The Federal Reserve is expected to raise rates at their March meeting. Scott Colbert, executive vice president and chief economist at Commerce Trust Co., will discuss what the Fed did, why and what to expect going forward. The conversation will include a discussion of inflation and his thoughts on monetary policy.
Transcription:
Gary Siegel: (
Hello, and welcome to another bond buyer leaders event. I'm your host Bond Buyer managing editor, Gary Siegel. Yesterday, the federal open bar market committee increased interest rates by 25 basis points. Today. We're gonna discuss that decision and everything else relating to the statement and chair Powell's press conference. My guest is Scott Colbert, executive vice president, and chief economist at commerce trust company. Scott, welcome, and thank you for joining us.
Scott Colbert: (
Happy to be here.
Gary Siegel: (
So yesterday the Fed's announcement basically hit all the points they raised. The rate 25 basis points said there are more rates coming, more rate hikes coming, and they raise their projections for inflation. And the number of rate hikes in their summary of economic projections. Was there anything in the statement or fed chair Powell's press conference that surprised you or grabbed your attention?
Scott Colbert: (
Well, I think the, the first thing is, is that he was very clear, not ruling out the potential for 50 basis point rate hikes when he said that that kind of did Royal the market and it pushed stocks and bonds were bond. Interest rates were going up and stocks were coming down, but he managed to salvage the whole thing. By the time he was done talking and done answering questions and the market had had rebounded quite a bit. Um, the second thing is probably the dispersion that occurred in the dots. There's obviously a, a wide range of opinions, um, on the federal reserve themselves on how quickly they need to be raising rates. I think we know that we have the typical, um, um, uh, folks from Kansas city and, and St. Louis that wanna raise rates quicker. And those are generally the fed governors and the ones that are a little more, I mean, the non, uh, the, the bank presidents, but the fed governors are usually a little more benign on this.
Scott Colbert: (
Um, and then, uh, you know, perhaps those, perhaps those inflation thoughts that they have of this, you know, they constantly want to hang on this magnificent rollover. Um, I did hear one commentator on Bloomberg say they almost thought it was magical, the, uh, the forward forecast, um, for inflation. So I would say those, those three things, the, the, the still optimistic hope for rollover, magnificent rollover, inflation, not ruling out the 50 basis points. And then one other thing probably, um, he almost said, but didn't say they will be telling us what they're going to do with QE in may. Um, and I think that's probably, you know, they will, they will start the QE in may. He practically had to give us a wink and a nod to tell us that. And I think that will satiate the boards on the committee, uh, the Jim James boards on the committee that wanted to go 50 basis points. Anyhow, uh, you, you recognize that when the F OMC meets, there's usually two or three people that wanna go 50 basis points, but in an effort to not look that tough, um, and, and to, to for consensus, they usually only pick one person to, to, to throw the, the black ball, if you will, um, out there, uh, to, uh, you know, uh, so that they don't seem so discombobulating.
Gary Siegel: (
Well, that's an interesting point about the 50 basis points, because I know governor Waller also was advocating for a 50 basis point hike. Uh, it's hard to say, but maybe the Russia situation pushed. I think people think once that started it cut the rate hike projection from 50 basis points at this you to 25. So is there some kind of flexibility that the fed is trying to preserve? They're keeping the 50 basis point option open, but will it ever be an op a real option?
Scott Colbert: (
I don't think they're asking for that flexibility so much as just telling that they're willing to use it. If they have to, it's a tool that they don't want to bring out, but that they certainly haven't, um, put off the table. And of course the fed always directs us with almost a hundred percent certainty. What's going to happen at every meeting. You never go into a meeting with this idea. It's 50 basis points or 25, and the market's 50 50, how was very clear. He actually, you know, said there's gonna be a 25 basis point rate hike before the war. So, you know, they were sticking with that 25 basis point, um, you know, starting point almost no matter what. And, and you're right, there were probably a couple folks that still wanted to go 50, even despite the war. But again, like I said, they looked around the table and said, okay, you get to be the dissenter this time.
Gary Siegel: (
Yes. The fed has been very clear about what it plans to do. Um, I guess the situation is different now because the market and some observers say we need a 50 basis point hike. And the, the fed is looking from a different angle. They're looking at a long game with 25 basis point hikes. It seems.
Scott Colbert: (
I mean, I mean, in a way they're giving us forward guidance without giving us forward guidance, telling us that look, you know, as far as we know, we'll be hiking rates at every meeting being very consistent. We don't wanna overdo it and we don't wanna underdo it. On the other hand, you know, the market honest to God could use a one or two or 3% rate right now. Um, really, and they're just still going to very cautiously, take their time getting into it, and probably rightfully so, I suppose, with the war, but there would be a lot of folks that would say, what is the difference between 25 and 75 or zero and one? Um, I, I did, I was talking to a group of folks the other day now they were wealthy folks down in Naples. And I said, is, are any of you going to have any different attitude or do anything different on here or in your businesses? If the short term rate is zero or one. And I, I think the answer to that is there's not much the changes. Now, if the rest of the yield curve is moving, then, you know, then there might be a bigger impact, but I don't think the difference between zero one and even two right now when the two year treasury is about 2% really makes any difference whatsoever.
Gary Siegel: (
You mentioned the yield curve and the yield curve has been flattening. Are you concerned at all about the yield curve?
Scott Colbert: (
Well, you, you ought to be, I mean, they, they, they say it's the perfect indicator. Um, and even even in 98, 90 or 98 0 8 or not, oh, eight, 18 and 19, I'm showing my age now. Right. Um, the yield curve was flattening quickly and then steepened up a little bit prior to the COVID. I don't think the yield curve was really predicting the recession in COVID. Um, but the yield curve has gotten it awfully, right? The difference today is versus the yield curve historically forever is that they've got QE and we don't know how much QE has distorted the yield curve in aggregate. The fed doesn't know, nobody really knows. And it's a massive amount of, you know, treasuries. And of course, some mortgage backed securities that they've taken out of the market and how that's impacting the shape. It, it, it's really, really, really hard to say.
Scott Colbert: (
I hope that the yield curve that they, that they can avoid inverting the yield curve when they do that, typically, you know, leads us to a recession. I think in order to not invert the yield curve, they have to produce quite a bit of quantitative tightening at the same time. They're raising rates to provide enough bonds out there to raise the entire, you know, interest rate level of the curve, which will really have more impact on the economy. You know, the five and the 10 year, you know, really in general will, will, you know, the average corporate bond is 12 years of maturity. And of course we all know that home loans are set. Basically the 30 year fixed rate is set off the 10 year treasury, that those are much more impactful to the average person than the short rate being zero one or two.
Gary Siegel: (
You mentioned uncertainty because of quantitative easing. There's so much uncertainty now throw in COVID and we don't know how two years in, we're not sure where that's going. Now, you have the Russian war, how much more difficult it is it to predict what is gonna happen now than it was three years ago?
Scott Colbert: (
Well, I think it's, I think it's awfully tough or at least a year ago. Well, now, now pre COVID, you know, no one was predicting a recession until the COVID really showed up aggressively. Um, uh, and then no one predicted that the magnificent recovery we were going to have either, um, because of the, basically because of the massive amount of fiscal stimulus that was provided, um, about out three times more stimulus than we got during the great recession. And they gave it to us three times faster. And of course the vaccines, you know, worked quicker and were produced faster than, than most people thought. So, um, you know, today, uh, I think it, you know, it's, it's a particularly precarious environment, of course, and that almost sounds stupid us to say it, you have, you know, stock markets that were at record highs that, you know, are now falling. You've got a war in Russia that, you know, or Ukraine with Russia that you don't know is gonna turn into a, a bigger, you know, bigger conflict. Um, and then, you know, you've got the fed raising rates all into the basket. I will say, they're doing all this, you against an economy that had a tremendous amount of forward momentum
Scott Colbert: (
Wages were growing. Jobs were growing, we grow six and a half million jobs last year, 6.6, 5 million jobs. That's more than 4% more workers. We know that from a top down perspective, the average worker got 4.7% more in wages and salary. So that's 8.7 more spending the consumer had not including all the pen up savings, uh, the lack of supply and the pen up savings that was going on. Um, plus the wealth effect that was accruing plus the QE that was keeping interest rates ultra low plus the ultra accommodated monetary policy. That was the, you know, put pin them at zero. You know, we went into this to this downturn, if you will, or slow down with a lot of momentum,
Gary Siegel: (
Well, consumers fuel the economy obviously, and they don't
Scott Colbert: (
See sales just came out. They were up on a nominal basis, a nominal basis. I wrote it down here. So I get the number exactly right. Where is the heck the thing it was, uh, let's see, you know, almost 17% year over year, about 10 of it was price rises. Okay. And about six of it was real growth, but, you know, nonetheless, that's just an amazing retail sales up 17% year over year,
Gary Siegel: (
Right. And consumers fuel the economy. So consumers seem to be willing to spend, it's only a few areas that COVID has stopped them from spending, you know, the price of cars is incredibly high. Uh, vacations are out for some people. What does that do to the economy? The,
Scott Colbert: (
Well, certainly the inflation, you know, and the, and the real growth in wages and salaries was actually negative last year. Right? And so it feels good to, you know, get your raise, you know, and it might be bigger than it's been when you look up and you say, my gosh, food prices have gone up. And of course the car prices, especially used car prices have soared. You know, we're only producing, or we're only providing about 14 million cars a year for people to buy. And there's probably demand at least for 17 or 18 million. So, you know, we're 4 million short. Now, two years in a row, I live close to an enterprise lot just down the lot. And I was talking to 'em the other day. You know, you wanna know why that, you know, cars are 35% higher, used cars are 35% higher it's cuz no one will sell enterprise, a brand new car they're out there buying the largest car buyer on the planet is buying up the used cars.
Scott Colbert: (
And you know, that's why they're up 35% year over year. So, you know, the purchasing power, um, is, you know, is, is impacted, but not nominal. We, you know, forget that, you know, just nominal money running through the economy, drives things forward. It also, you know, has increased employment as employers try to catch up. Um, we are a country that never has a recession if we're not losing jobs. So if you wanna tell me that we're losing jobs by November, December, I will tell you that will be the coincidence, start to the recession. But if we're growing jobs, even just one job in a month, we are making forward progress in this country.
Gary Siegel: (
A lot of people have left the workforce. How does that, how does that impact this?
Scott Colbert: (
Well, you know, the, the fed is trying to thread a needle here by bringing inflation down, causing a recession, right? And one of the biggest reasons there seems to be some, you know, inflation is that we've had so many people disappear from the workforce and we've had a hard time bringing them back. That is one of those things that would help tremendously. If we could suddenly increase the participation rate or at least get it act close to what it was pre pandemic. And it would afford, you know, basically more labor, probably keeping a lid on, you know, the increase or acceleration in wages and salaries. I don't know that we're going to get that because we all know based upon demographics, we're getting older and that was slowing the new entrance into the workforce as the boomers were appearing. And I really think, you know, the, the heart of the matter, the core of the matter has become childcare.
Scott Colbert: (
When you look and find out that the people that disappeared from the workforce tend to be 3.8, outta five of them are younger women with children. It tells you that, you know, if you have one or two kids at home, the cost of childcare, which is pretty much doubled, you know, it sets a pretty high bar for you to want to go to work and on an after tax basis, even make enough just to cover the childcare. So, um, I would tell the, the country that, you know, I hate, you know, and I, I hate to create a new program for anything. My gosh, I'm a, a right wing, red meat, eating, you know, Republican economist from Missouri here for gosh sakes. But the one part that really, really needs some help in this country is the childcare or affordable, you know, access to affordable childcare.
Gary Siegel: (
We have a question from one of our listeners, he wants to know how will the economy and interest rates be impacted if Russia goes into default?
Scott Colbert: (
Well, I, you know, I, I, this is I, I spent a lot of time thinking about this, um, because during the subprime crisis, what everybody missed at first was they said, well, look, mortgages are, you know, 10 trillion and subprime crisis are two and a half. And of that two and a half trillion, we'll get a 50% recovery. So that's a one and a quarter trillion dollars worth of losses. We can absorb that, no big deal. And it turned out that, you know, there were contagion effects that people were borrowing money to own these mortgages. I don't think there's a lot of borrowing going on in terms of leverage to own a Russian asset. They seem to be pre well dispersed. The total amount of debt seems to be if we're, if we're getting the numbers right about 480 billion of which basically about 145 of it is in dollar denominated or Euro denominated debt.
Scott Colbert: (
I think that at the margin, a bigger loss of course, was the Russian stock market, um, in terms of, you know, magnitude. So I think, you know, that the wiping out or the zeroing out of the Russian stock market, which is about three and a half percent of the emerging market index was a bigger impact than zeroing out the Russian debt, which also happened to be about three and a half percent of the emerging market debt index. Um, I've already absorbed my losses in a sense, and I look through a, all of our portfolios and on average, we had, you know, basically fractions of basis points of Russian debt. And I think that that's largely spread out. You heard that black rock has the most, but of course they've got 2 trillion. So why wouldn't they have the most, um, these are very modest, you know, equity losses, uh, the, the downturn in Alibaba was more market cap lost than if all the Russian debt defaults to zero. And we absorbed so far, we're absorbing the Chinese stock market decline, which of course is much more material than losing all of Russia.
Gary Siegel: (
We have another question from the audience. Do you think the fed will do everything it can to avoid an inverted yield curve? Do you think they will sell bonds and not just let their balance sheet run off in the background selling bonds? Shouldn't
Scott Colbert: (
I, I don't think they're gonna sell any bonds at all. Okay. Um, because if they do, they're gonna have to take losses. And the fed, you know, the fed is not really funded by Congress necessarily. Um, they, they are in a, they make money and they, they, they, they generate positive carry typically and send it back and actually help lower our deficits by earning money. The fed finds itself now in a precarious position where their entire balance sheet is now below water. And I think the only way they're gonna do it, they're gonna do it. The old fact, which is to close their eyes and let it run off. Now, it is largely skewed towards the shorter round and it can run off fairly quickly, but I don't think you'll see them sell anything. What I hope to to see is that they'll put at least a large enough cap on the month to month, um, decline that it's meaningful and significant. I think you can expect, you know, a trillion dollars of runoff per year, pretty easily out of this portfolio without any sales whatsoever and I've eyeballed it. And, you know, we've, there's a lot of studies out there that would suggest each trillion dollars is at least an eight to a quarter in terms of lowering the interest rate level. So a trillion dollars runoff ought to be the equivalent of possibly, you know, a 25 basis point rise across the yield curve.
Gary Siegel: (
And the Fed's balance sheet is roughly 9 trillion. Now, how much of that? Can they let run off?
Scott Colbert: (
Well, you know, they're normal operating what they would normal. We need now to operate based upon the size of the banking system would be about a trillion and a half. So there's seven and a half trillion of excess reserves. Um, and you know, in a trillion dollars a year, it would take 'em seven and a half years to, to unwind the whole thing. Unfortunately, we'll probably have a recession before the next seven and a half years. And so they're gonna have to stop just like they did the last time stopped right in the middle of the COVID after they were making just some very, very modest progress. They reduced their balance sheet from roughly four and a quarter to roughly three and three quarters, you know, prior to the, um, uh, uh, the, the last procession sparked by the COVID.
Gary Siegel: (
Do you think we're headed for stag flight at any point?
Scott Colbert: (
Well, this is certainly stagflationary at least for a period of time. Um, I think you have to ask yourself what has changed today that, that, that, that drove interest rates down and down and down over our lifetime. Um, of course, uh, you know, when I was in college, we had those magnificent 21 short term prime rates. And so in my entire investing life, I've watched the prime rate of course go from 21% to essentially three or two or three quarters or wherever the heck it ended up. Um, so I've watched, you know, for 40 years, interest rates, 42 years, essentially interest rates coming down and down and down. Um, so, you know, what has changed in turn of inflationary pressures? The big thing, the big driver were really twofold that brought in, you know, inflation down over our lifetimes, maybe three, number one, you had an assertive fed that was willing to put short term rates into real territory.
Scott Colbert: (
They were giving you an incentive to total cash. Clearly that's not the case right now because you have the lowest level of federal reserve funds versus inflation. We have the deepest negative, real fed funds yield even after yesterday's 25 base point hike that we've ever had ever. Okay. So we've been more accommodated just on that. Um, so has that changed? I'd say, yeah, the fed kind of, isn't a mode where they, you know, they're not even talking about trying to get real rates up yet. I think they have to start thinking about that really to, to really tame this inflation. So is stagnation a possibility? Yes. Until the fed decides that that they're gonna have to get real about real rates, that's that's number one, number two, we've had this amazing amount of access to emerging market labor over our lifetimes. The rust belt literally started in 1979.
Scott Colbert: (
I was working a Cumings engine company that summer of my, of my, of my, one of my college years. And they fired us all in August because of course they were raising rates and no one was buying a diesel truck to save your life. And that honestly was the start of the, the Midwestern, you know, hollowing out of all those general electrics and, and, and, and, and, and, you know, big plants and that, that we had. And global trade as a percent of GDP was 10%. It peaked at 30%, and it's actually been coming down and down and down. So I don't know that we're going have the tailwind that we used to have about having basically unlimited cheap access to emerging market labor. So that has kind of gone away. That's helped drive things, but the one thing that hasn't gone away clearly is the use of computers and productivity and businesses are clearly driven, you know, to become more productive over time. So, you know, I think things have changed. I don't think that there you have as many deflationary forces as we used to have, um, at all. And I think it means that the fed is gonna have to get more serious than this idea that a two and three quarter percent terminal rate is where we're going to get or where we're gonna need to get to wrestle inflation down so that we don't end up in AAG inflationary environment.
Gary Siegel: (
You said that you see recession sometime in the next seven years, when do you think and how bad?
Scott Colbert: (
Well, I say that because if you, if you go back to 1960, the average, you know, recovery time has been seven and a half years now, it's been getting longer and longer, more recently because we are less manufacturing ordered or, you know, so we don't have the, the cyclical swings that we used to. I think the federal reserve has learned to become much more adept with policy in general, trying to, you know, be a little gentler, softer than, than they, than they were under the Paul Vage. Uh, and even maybe the Allen green spanning age. Um, uh, uh, so, uh, uh, the economy's been expanding and then the third thing that's, that's caused each expansion to expand is that government spending as a percent of GDP keeps going up. Now, I hate that, but it's true. So security payments are given and once they receive, they are entirely spent.
Scott Colbert: (
And so security just in and of itself is a center of the economy is growing and growing and growing. So, you know, those three things have, have, have lengthened the cycles, but we're already two years into this recovery. This is the fastest recovery we've ever had. And, you know, the, one of the reasons I think we had a 10 and a half or 11 year recovery the last time is because we came out of the gates. So slowly in this case, we came out like a fighter jet instead of an old rum wing, B 52 bomber. And I think that shortens the recovery in general. And that's what we're seeing because we're getting the inflation faster, sooner, and we're forcing the fed to move quicker than it normally would, you know, post a recovery. So I think this recovery is much less than the average seven and a half years.
Scott Colbert: (
When is it, you know, I don't think it's this year, but gosh, darn it sure could be next year. I hate to say it, but it really, really could be because I don't think the fed is going to be able to tame inflation as much as they think by gently raising rates, 25 basis points per session and taking them all the way, way to a whopping 2% by the end of the year. Again, I will tell you the difference between zero and two is absolutely nothing to the average person that's out there running around in this country. They don't know the difference.
Gary Siegel: (
So that brings us back to the 50 basis point hike. You don't think the fed will do it, but it sounds like you think the fed should do it.
Scott Colbert: (
I don't think they'll do it. I think they, I, I, I do think that they, they should look back in history and realize this simply simply put, um, since 1970, till today, there's been seven recessions on average, the inflation rate has risen during those recessions on average five and a half percent. And they've never been able to soft land. We are up now from about one and 0.4% to what it's gonna be 8% probably print in April. So we'll call that six and a half percent from the end of the recession to, to today, um, six and half percent, it's higher than their average. They know what they've had to done to, to call this inflation the last time I think it's gonna take quite a few rate hikes and you know, it get it. It's very, very difficult to, to soft land, such an occurrence.
Scott Colbert: (
Now they have had some soft lands. People say this they've never soft landed. They did 94 when they were raising rates, they gently saw, you know, um, uh, there was a, they slowed down there. Um, uh, that was the Mexican crisis, the payso crisis where they immediately stopped raising rates, brought the 'em down a little bit. They did in 98 with the irrational exuberant speech from, uh, Allen Greenspan that thought that the markets were a little too expensive. Um, well the Thai bot collapsed, uh, uh, the Russian defaulted in 1998. And of course, uh, we had a, uh, uh, the long term capital management crisis. They reversed directions there and extended the recovery. So it's possible that they soft land this, but I'll tell you, they're setting this thing up from a much uglier position with much higher inflation and bigger headaches to worry about than either the Mexican peso crisis or frankly long term capital management and floating
Gary Siegel: (
Without a doubt. It's a more complicated situation. Yeah. So what would the fit need to do if they want to, and I'm sure they do want to bring in, in the economy in this off landing,
Scott Colbert: (
You know, it's hard to say that they ought to give us more, more, a more forceful, you know, liftoff right now, because you say, well, geez, when that slow thing quicker, I think it would, it would create a situation where people would, the inflation expectations would at least remain anchored and they don't let them, you know, get, get, basically continue, increase, like, like they've been increasing. And I think the 25 base point rise will afford, you know, that, that anchoring to, to basically dislodge, to make people start to think about three and 4% price rises year after year and, and keep people, you know, running out to buy things today rather than just waiting. I mean, um, people are still running out to buy houses, cuz they're worried about houses, prices, you know, going up, uh, people are still, you know, panicked to buy a car because they can't get a car and they, they haven't been able to satiate, you know, their demand there.
Scott Colbert: (
So I do think that a little tougher love earlier makes it easier to soft land this than a slow gradual love, which basically forces them to overdo it ultimately to finally wrestle control of inflation. They need a lot of things to go right for this inflation to come down. I wrote five things down here. I thought about it the day. And I said, what, what does the fed need to have break their direction to afford us as soft landing, number one, they need these commodity prices to cool. Now perhaps they will. Um, because you know, they've shot up so much. And we, we know that commodity prices in and of themselves are very in elastic and they're reacting to all the news. And we saw that with oil G you know, getting to for a brief moment, you know, to 140 ish dollars and then back to 96.
Scott Colbert: (
Um, and of course we saw that with nickel, with its a hundred thousand dollars per ton and now it's opening down limit and it's back to $48,000 a ton even wheats off $2, $2 and 50 cents, you know, from its, uh, $12 and 80 cent, you know, high. So we need prices to cool. Um, we need good prices to cool because we need these bottlenecks to, to, to alleviate and by good, good prices will cool. If we can create the supply. The reason that every car is being sold at full list price is because the dealers don't have a hundred cars on their lot. The average dealer in this country, it's hard to believe. There's there's 17,000 new car dealers. There are only 34 new thousand car, new cars in the country right now sitting on dealers. Lots. I assume I hate to say this, but I assume they're all Mitsubishis and Fiats.
Scott Colbert: (
Um, because you know, they're, they're just, there are no cars on the dealers. Lots they're really, it's just the average dealer has two and a half cars. Um, so I assume the Fiat dealer has 10 and the, the, the Ford dealer has only one. Um, so we need those good prices to cool and the bottle next to ease. And the war, of course, doesn't help these bottlenecks at all. Three, we need wage growth to slow and increase that participation rate. And we just talked about the demographics for the participation rate and the, you know, childcare problems for the participation rate are pretty tough to overcome. Um, Walmart's out there trying to hire 50,000 people target just upped its short term. You know, it's its wage it's minimum wage essentially to $24 an hour. So I don't know that we're gonna suddenly get a lot more people.
Scott Colbert: (
We're certainly not letting a lot of immigrants in. I would tell you we could use two and a half million Ukrainian folks here right now in this country who wanna work. We could use 'em today and we put 'em to work. Um, so, you know, basically the, the workforce participation rate and the workforce growth rate, very modest, hard to see that changing a lot. Um, we need the financial markets to correct now the stock markets down 10%, 12% at its bottom. It actually rallied for the last two days. Um, small cap stocks have corrected 20, um, uh, almost all the major indexes were down 12% year to date. Uh, just, just prior to the fed meeting, um, that's to correction, but we have to recall that, you know, stock prices were up over 120% from their bottom, the fastest market recovery ever. We have more wealth in this country per, per, per, per GDP.
Scott Colbert: (
We have six times 150 trillion of savings in this country. Essentially six times GDP. We have the most amount of wealth that we ever had. We need a significant need. The financial markets tighten, and it wouldn't hurt down the stock market down a little bit. And by the way, those are very benign outcomes. When the stock market falls in 87, we didn't have a recession. And even in the internet bubble, that was a very mild recession cuz they were equity driven. So we need, we need stock prices to correct a bit more. And then we need these basis effects to really start kicking in. Can use car prices, really honest to God go up 35% next year. I think the answer to that is almost an impossibility, but energy prices. I said at the beginning year energy price would've to increase 70% this year compared to last, that was $109 average barrel of oil. Well we're getting close to $109 average barrel of oil. And I thought that it was no way energy prices would be up another 70% year over year. So we need all five of those things to basically help the fed along. I don't know that they get that lucky.
Gary Siegel: (
I'm gonna ask you just one more question. Before we go to a ton of questions we have from the audience. Powell said that a 50 basis point increases possible in the future, given that he said that and he's been so clear. I mean he told Congress that this rate hike was gonna be 25 basis points. If the fed does decide to make the next rate hike 50 basis points, does the market go whoa, or given that they have advanced notice, it'll be smooth.
Scott Colbert: (
I think, I think that they'll give us the 50 basis points in made by this way. They'll give us the 25 normal that they've already projected and they're going to start their reversal of the QE. The they're gonna start quantitatively tightening. We gotta start to hear that word QT instead of QE. The combination of that, he'll tell you, I think he'll tell you that the market or he'll someone will tell us that we think by reversing the quantitative easing, that's like the equivalent of raising rates by 25 basis points. So they're gonna give us the 50 basis points in may a new way. A combination of both. I think that puts June into play. And if, if inflation is still increasing and hasn't come down an Iotta from basically, what's gonna amount to probably an 8% handle here in March, then the 50 basis points will be in play, but they need to see inflation stop progressing higher.
Gary Siegel: (
Okay. So we have some questions from the audience. What is your outlook for home sales prices with the rates with interest rates increasing?
Scott Colbert: (
So, you know, yesterday we also had, you know, home sales printed, new home or not home sales, but new home starts new home starts are back to about 1.7 million. They were peaked at about 2.2 trillion, uh, 2.2 million in the subprime crisis. So we have some growing supply in terms of starts, but we still have today. When you look out your window, the lowest nominal inventory in the last 30 years of homes available to purchase. So while inventory was about 10 months worth of inventory going into the subprime crisis, which eventually tilted the prices down, a lot of inventory falling demand, we have still the exact opposite. We still have growing demand and almost no inventory. So from that perspective, it will take a while for inventories to increase and demand to cool off before you're going to start to see prices moderate in any meaningful way.
Scott Colbert: (
Secondly, this is goes without a lot of thought and you don't see it in the charts, but the underwriting today for mortgages is magnificent. Um, I just bought a house back in August and I hated doing it because I know it's right into the, the highs of the market. And I'm, I'm, I'm, you know, I'm sitting there saying, I know that if I bought a house, it's gotta be the top of the market and it isn't yet, but it, but, but it could be, but I will tell you, um, the banks dot every I can across every T even when you're their employee and they know what your salary is to a, to, and they know where, what your employment history is. Um, and if I got worked over like that, I can't imagine the average person isn't getting worked over pretty well. So underwriting, there are no such thing as the ninja loans, the no income, no job, no, no verifiable assets.
Scott Colbert: (
So, so, um, underwriting's very tough. Affordability has been coming down because of course interest rates have been coming up and prices have been rising faster than wages and salaries have been growing. Okay, that's fair. But right now today, affordability is spot on it's 50 year average. Now it's going to have less affordable and unaffordable and we're starting to see this. There are several surveys out that suggest is this a great time to buy a home? They've been coming down and down and down because of course the mortgage rate has gone from sub 3% to basically right about 4% today. And of course the prices of sword. So the number of people interested in buying home is clearly starting to, um, D climb. But I would tell you, this home prices are still set to rise. This year. Home prices in our lifetimes never fell except for the subprime crisis. They're again, moving parabolically. I don't doubt that they're poised again to fall, but in the long run home prices tend to increase at CPI. Plus 1%, that's the long run 50 year trend for home prices. And of course we did have 8% inflation right now, year over year. So if you told me home prices are up 9%, that's just what they should have been up. Normally
Gary Siegel: (
The next question Scott is how much do you expect banks to raise CB rates in the next six months to a year?
Scott Colbert: (
They're not gonna do anything that they don't have to do so, so they will lag the treasury market, um, as they, as they generally have. I, the two year treasury is 2%, but bet you can only find three on the internet that are paying you 2% for two years right now. So, you know, they will, they will follow the treasury curve up with a great lag. Um, uh, but you know, they're, they're gonna be forced to move up. Um, you know, there're almost no CDs in the banks anymore. Anyhow, everyone's kind of gone to cash CDs. Aren't really a, a, a much of a funding. No one come came in and said, I want a one year CD during 27 basis points. So they just said to heck with it, keep it in my checking account. Um, so CD CDs may become, you know, a, a source of funding again in terms of footings for a bank.
Scott Colbert: (
But, you know, they, they, they, they basically, you know, for commercial banks at least largely disappeared, but the banks will be slow to raise. They always are. I do think that this deposit surge that the bank, you know, have seen and they've seen it pretty much as, as, as the money supplies increased because there's been no competition for the money. So the 45% increase in, in the, in the money supply over the course of this has also increased banks assets by almost exactly 45%. Some of those assets will bleed all off to the money market complexes, which will of course, you know, move rates up faster, quicker, um, than, than the banks will.
Gary Siegel: (
The next question is if you were borrowing money, either on a fixed rate basis or variable rate for five, seven or 10 years, what would you choose based on the current environment and your outlook? And I just wanna,
Scott Colbert: (
We have a discussion just, I'm just, I'm gonna ask anybody. And I say this with, with kind of a joke is a 2% 10 year, two and a half percent, 10 year, and a 4% 10 year borrowing rate really seem tough on you do it, lock it in. And you've got the option then to, to refinance if rates come down. So to the extent you can't, and you know, the, the feds already told you that short term, rate's gonna be a two. And of course there's gonna be a spread on your borrowing of at least one or 2%. So your short term, rate's gonna be four anyhow, by the end of the year for a typical variable rate borrowing, it's only for right now, if you go out to the 30 year, so lock this stuff in, it's why, you know, you don't have all the consumer what to do. They, they intuitively know exactly what to do, and it's why almost 97% of all mortgages have been basically fixed rate mortgages. Cause the consumer says, I'll take the, the fixed rate. So go ahead and lock those things in now don't, don't wait around, uh, while the banks still have plenty of money to lend and they do, the banks have a ton of money to lend their loan to deposit ratios have never been lower.
Gary Siegel: (
Next question is, as China's Yuan starts challenging the us dollar, what role will Russia pull? How will the dynamics play out?
Scott Colbert: (
I, I, I hate to be light about this, but you know, Russia is literally 8% the GDP of our country. It's, you know, it's, it's less than a 2 trillion economy and Ukraine is one 10th. The size of Russia Ukraine's entire economy is not, this is honest to God. It's less than the economy in the St. Louis region by about $20 billion on an annual basis. It's about twice as large as Memphis, if you wanna put that in context. Um, so I don't think that this is gonna be, you know, materially impactful to the you on, in any way, shape or form. It does probably start to set up this geopolitical Alliance that is us versus them, as opposed to us versus Europe versus Russia versus China. I do think it kind of starts to bifurcate that thought process. And of course, Russia will lean on China to the extent that China is willing, uh, to, um, uh, afford them anything.
Scott Colbert: (
And China will take advantage of the situation if they can. But let's recall who is China's biggest customer. We are, we import as much from China as the entire Russian economy. So just our imports are bigger than if Russia is shut down everything and said, we're gonna buy every thing from you, China, everything. They would have to do that to be as big a customer as us. And by the way, China exports plenty to Europe and the rest of the world. So, you know, China's gonna have to play this relatively close to the vest. They don't wanna upset us anymore than they have to. Um, given the fact that they know that we can begin to basically impose sanctions on them. We know that the tariffs tend to stick. All those tariffs that we put on during the Trump era are still there. And they're all gonna be renewed this year to a T that did slow down the export growth of China. To us. It did dent the amount of secur, you know, the things that we buy from China. So I think that China's gonna be very cautious of about this, and it's not gonna be nearly as impactful or turn the U on into anything, approaching a Euro. And of course the Euro has really never approached the dollar in terms of being the, the, the world's standard currency.
Gary Siegel: (
We have a two part question. Do you think the rapid inflation was caused by too much government's stimulus in early 2021. And what are the odds of a recession in 2023?
Scott Colbert: (
Well, I will say that, you know, looking back on it, when we looked out our windows in April of 2020, and they had those pictures of times square with literally no people on 'em at nine o'clock, it did feel like the end of the world, you looked out there was no traffic. You went out on a highway and you're the only person driving around. You said, what am I doing out here? That's kinda like being out on a boat in the middle of the ocean when there's a storm. And you say, well, I understand why everyone's on shore, but you know, know what the heck are we doing out here? Um, so the government reacted forcefully. They reacted forcefully for, for probably two major reasons. Number one, they couldn't blame anybody. So the Republicans couldn't blame the Democrats and the Democrats couldn't blame the Republicans for this problem.
Scott Colbert: (
They probably tried to, as you recall, we probably tried to blame the Chinese, but that did didn't stop us from doing a lot. And then the political change from Trump to Biden, they were both trying to outdo each other. In retrospect, we did not need 6 trillion to get through this three. Would've probably done it. And so, yes, in retrospect, it was we, we provided the country 25% of GDP or three months worth of spending or $18,000 per person to get us through the recession. And I know everyone on the call saying where the heck's my $18,000, where was my $18,000? Well, it got dispersed to a lot of different places, but yes, that was the start. We gave us too much fiscal stimulus and we didn't know it at the time. We just didn't. And I guess you'd say they were better to air on the side of, you know, being conservative than not. Secondly, of course these bottlenecks occurred that that ha are big. I mean, look, if we could, if we could have produced 18 million cars a year, you wouldn't see the inflation in cars. Um, if we had the truckers and employees to move stuff around the country, you wouldn't seen the, the skyrocketing transportation cost. And if we had had probably the ability to get drillers in Texas and, and, and a little more friendly, non ESG oriented, you know, culture, we might have been drawing for a little bit more oil sooner, too
Gary Siegel: (
One listener. Thanks you for your knowledge and expertise and wants to know if you have a daily or weekly newsletter that they can subscribe to.
Scott Colbert: (
Um, you can, if you, if you go to commerce bank with our tickers, CBS H or commerce trust company, and we're just a division within the bank, that we're just the money management arm of commerce bank shares, Inc. Um, you can get in there and log on and, uh, get our research. Um, I do produce a five minute video, uh, that, that actually is pretty widely watched, not like big time economists, but at least a smaller and a smaller pool of, um, uh, in the region. Uh, and that, that we produce that every two weeks I'm gonna do that. Uh, just today just did provide a 30 minute economic outlook, just like this, to all our banking co uh, uh, clients that's videotaped and out there. And then anything that we write, I don't, I don't do things routinely. I do things when I think that there needs to be something done, but the, the five minute update is pretty much done every two weeks
Gary Siegel: (
We're running into overtime. So I'll just ask one more listener question with interest rates, moving upward from prolong doldrums, equity markets, still strong and meaningful inflation. Where can retail investors move capital for preservation and income purposes? Do we see a retail Exodus from unis in the near term? For example,
Scott Colbert: (
Let me tell you, you know, I mean, my job is really to manage other people's money. I manage 30 billion for other people. Um, that's my day job. And there aren't any pockets of value out there when you're really looking at a portfolio. Yes, we've had 10 or 11% correction, but the market is still relatively expensive compared to where interest rates are likely to be. And that will compress PEs, which basically got to fairly outrageous levels. So you've got this pressure on interest rates that don't afford stocks, a lot of upside on average one year at, after a geopolitical event, or the fed starts to raise rates. Stocks actually are up five to 9%, but if the fed is assertive and aggressive, meaning they raise rates at every meeting, the stock market is down. So it's tough to suggest that the stock market will likely be up one year forward from today.
Scott Colbert: (
International stocks of course are two on a relative basis, but they're much, much closer to the war. And I can't tell you that, you know, who could predict that the Chinese stock market would collapse. And then I saw one of the Chinese ETFs was up 33% yesterday. So I think, you know, the, the stock markets are tough to say, you're gonna preserve capital. You will be able to finally buy some CDs or some bonds with some reasonable yield. The yield at the Lehman aggregate is 2.75% today. And the average bond fund returns over a 10 year time period, the 10 year treasury plus 80 basis points for credit risk. 10 year treasury is called two and a quarter at 80 basis points. Your average bond fund will probably give you 3%, but those still probably are barely anything if you're lucky, a real return at all.
Scott Colbert: (
So it's very difficult to suggest there's anywhere to find a real return. And in fact, you have to go out to a 30 year treasury inflation, protected security to just guarantee yourself a zero real return. So if you're, if you're a perplexed investor trying to say, where can I make some money there? Aren't a lot of ways to, to honest to God say, you can preserve capital. And this is a market where I think that's your ought to be your number one for focus, preserve capital, get valuations up, get through this interest rate hike, get through the slow down. If there is a recession, everyone should know that the average decline in the S and P 500 has been 34%. That's the kind of downside you're looking at. If we really tip into a recession by 2000 and say, uh, 24. So it's very difficult to suggest that there's a lot of way.
Scott Colbert: (
Hopefully what you are is you're young enough to dollar cost average in the market. You ought be thankful that the stock prices don't keep going up and up. If you're older like me, you don't like it much because I have fewer years now to save. But if you're a younger person, you'd rather see that stock market stock going up so that you can dollar cost average into a cheaper market and hope that it goes up. You know, when you're about to retire, uh, not right now, but I tell you, it's a tough, tough place to find. Stocks are down this year. Bonds are on this year. It's only happened three times since 1968. This is the fourth time.
Gary Siegel: (
I know we said this was the last question, but we had one follow up. Someone wants to know where that 18,000 per person, uh, went,
Scott Colbert: (
Okay. You, you, you dial it out. All right, you can start with the P P P P program. That was 800 billion of it. Okay. Um, and that went directly to businesses. And we know at our bank, because we, we lent 1.8 billion of it directly to businesses, and it's almost been entirely forgiven. Hospitals and schools had emergency funding sent to them in the tune of about 400 billion. We deal with a lot of hospitals, a lot of school districts, that kind of stuff. And that money just poured in the door. I have a daughter in Manhattan who lost her job during the downturn. She was afforded an extra $600 a week. Thank you very much from the government $2,400 a month for an entire year. I say, I didn't get my $8,000, but I would tell you, I had one member of my family collect about 24 or $25,000. Thank you very much. You know, United States government to help her get through the downturn in terms of the, you know, the, the added unemployment benefits. Um, uh, so, so it got out there indirectly or directly, um, to, to, to almost everybody it's hard to believe, but 6 trillion divided by 330 million people is about that $18,000. You know, it's out there and it got around. I mean, that is why we have this booming economy.
Gary Siegel: (
Scott, I want to thank you for your time. This was a wonderful presentation. I'm sure many of the list have enjoyed it. Some have actually said in the comments how much they've enjoyed it. So thank you again for your time and your thoughts.
Scott Colbert: (
Happy to do it. Thank you for having me, Gary.
