On today's episode of the Macrocast, Ylan, Brendan, and John examine the implications of extensive borrowing, as the U.S. debt approaches 106% of GDP. The group discusses the projections from the Congressional Budget Office, the impact of rising interest rates, and the scrutiny on the Treasury Department's past decisions. Ylan, John, and Brendan also discuss the impact of expiring tax cuts.
Ylan, Brendan, and John then shift to a discussion about the challenges confronting the commercial real estate sector amid the ongoing shift towards remote work. They analyze the potential repercussions on pension funds and insurance companies, posing questions about the necessity of government intervention. The group then delves into the evolving labor market landscape, the Federal Reserve's response to inflation concerns, and the strategic maneuvers undertaken by companies like PepsiCo and McDonald's to navigate consumer resistance to price increases.
On today's episode of the Macrocast, Ylan, Brendan, and John examine the implications of extensive borrowing, as the U.S. debt approaches 106% of GDP. The group discusses the projections from the Congressional Budget Office, the impact of rising interest rates, and the scrutiny on the Treasury Department's past decisions. Ylan, John, and Brendan also discuss the impact of expiring tax cuts.
Ylan, Brendan, and John then shift to a discussion about the challenges confronting the commercial real estate sector amid the ongoing shift towards remote work. They analyze the potential repercussions on pension funds and insurance companies, posing questions about the necessity of government intervention. The group then delves into the evolving labor market landscape, the Federal Reserve's response to inflation concerns, and the strategic maneuvers undertaken by companies like PepsiCo and McDonald's to navigate consumer resistance to price increases.
Hello everyone and welcome to this episode of the macrocast. I'm your host, Elon Mouly, a managing director at Penta. My co-hosts are Brendan Walsh and John Fagan of Markets Policy Partners and guys, I feel like the big news over the past week was just the size of the massive US debt load. The Congressional Budget Office projected that the debt held by the public will hit a record 106% of GDP by the end of fiscal year 2028 and eventually hit 116% of GDP 10 years from now, and a lot of that is actually being driven by, obviously spending in the past. So that's number one but two the fact that interest rates have been higher than the CBO expected and will remain higher than the CBO had previously forecast, and that's really driving up a lot of the increased in cost for the federal government.
Speaker 2:Yeah, and this is one of the consequences of higher for longer.
Speaker 2:Now, a higher for longer is not set in stone by any stretch of the imagination, and the market doesn't see and the Fed, to be fair, really doesn't see interest rates being around these levels for very long.
Speaker 2:But still, I think that the general consensus is that the zero interest rate era is a thing of the past.
Speaker 2:The Fed is unwilling to go back to it, and money will have a cost again, and we just saw the post-global financial crisis era allowing fiscal authorities to kind of do whatever they wanted without a whole heck of a lot of consequences, because the Fed was there to backstop you and interest rates were incredibly low and were never going up, and so I think that spawned a lot of sort of magical thinking about deficits. But at the same time, the US isn't the worst offender. You look at, obviously Japan is way ahead of us in terms of its debt to GDP ratio, and so the US is at this tipping point, and it's kind of the time where you would tend to get a reaction on Capitol Hill, but that reaction typically came from the Republican side and former President Trump is not a fiscal contractionary type politician, so it's hard to find a constituency in Washington DC aside from, probably, the Treasury Department that is really concerned about where this might go and trying to find potential solutions for it.
Speaker 1:Yeah, I feel like when you talk about the Treasury Department, john. I feel like it was a lifetime ago that Janet Yellen was encouraging Congress to go big on the fiscal stimulus package post COVID, because right now interest rates are low, so we can afford it right Like spend now while debt is cheap, and now that's coming home to roost in the form of higher net interest payments. The CBO calculated that interest on the debt doubled from FY 2020 and then 2023, and they projected it will double again to $1.3 trillion in 2031. So over a trillion dollars just going to paint down the debt. Not even like the underlying principle here. But I also wonder if it even matters to the markets, because there's still a healthy appetite for US Treasuries.
Speaker 2:Yeah, we just saw a record breaking size of a 10-year auction yesterday and it was taken down pretty handily and the demand for the demand for Treasuries is still obviously very strong. There are some issues with the Treasury market that we've seen some volatility in Treasuries Remember last October there was that real upswing and when yields seem to have the bit in their teeth and just start running, there was a question of whether this was a fundamental price action or whether this was what they call a term premium in the longer duration bonds, which is essentially the factor in the price. That speaks to the market's lack of confidence in the Treasury and in the fiscal situation, among other things. But if you have a situation where there's a fiscal freakout, then the term premium blows out. We saw that in the UK when short-lived Prime Minister Liz Truss put out her ill-fated budget and the markets just rejected it like an organ recipient rejecting a donated organ.
Speaker 1:Dramatic analogy there, john, yeah, sorry gross analogy there.
Speaker 2:That's what happened and so there was real heartburn around that kind of period of time. But the sense is here that there are some recriminations. There are some economists and market participants that think that the Treasury was sort of derelict over the zero interest rate era of not extending the duration of its holdings, not locking in mortgage rates, locking in that low rate. They could have done that by extending duration out and issuing like 30. You saw Austria issued a 100-year bond. Didn't we flirt with 50? They did.
Speaker 2:And the sense really is I'm sort of biased in favor of Treasury. It's not really fair to hold them to the same standard that you hold other monetary and fiscal authorities to because they set the world benchmark. You can't go off and do these flyers like throw a 100-year bond in there because it ends up whipping the yield curve around. You need predictability and stability. Of all markets, this is the most paramount one for predictability, stability and gradualist changes. The Treasury I'm springing to their defense. I don't think that they were derelict in their duty of not extending. It's not as easy as it's. It's easier said than done. I think is proud.
Speaker 3:But it is an important point because some Wall Street people criticize because their goal is to make money. The Treasury's goal is not fully to make money. A bank can't just not have one-month bills be issued. The entire financial system falls apart. So there are reasons why the Treasury does these things that are completely driven by maximizing the profits.
Speaker 1:Yeah, I think it's also important to note that the CBO's projections only take into account legislation that has been passed.
Speaker 1:When we think about the 2024 elections and we think about 2025, when all of these individual tax cuts expire there could be significant fiscal impact coming down the pike, even if we're not talking about new spending or new big government programs. Neither political party seems to have the appetite for that. When you just look at keeping things the way that they are right now, those individual tax cuts are not included in the budget calculations that CBO and other forecasters put out. If you were to make them permanent, I think that would be something like another, or even extend them for another 10 years. That's something like another $2 trillion. So there could be a pretty outsize fiscal impact, even though we wouldn't necessarily consider it an economic stimulus, because nothing is really changing except in the world of fuzzy math of Washington, so there's more debt to come. I can't see any significant lever that either party would be able to pull in order to offset the cost of keeping those individual tax cuts.
Speaker 2:Yeah, I'm not an expert, but honestly, the idea that Getting the tax code I think there's plenty of arrows and slings to be flung at the tax code and how suboptimal it is in lots of ways. But I'm sympathetic to the view that you just can't tax your way out of this and the simple answer is entitlement reform. But it's a third rail in politics so you have to find some sort of political equation where a leader, a president, is ready to touch that third rail and really make a hard decision and essentially try to communicate with the country and marshal a bipartisan approach where they all hold hands and jump off the cliff together. It seems in this particular partisan environment it seems very far-fetched. But hey, I mean weirder things have happened. We had this partisan, poisonous environment on Capitol Hill and they got a lot of bipartisan bills done in the early part of Biden's first term. So it's certainly not impossible.
Speaker 1:Yeah, you can't tax your way out of it and you also can't spend your way out of it, in the sense that additional federal spending will result in economic growth. So you're kind of stuck, I feel like.
Speaker 2:Besides, all you can do is just issue more debt and I hope Arthur Laffer isn't listening to this His cocktail napkin Laffer curve. I mean it's a. I think the you know the tax cuts will pay for itself is. I mean, that's still. That still plays in some political corners, but it's basically just. Everybody realizes that that's just politics, not economics.
Speaker 1:Secretary, secretary Janet Yellen, was on the Hill talking about fiscal and financial stability. You know there's been a lot of officials who have said that the nation's debt is on an unsustainable path, but, as you were mentioning, john, there's not a lot of political will to do anything about it. But another thing that she called out during her testimony was the possibility of commercial real estate stresses and how that could potentially be a crack in the foundation of the economy right now. Brendan, what do you? You've been, you've been looking at this a lot. What do you think about that?
Speaker 3:Yeah, it's definitely a huge, huge issue. I mean one, the higher rates are clearly not great for commercial real estate. It's a load, you know, but but that's unfortunately not the what's driving the issues for commercial real estate, it's the work from home. So, you know, a lot of companies are still having keeping office space, but they're they're shrinking it. A great example is, ironically, fannie Mae, which is involved in all this stuff. They sold their office, which is kind of farther uptown in the kind of the residential area of DC, and they sold it for a lot of money. And then also someone did a big development up there and then they moved downtown, kind of close to our office, and took a huge amount. I think it's a hundred thousand square feet, and they've just announced that they're trying to, not until you get out of it, but sublet it because they just don't need that amount of space. And even, I guess even more ironically, the, the guys that built up there, the, the, the corner tenant there also is trying to shrink his space. So companies just don't need the, the space that they, they used to, which leaves a huge amount of office space in in, you know, downtown areas, the, the other part of commercial real estate. You know, in the suburbs, you know strip malls and things like that. They're all doing quite well, but it's the, it's the. You know the big office space that's going.
Speaker 3:And the unfortunate part about this whole situation is it's hard to turn an office building into a residential building, especially the newer builds, because of air conditioning, heating and and plumbing. They're just, they're built totally different. So there's not like a really easy solution to this. The other problem that has to worry Yellen and all policy makers is, you know, pension funds and insurance companies. Life insurance companies are big holders of of. You know commercial real estate because of the long term in the past, you know good returns on that. So it's kind of a it's a slow moving train wreck because the companies are still doing well, they're paying their rent, they're paying the rent to the lease rolls off and then they they find a smaller and a lot of times nicer office building. But you know smaller office space and there's really, you know lower rates will help because you, a new developer, can come in and try to, you know, do things. But it doesn't solve the problem.
Speaker 3:Yeah is we've kind of changed the way we work. People are coming back, you know, and I think the labor market's becoming a little tighter in the white-collar jobs. Blue-collar jobs and service sector are still kind of booming and doing quite well. But the white-collar jobs, we're seeing more and more announcements of layoffs. So you know, the management definitely is. You're seeing more and more people calling people back. But I think the kind of Friday's work at home is maybe becoming a norm From here and flexible working hours. So your average company just doesn't need as much space. So I don't know what the solution is, and it might be in the end a government bailout. It's usually where we end, right, john?
Speaker 2:Yeah, well, I mean, that's the impulse, right?
Speaker 2:I mean, ever since the global financial crisis, the impulse has been to, you know, for the markets to, whenever there's a hiccup, whenever there's a problem, to have policymakers ride in and put the safety nets in place. It's Fed rate cuts and that sort of thing. You see those flickers in the market with New York Community Bank, core and stuff like that, where immediately, as soon as there's a problem in commercial real estate and as soon as there's a problem in a regional bank and we saw this around the Silicon Valley Bank episode as well immediately the market defaults to the Fed's going to cut rates, Because that's what they've done always in the past and in this particular circumstance. Just, the context is completely different. In the past, in most of the post-global financial crisis era, interest rates could be moved around in response to some of these issues. Flashback to 2019, when the economy was doing basically fine and Chair Powell was cutting interest rates because he was worried about a trade war with China that the President Trump started, and that's the kind of logic.
Speaker 3:And the market had really started to price. In a recession, there's a lot of fear in the streets.
Speaker 2:You're kind of walking around and everyone's doing quite fine, yeah, and that was essentially the why not cut because you had interest rates.
Speaker 3:We were what? Almost 4% then when Powell started to kind of slash them down right.
Speaker 2:No, he was only 2.5%, like they'd gotten to. Oh, we were only at 2.5%, you're right, yeah, yeah, yeah. They'd gone into late 2018 and he'd said in October we're nowhere near neutral. And the markets were like what?
Speaker 2:We thought you were done, and then he gave you one last rate hike in December and markets fell out of bed. And then it was. I remember being on the phone with you, brent, at the time, and after he hiked rates and markets spiraled downwards. I remember saying that Chair Powell is never, ever, ever, ever, ever, ever, ever, going to hike rates, ever again, ever. And I was wrong.
Speaker 3:but Well, it took a global pandemic to make you the consequences of a global pandemic.
Speaker 1:This is a little bit of a side note, but, brendan, I just couldn't help it. Take a trip down memory lane when you mentioned Fannie Mae pulling out of that building. But that building that Fannie Mae and that developer had built was in the spot where the old Washington Post building used to be.
Speaker 3:Yeah, it's a beautiful building.
Speaker 1:Well, the building now was not beautiful when the Washington Post was there.
Speaker 2:I'll tell you that much.
Speaker 1:It was all the president's men era. I think there were probably still newspapers stacked up in people's offices from the back in the 70s. So it was sad when the building was sold and the Post moved and it left the hands of the grand family. But what they put in its place is really quite lovely. So it's a little bit of a heartache to see the empty of the year.
Speaker 3:The basement is now a huge Wegman's.
Speaker 1:Really. Yeah, I had no idea. Well, the Post pub is still there. That's what's most important. It's still across the street.
Speaker 2:Yeah, that's the key.
Speaker 1:You can still get chicken tenders and a beer and a dive bar. Yeah.
Speaker 3:It's down in the pandemic, but it reopened Just back to interest rates.
Speaker 2:I mean, as Brendan said, there's just no way that the Fed is going to cut interest rates to the extent that commercial yeah, it's not going to be the savior of commercial real estate. Let's face it.
Speaker 3:We would have, I mean going back to zero, where you could. You know you could have cap rates so low, might you know it won't save it, but it would help. But we're not doing that it's not happening.
Speaker 2:Yeah, we're going to get inflation data next week for the US and we've just seen this barrage of communications since the late January Fed meeting with Fed Chair Powell just reiterating again and again and just official after Fed official coming out and saying we are not in a hurry, we are cautious on rate cuts. The markets are beginning to get the message, obviously reinforced by solid US economic data, but the expectations at the end of December, expectations for a rate cut in March, were like 90%. Now that it's like under 20%.
Speaker 2:That's a big move and now still it's 125 basis points of full year cuts are priced in, but the bias is toward less and that shows that the market is beginning to get the message here and you can see that the inflationary impulses will get a closer read on that. And the Fed. The mantra has been we just don't have enough information and there's a lot of talk about how this last mile of the inflation fight is probably the hardest one. The year-on-year comparisons aren't as favorable, and so forth. Energy prices are sticky.
Speaker 2:Some of the countermeasures against energy price increases in Europe are rolling off and so there's a tendency to and you look at some of the earnings that came out. We saw PepsiCo come out this morning and their average price increase for the fourth quarter was 9% for their snacks and stuff and they lost part of the reason the stock is down is because they missed on sales. Because of that, because consumers can only stomach so much. Mcdonald's maybe is in their earnings earlier this week Showed that very similar kind of hey, we topped profit estimates but we missed our sales targets. And the idea is essentially, if a Big Mac meal is 18 bucks, maybe grill it home. They're high prices.
Speaker 1:Yeah, I mean, I guess are we starting to see the consumer pressure on these companies bring down prices? Will that be a disinflationary force? I feel like for so much of 2022, really, prices were moving higher, but folks seem to still be able to stomach it. As you were saying, they were still pulling out their wallets and now have we reached that ceiling.
Speaker 3:Yeah, I think we've come to that equilibrium where, because prices went up about 15% overall and that was because the prices and the pandemic, everything it reset, so now inflation prices on a monthly basis and also a yearly basis have kind of normalized back down to that, probably around 2%. But most importantly, the price of everything you buy today is still 15% higher than it was before the pandemic and that still annoys the consumer and I think the consumer is just not willing to take anymore. So that's what I think we're seeing play out on a day-to-day basis that the consumer now is pushing back and not accepting these higher prices and has also figured out how to, as John said, kind of replace with a lower item, eat at home or just not buy it. So that we're seeing that play out in real time and I think that's a good thing. That's how supply and demand works.
Speaker 2:Greedflation is how it has been spun in the political circles. But guess what? If you're in a period where companies are beginning to raise prices, what's management going to do? They're going to try to raise prices as much as they possibly can.
Speaker 1:Until people stop buying.
Speaker 2:This is exactly what you would begin to see. You would begin to see a demand. You see this in oil price, oil markets all the time. You begin to see demand destruction and then they realize, okay, price increases may have gone too far, now we have to try to increase profits by bumping up sales. And so you make the, you know, put a lid on prices, make a few deals better, and that sort of stuff.
Speaker 3:The pendulum swings the other way A perfect example of this whole thing is Boeing, which encapsulates. You know, trying to raise your own prices, and also the battle between labor and management, where Boeing's got their own issues. You know doors flying off, but they still have to sell their. You know their buses, but now the their workers are demanding a 60% pay increase. I don't know that they're going to get 60%, but it seems like they're going to get something. So say it's 20%. Boeing is not going to be able to just charge 20% more for their planes. You know people say no, we're going to Airbus, so that's just going to eat into. You know their margins, which is the solution too. You know, if you can't raise prices, you just make less money, and there is that valve too. So that's playing out in real time. So and we're seeing that in, as John said, the quarterly earnings for all our companies.
Speaker 1:Yeah, so companies are getting hit as workers demand higher wages and they're also getting hit from the same interest rate pressures.
Speaker 1:that we talked about that the US government is facing. Are you guys worried at all about corporate debt? I saw a report from Goldman Sachs I think this came out last fall but basically it was warning that something like you know, 15% of corporate debt is going to mature over the next two years in an environment where interest rates are going to be higher for longer, and that that's that's going to have an impact on how much is left over to spend on, you know, investment, to spend on capital, capital expenditures, spend on workers, on salaries.
Speaker 3:So I think that's what's always kind of worried John and I in terms of the economy, because so much of the news is focused on the consumer. But consumer debt is basically almost 80% is fixed rate and most people have already locked it in. So it's your mortgage rates, your car loan, and then you know your credit card bill. The rate is already set. So you know it's around 15%. So the Fed doesn't really massively affect that. The bills are set by Congress.
Speaker 3:So we haven't seen higher rates haven't massively affected the average consumer, the new consumer, if you're buying a new house, things like that. But that's, you know, at the margin, because so many people you know aren't moving because they have that low mortgage. But it 100% affects and small businesses, everybody. And that is just starting to be we're just starting to see that because you borrow at generally two to three year time horizon. So those are starting to roll off and you're having to now, as a company or small business, borrow at these higher rates and I think that's where, if we're gonna see a slowdown in economy, that's where the slowdown is gonna be driven. It's not gonna be driven by the consumer.
Speaker 1:Is there any chance that they're gonna get lucky and that by the time they need to refinance essentially or roll over their debt, that the Fed will have cut?
Speaker 3:And that they're actually in a that's what the I mean that's what maybe they're hoping for.
Speaker 3:No, that's what every treasurer in America is trying to play that waiting game. Borrow as late as you possibly can, because the Fed has promised you some lower rates and the market also. More importantly, it has priced some of those cuts in. So the first cut probably won't massively change overall rates. It'll have already been priced in. But I don't think that the Fed is gonna deliver as many rate cuts in the next, say, 12 months as the market is priced in. The market's actually quite terrible at predicting Fed. The Fed forecast isn't even great for what they actually end up doing and what the Fed does isn't necessarily perfect, but it is what the Fed does. And the market's always way too optimistic on what the Fed is going to do, whether it's in an expansionary term and how much they hike, and but more importantly, in times of cuts the market always prices in is way too optimistic on those assumptions.
Speaker 1:It's almost like a wish list as opposed to, of course, ask the house.
Speaker 3:So it's funny because we always talk about what the market has priced in, but you just have to look at a chart from the last 30 years. The market's actually very terrible at pricing in what's gonna actually end up happening.
Speaker 1:Well, that's certainly a lot to digest and a lot to discuss. What is on the agenda over the next week? Anything else that could be important and that we should be keeping our eye on?
Speaker 2:Yeah, a lot of economic data. So we've got the USCPI next week. We also have industrial production and retail sales, and so these are important data points to give us some signposts for Fed policy overseas. Similar kind of cavalcade of economic data EU industrial production and economic sentiment gauges, uk GDP. It's a lot of. It really is a lot of the meat and potatoes of global economy and growth pillars. Peak earning season is pretty much over. It's been kind of a mixed bag but basically because of essentially like the five of the or I guess, four of the magnificent seven, kind of impressed. Yeah, that's kind of the big swing factor. You got really good, really good from Metta in particular and Amazon, even though some of the others were a little bit squishier, and Tesla has been an outlier. A real dog.
Speaker 3:The company that was most fascinated me this earnings season was AMD. You know it's a pretty good size chip maker and the stock is up a hundred percent. You know the kind of stuff you don't normally see, and so much of that is driven by the demand for their chips, with all the AI demand that is going through the world right now.
Speaker 2:Yeah, that's still been a huge part of, you know, the buoyancy of stocks and the big theme of earning season. But you know this, under the radar, consumer credit I mean the consumer companies that you know, as we said, have shown a little bit of nuance here, and Coca-Cola and Kraft Heinz are coming in next week to maybe give us a little more data points on that front.
Speaker 1:Great. Lots more signals from the consumer still to come. Guys, that does it for us today. Thanks for listening to the macrocast. I'm Elan Mui with Penta. Thanks to my co-hosts, Renzin and John, of Markets Policy Partners. We hope you all enjoyed our show. Thanks for listening and remember that you can always subscribe to the macrocast wherever you get your podcasts. Have a great day, енно.