UBS Americas’ David Lefkowitz and Shane Lieberman on the federal response to inflation
Inflation continues to be a top-of-mind challenge for small and midsize business owners and CEOs as anxiety increases over rising costs, wages and prices. In the recent Q1 2022 CEO Confidence Index, 87% of CEOs reported increased labor costs, up 15 percentage points from last quarter.
In a recent interview, Vistage Chief Research Officer Joe Galvin sat down with UBS Americas Federal Affairs Manager Shane Lieberman and Head of Equities David Lefkowitz to look at inflation, the Federal Reserve’s response and what businesses can expect in the long term.
Joe Galvin: We had thought coming into this year that we would see inflation begin to abate mid-year to the second part of the year. We thought other factors that were drags on the economy would also go away and we’d see an up until the right trajectory for the next couple [of] years at least. What are your thoughts now on when inflation … Because that’s clearly one of the biggest issues that our members are facing right now; they’re seeing the rising cost of everything, there’s cost for materials. There’s supply chain channels. There’s the rising cost of people, all these things come together. Each of you, in turn, what are your thoughts on the immediate term, but more longer-term on inflation? When do we think that we’ll begin to… Have we seen the peak? Is it going to get worse? And when will it get better is probably the bigger question.
David Lefkowitz: Sure. I’ll take a crack at that first and happy to have other thoughts here, but I would break the inflation question into a few different buckets. Because I think there’s a lot of different things going on with inflation. I put them in three buckets.
First I would say it’s all the pandemic-related effects.
And in the pandemic-related effects, we saw … And actually, I’m just going to show a chart Joe because I think this is so interesting to me and I’m a numbers-and-data geek. So I mean, this year — This to me is just astounding. What I’m showing here on this chart is this is goods consumption, and this comes from the GDP.
What are goods? Goods are anything you can touch and feel; cars, iPhones, furniture, appliances, et cetera. And we’ve just seen the largest surge in goods consumption probably since World War II, as the country was gearing up to fight that war. And this was not war-related, this was pandemic-related.
We put a lot of stimulus into the economy. What did consumers do with that? They couldn’t go on vacations, go out to restaurants, go see live entertainment and they needed to reorient their houses for homeschooling and work-from-home, and people bought bigger homes, they bought standing desks, they bought more computers, and the global economy is just not designed to accommodate this kind of surge in consumption.
And you can say, “This is a seven-standard deviation event based upon the history since 1960.” So the good news is that this is now beginning to slow down. We’re getting to a point where the growth in goods consumption is beginning to normalize. We’ve seen that in the last couple of quarters, and that’s going to continue to normalize going forward. So I would say the first bucket is really these pandemic effects.
And I would put this kind of feeds into the supply chain as well. And the reason on that, our logistics networks are just not designed for this level of volume. But as businesses are adding more capacity, as you’re seeing a reduction in the growth in goods consumption, you are starting to see some of these pandemic effects are beginning to ease. And I think that’s going to be the big story as we go over the next several months.
The other piece I would say are oil prices.
Now oil prices is obviously and energy and commodity is more broadly, but oil is such an important commodity because it touches so many different aspects of our lives, and it’s actually the largest commodity by far in terms of dollar value. Oil prices have risen, let’s not forget. At the beginning of last year, oil was at $50 a barrel, now it’s at $100. It’s very unlikely it’s going to go to $150. The market knows all these issues we’re just talking about with Russian supplies and things like that. So the market is already pricing all of this in.
So I don’t think we’re going to necessarily see oil prices rise another $50 a barrel. Obviously lots of uncertainty in terms of the war and how that plays out, but I think we’re going to start to be seeing much more moderate increases in oil prices from here. In fact, they could modestly go down a bit. I don’t think there’s going to be a lot of downside in oil prices because it’s a relatively tight market. But the point is that, I think we’re probably past the most painful parts of the surge in energy prices.
And then the last piece, and I have another chart on this is wages. And this is what the Fed is really worried about.
This just showing here comes from the Atlanta [Federal Reserve]. This is the median in increase in wages across all different types of jobs in the economy.
What’s been the rate of change in terms of wages, and it’s really skyrocketed. We’re looking at one of the tightest labor markets we’ve seen in many, many decades. And what the Fed is trying to do is slow down the economy a little bit in order to try to cool this off a little bit.
So if I put this all together, I think the pandemic effects should begin to start easing, they already are, you are going to start to see that more clearly I think as we go through the balance of this year. The energy shock, I think we’ve kind of absorbed it, it’s probably not going to get materially worse from here.
The open question is really on the labor side, but labor mark — even if we do have 6% inflation on wages which is too high from the Fed’s perspective, that shouldn’t lead to 8% inflation in the economy which is what we have right now. It should lead to more like 3% or 4% inflation. So I do think that inflation can come down to this maybe 3% or 4% level over the next say 12 to 18 months. But if it’s 4[%], that’s probably even a little bit too high for the Fed. So they may want us try to slow the economy a little bit more without tipping us into recession. That’s going to be a tricky thing that they’re going to have to navigate over the coming months and quarters.
Joe Galvin: Shane, your thoughts on these topics?
Shane Lieberman: Yeah. And thanks, Joe. I always like listening to Dave, what he has to say here. I think the only things I’ll add is that from the federal government side to David’s point, the spigot is not completely turned off, but it is slowing down. You’re not going to see another $2 trillion COVID relief bill.
There are some more targeted measures that Congress is looking at. The Senate has come to a verbal agreement on $10 billion for testing vaccines, et cetera, and then the house is looking at about $50 billion for restaurants, and I think, like, gyms. Still, I think that $10 billion bill probably passes the larger $50 billion bill is a bit of a question mark. So that’s a little fluid, but again, you’re not seeing these trillion-dollar efforts of new spending initiatives that keep that pedal to the medal, we’ll say.
Additionally, Congress is going to talk about fighting inflation, really there’s not much on the horizon for them that’s going to 1) pass and 2) really have an impact. You’re hearing about a “gas tax” holiday, I don’t think there are the votes for that to pass in Congress. So there’ll be a lot of talk out of Washington D.C., but I don’t think anything is really going to translate into at least Congress making a difference here. And to David’s point, the Fed is where the action will be and he’s laid out what he sees going forward there.
Joe Galvin: Well, interest rates is a big topic. It has been historically low. The comment has been, “if you can sleep at night, you simply haven’t borrowed enough money.” Clearly, we’re coming to the end of that. But how high and how long is that going to go and what are the implications of that? Again thinking about it as a business owner, how do I manage that?
David Lefkowitz: So in terms of short-term interest rate, which is what the Fed controls and from a business owner’s perspective, most loans from banks are going to be indexed to the short-term interest rate, the revolving line of credit or something like that. That’s going to be more heavily influenced by precisely what the Fed is doing with rates. The Fed is clearly going to be raising them, right, they’ve told us that. And we’re looking for the Fed funds rate to be… Right now the range is a quarter-point to a half a point. We’re looking for that to be around just over 2% by the end of this year and then rising a bit more thereafter. I would say the market — if you look at the futures market — it’s actually even higher.
The Fed futures are getting close to 3% by the end of this year. Now that being said, I don’t think we’re going to be looking at interest rates going again at the short end, much above 3[%] anytime soon. Could it get to 3.5[%]? Yeah. And then obviously the bank’s going to charge you more than that obviously for borrowing money, because they want to make money too. But the way the Fed thinks about this is they think roughly 2.5% on the Fed funds rate, that’s what they call neutral and that’s the level in which they think interest rates are no longer stimulating or restraining the economy. So what they think they need to do is get a little bit above neutral and that should help slow down the economy a little bit, get a better match between supply and demand, [and] bring some of these inflation pressures down.
So I think at the short end, I don’t think you’re going to see… Again, I think the way the thing to think about is maybe 3, 3.5 … somewhere in that range, but the inflation dynamics are difficult to have a strong conviction on. And if inflation remains stickier, then what we think or what the Fed thinks, though those numbers could go a bit higher.
Now at the long end of the interest rate curve, 10-year treasuries, we’ve probably seen as much as we’re going to see … 10-year treasury … I’m just looking at my screen … 270. We’ve seen a surge in 10-year treasury rates. We don’t think it really can go much further from here so we’ll be watching the inflation data like everybody else but the market has, has already made a very substantial adjustment where it hasn’t adjusted as much is at the short end of the curve.