Artificial intelligence is juicing up inflation. The immigration policy is juicing up inflation. There's just a slew of things going on that suggest that while inflation will come in, assuming the Iran war sticks roughly to script, it's not going to come in fast. It's going to come in slow and sticky, and it might not be a couple, three years before we get back to anything we all feel comfortable with.
Welcome to Prof G Markets. I'm Ed Elson. It is July 15th. Let's check in on yesterday's market vitals. The major indices climbed on a better-than-expected inflation report. More on that in a moment. The inflation reading also sent Treasury yields lower. Meanwhile, Brent crude was volatile as the US carried out its fourth consecutive day of strikes on Iran. And finally, IBM plunged 25% after pre-announcing earnings that missed expectations. It was its worst day of all time. Okay, what else is happening?
Inflation cooled to an annual rate of 3.12% in June, which was lower than economists had predicted. Consumer prices fell 0.4% between May and June. That was the largest one-month decrease since April 2020. Much of that drop was driven by lower energy prices after the US-Iran ceasefire eased fears of supply disruptions, but that relief may be short-lived. Last week, of course, President Trump declared the ceasefire over. And yesterday, the US launched a new round of strikes on Iranian targets. Brent crude has since climbed back to around $85 a barrel, raising the prospect that energy prices and inflation could move higher again. So joining us to discuss this inflation report, we are speaking with Mark Zandi, chief economist at Moody's Analytics. Mark, great to see you. Thank you for joining us on the show.
Inflation's come down. We were at 4.2, which was really high. We're now down to 3.5. Still pretty high, but lower than expected. I think the bigger question, though, is how much of that was because oil prices went lower in June. And I ask that because oil prices are, of course, rising again, which makes me think maybe this is not here to stay.
Yeah, it's odd when you say inflation is easing to 3.5%. You know that it is easing. It's down, but you know it's still awfully high, uncomfortably high. You know, as everyone knows, the Fed's target — what is it? — is 2% inflation. That's kind of what we take as being a comfortable rate of inflation. And I think under what I'll call underlying inflation, kind of abstracting from all the vagaries of the data — and by the way, in this report there was a lot of noise. I don't know if you noticed, but it's a very noisy report and, you know, a lot of anomalies in the data, and I'm not sure how much to read into it. But, you know, abstracting from that, I think underlying inflation is kind of three to three and a half percent, somewhere in there. Again, uncomfortably high, and that's abstracting from the swings in energy prices related to the war, which obviously, you know, added a lot to inflation, you know, coming into the war back in the spring, early summer, and is now detracting from inflation. But abstracting from that, you know, we're at a very high, uncomfortable level of inflation. And this is after a number of years of very high inflation. In fact, inflation's been above the Fed's target for five years, and so, you know, the cost of living is extraordinarily high. It reflects, you know, the cumulative effect of those high rates of inflation, and I think people just are feeling very uncomfortable with that. And hopefully the Iran war moves in the right direction here and begins to abate, but as you point out, that's now a new risk.
I mean, I think the big question is: is this going to be the trend? Will we keep seeing the number go down? And that's what I'm trying to understand from this report. Does this tell us that inflation is now headed in the right direction, specifically down, or is this a blip? Because what we know about last month is that, you know, specifically when we look at the energy markets, people seem to think the war was over. Now here we are in July, prices are going back up, and people seem to think, 'No, it's not,' because the president told us as much.
Yeah. I mean, obviously a lot depends on what the president does or doesn't do and whether the strait reopens and we get oil flowing through or not. I mean, I think — and there's no way to know for sure, obviously, given the ups and downs and all the rounds here. You know, I think the most likely scenario is that the incentives here for the president and the Iranian regime to figure this out and open up the strait, you know, over time and get oil flowing, get oil prices down, are pretty high, and that they will figure that out. But obviously I say that with no confidence — this can go in a boatload of directions. And if we just assume I'm right and the oil prices come down and inflation continues to come in, it'll take time. It's not going to come in fast. It's going to be sticky. You know, I think that there's a lot of other things going on here. You know, artificial intelligence is juicing up inflation. The immigration policy is juicing up inflation. There's just a slew of things going on that suggest that while inflation will come in, assuming the Iran war sticks roughly to script, it's not going to come in fast. It's going to come in slow and sticky, and it might not be a couple, three years before we get back to anything we all feel comfortable with.
Do you expect that three and a half — will it go up from three and a half over the next few months? Will it go down? I mean, directionally, where do you think we're headed?
Yeah, I think we're directionally lower. Again, assuming that, you know, the Iran war doesn't go off the rails here and oil prices stay roughly where they are, let's say, or 80, 85 bucks a barrel, then I do think we will see it come in. Because the other thing to consider on inflation that's really fundamental is the job market. You know, that goes to wages and cost of labor, and that is the single most important driving force of inflation. And right now the labor market is soft. You know, we saw that in the last jobs report. We're not creating a whole lot of jobs, and there's slack in the labor market that's continuing to increase. That's putting downward pressure on wages. Wage growth is below the rate of inflation and slowing across all different wage groups. And that should ultimately drive the rate of inflation lower. But again, that's a process that takes time. That doesn't happen in a month or two or three. That happens in a year, two, or three.
Yeah, just looking at the US inflation rate compared to other nations, we currently have the highest inflation rate in the G7, which is quite interesting because it seemed as though we were kind of the most sheltered from what was happening to oil prices as a result of the Iran war. But now, I guess that's not really the case. I mean, what do you make of the fact that we're actually in a worse spot now than many of our peers?
Yeah, I think that goes to the fact that most other countries provide subsidies or regulate the price of energy. They don't let it pass through. You know, the Europeans don't let it pass through. Some countries do, you know, some Asian countries, but most don't. The US is very different in that as soon as oil prices go up, our cost of gasoline, diesel, jet fuel goes immediately up. Now, there's problems with that, and that is, you know, we're all struggling with lower purchasing power. Our real incomes are declining, and it's hurting the economy. But the benefit of that is we adjust a lot more quickly. We, you know, we pull back on our driving. You know, we fly less. You know, we become more efficient in the use of trucks that deliver packages to our door. The rest of the world — there will ultimately be a pass-through, but it just takes a much longer period of time for that to occur. The other thing that might be going on to help explain — and this is a little more problematic — is lack of competition. You know, competition in different industries has eroded over time. An increasing number of industries are dominated by a few companies that can set prices more significantly or are able to hold their pricing for longer in the face of weakening demand or slower costs of doing business. And so that lack of competition, which I think has occurred over the years and become more pronounced now, may also be playing a role in the higher rates of inflation that we're seeing here, and maybe another reason why inflation might be more sticky here, because the businesses are under less pressure to cut prices because of the lack of competition or the lessening of competition.
Yeah. Kevin Warsh, new Fed chair, spoke to Congress. He said the CPI drop does not mean, quote, 'mission accomplished' on inflation. He seems to be a lot more hawkish than people expected. I mean, what do you make of his statements? What do you think this means for interest rates going forward?
Yeah, I've been surprised at how, as you say, hawkish he has been. You know, going back to the FOMC meeting, the policymaking committee meeting, he used the words 'price stability' several times, you know, and he convinced investors that he's serious about that. If you look at inflation expectations — what bond investors think inflation will be in the future — they came back down, back up to where they were prior to the Iran war. And so they're convinced that he's going to work hard to keep inflation down. That's his primary focus. And I take a great deal of solace in that because, you know, six months ago when we were having these conversations, I was much worried about the Fed's independence and that whoever the Fed chair was going to be could buckle under the weight of the pressure from the president who says he wants lower interest rates. But I feel less worried about that. We'll have to see — obviously we'll have to see how this plays out, and there's a lot to be learned — but so far so good, and I think that feels very good. Now, it does mean the potential for higher rates. I mean, markets are now anticipating — last I looked, it might come in today with these better inflation numbers — but last I looked, two rate increases, a quarter point each time. And so investors are expecting that that hawkish rhetoric will translate into higher interest rates. And so, you know, one of the side effects of a more hawkish Fed chair is you're going to have higher rates for longer. But I think ultimately, you know, the key thing here is Fed independence, and I feel much better about that in the wake of all the things that Kevin Warsh has done since he's been appointed.
Do you have a view on the path for interest rates for the year ahead? I mean, this seems to be like the biggest question for investors. Will rates go up or down, or will they stay flat? And people have been debating this since the beginning of the year. Everyone seemed to agree they were going to come down heading into the year. That's changed now. Do you have a view on that debate?
Yeah, of course. I've got lots of views. Yeah, even on the World Cup, I got a view. So, or will the Phillies win the series? Yeah, I got a view. It's a bit outside of consensus. I don't think the Fed's going to raise or lower rates. I think policy will remain unchanged because I do think, you know, they have two mandates. One is low and stable inflation, and that's what we've been focused on. That would call for higher rates. But the other mandate is full employment. And there, the job market, in my humble opinion, is soft. It's weak. I mean, we're not creating any jobs. All the jobs we're creating is in the health care sector. It's very narrow. If you lose your job, you're in big trouble because you can't get hired back. Hiring rates are very low. The share of the unemployed that are unemployed for long periods of time is now rising and very high. Wage growth is very weak. And so I worry that there's slack in the labor market. You don't see it in the unemployment rate because the labor force is collapsing. People are leaving the labor force. And, you know, if the labor force participation rate had just remained unchanged over the past year, the unemployment rate would be 5%. And we'd all be talking very differently if it was 5%. And so I think the job market is very soft, and I think ultimately that will convince the committee not to raise rates. But, you know, like many things — like which way is this war going to go? Well, I say this with low levels of confidence because, you know, obviously there's a lot of uncertainty here.
Right. It seems like the question is, as usual, which one is more of a problem? I think I tend to err on the side of the inflation problem is more of a problem because I'm personally very worried about what we're seeing in terms of the Iran situation. But I take your point, and you said this recently on your social media. You said that the commentary on the employment report for June was, quote, 'much too dismissive of how weak the numbers looked.' And so I guess we find ourselves in the same position that the Fed always finds itself in, which is you got to choose.
Well, although they're pushed into this really bad place, right? I mean, because of policy. I mean, because of the tariffs, because of immigration, because of the war that leads to weaker growth and higher inflation. That's stagflation. This is a stagflation environment, and what do you do with that at the Fed? Do you focus on inflation or do you focus on growth? And it's a very tough spot to be in, and that's the situation that they're in. My sense is they punt and they say, 'I can't figure out which one to focus on. I'm not changing rates.' But I hear you. I mean, you know, at the end of the day, push comes to shove, they've got to focus on inflation. Now, I think the deciding factor ultimately on that will be inflation expectations. If inflation expectations stay down, then they may be able to get away without raising rates because inflation should come in. If inflation expectations start to rise — say, you know, right now inflation expectations are based on the expectation the Fed's going to actually raise rates. Now, let's say that they say, 'Okay, we're not raising rates,' right? So inflation expectations start to rise. Therefore, they got to raise rates. I mean, you know — so, I know that's mind-numbing, but that's the way this all works.
