force. Baby Boomers retiring early may never come back; working parents and in particular women are significantly less likely than their male counterparts to return to the labor force once dropping out.

But it’s those in the latter category that I would suspect eventually return. As money runs dry, potential workers will likely begin to come back into the labor market, particularly the younger potential workers.

But again, this will take time. There’s no magic flip-the-switch scenario. I imagine more of a slow trickle in, maybe six to nine months, to pull some of these workers back in, but it could take longer depending on the recovery in the economy, but also on any additional fiscal policy measures that are put in place in the near-term.

 

Ken Bentsen: So for those who do, work-from-office has not fully returned to pre-COVID norms, and notably the survey respondents were unanimous in the expectations that employees will never return to office at the pre-COVID levels. And as they noted, hybrid work schedules are here to stay. What are the factors you believe are limiting large-scale return to office?

 

Lindsey Piegza: I think the top variable is a preference from workers to have the flexibility to work from home. At this point, those industries that have to return to fulltime in-person, they’ve done so, and those that don’t need to, they continue to offer flexibility for workers.

For many, it’s a productivity issue. For others, it’s a cost savings — with near $5 gasoline, driving to and from work for an hour just got a whole lot more expensive. And of course for others, it’s a safety issue, as many still worry about creating a safe and healthy work environment outside of one’s own home.

So I think right now, if the industry can support flexibility or a hybrid work schedule, then workers are really demanding that, enjoying the flexibility that [we’ve had] the past couple of years in terms of working from our place of residence.

 

Ken Bentsen: Great, thank you. Lindsey, thank you very much for your insight and for chairing the Advisory Committee. And, thank all of our audience for joining us today. And to read the entire survey report, please join SIFMA.org. And again, Lindsey, thanks for joining us.

 

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Kenneth E. Bentsen, Jr. is President and CEO of SIFMA. Mr. Bentsen is also Chair of the International Council of Securities Associations (ICSA), Co-Chair of the British American Finance Alliance (BAFA) and Chairman of Engage China.

Dr. Lindsey Piegza is the Chief Economist for Stifel Financial. She specializes in the research and analysis of economic trends and activity, world economies, financial markets, and monetary and fiscal policies. Prior to her role with Stifel, she was the Senior Economist for an investment bank in New York City for eight years consulting clients in the U.S., Europe, Asia and the Middle East.

Related Resources

• SIFMA Research

  US Economic Survey, Mid-Year 2022

• Press Release

  SIFMA Economic Advisory Roundtable Mid-Year 2022 Survey

• SIFMA Insights

  Inflation 101