Despite an escalating war in Ukraine, high inflation, soaring gas prices, an economy still emerging from a pandemic and an anticipated rate hike by the Federal Reserve Bank, there are still reasons to remain optimistic about the strength of the economy in 2022.
That was the underlying message of JPMorgan Chase Managing Director and Head Economist of Commercial Banking Jim Glassman at a roundtable discussion moderated by San Diego Business Journal Editor-in-Chief George Lurie held March 16. The roundtable discussion was co-hosted by JPMorgan’s Multinational Corporations group and the World Trade Center San Diego for a meeting of area-based multinational companies.
Glassman, who served as a senior economist at the Federal Reserve Board in Washington D.C. from 1979 to 1988 and is a longstanding participant in the Federal Reserve Bank of Philadelphia Survey of Forecasters, shared insights on a broad set of issues affecting the economy including action at the Fed, inflation, pandemic recovery and the war in Ukraine.
Fed Rate Hike
The morning of the March 16 roundtable was the same day the Federal Reserve met to begin its planned roll out of quarter percent rate hikes. Glassman described the Fed action as more “moving back to the sidelines” than a move to address inflation, which he said was more caused by bottlenecks in the supply chain.
“Raising interest rates is not going to get the micro-processor chips to the auto industry, not going to clear the ports,” he said. “What they need to do is realign policy to a more sustainable economy over the next several years.”
The way to look at the rate hike is the Fed is “taking the foot off the gas, not stepping on the brakes” and there is little reason to worry the move will set the stage for recession because the economy no longer needs emergency stimulus, 0% interest rates or more asset buying at this point in the recovery, he added.
The reason he is “relatively optimistic” is that “the market agrees with the Fed that this will pass.” “Inflation expectations are still running around 2%, if you look at the TIPS (Treasury Inflation-Protected Securities) market and the nominal treasury security – where we sort of disentangle the inflation expectation,” Glassman said. “The conversation we’re having about inflation is not echoed in the market where people put their money to work.”
Glassman said the Fed is likely to continue its quarter point rate hikes until the fund rate lands somewhere in the 2-3% range, which is where the central bank thinks the rate should be when it has achieved its dual mandate of 2% inflation and maximum employment.
“What really matters to me is if they’re really good at communicating what it is they want, then it’s going to get priced into the market. And that’s exactly what’s been happening,” he said, adding that the market understands where it is going and is “already adjusting.”
What is less certain for the markets is what the Fed’s target rate for unemployment is.
“I don’t think anyone knows. My peers would have said 5%, and we’ve been below that for a while,” Glassman said, and added that Fed forecasting predicts inflation will still come down to 2% even if unemployment holds around 3.5%.
The big issue causing uncertainty around the unemployment rate is the four million people who dropped out of the labor market during the pandemic, only one million of which were due to retirement.
“If they want to rejoin the job market, that changes how much hiring needs to happen,” he said.
Glassman said pegging the inflation rate to 2% is the Fed’s greater goal than maximum employment “for good reason,” because with a specific target on inflation, markets are less nervous about possible political influence or transitions in leadership at the bank.
Impact of War
Besides the Fed rate hike, Glassman also weighed in on the other “conversation of the day” – the war in Ukraine and its implications for the near-term economy as well as the broader picture of its effect on global trade.
“Pre-Ukraine, we were thinking that this is going to be a really good year again. Maybe not as ‘boomy’ as last year but you have a lot in the pipeline that should help to keep the economy moving at an above trend pace,” Glassman said.
Before the war, the Fed was predicting the economy to grow 4-5%, and although the economy will be “rocky” from dislocations and high gas prices, economists are not “tearing up the script on 2022” because the petroleum futures markets are anticipating a “short-lived crisis.”
“If you look at petroleum prices out a year from now the market sees them coming back to 75 bucks a barrel or so,” Glassman said, adding that the futures market “makes sense” because oil is a global pool and unless Russia chooses to “turn off the taps,” that oil will be used somewhere.
“So at the end of the day, the market reaction may be a bit of an overreaction to what’s going on,” he added.
Another reason the war in Ukraine might have a limited effect on the overall economy is that in times of high gas prices, Americans tend to cut back on consumption.
“You can keep your gas bill the same it was a year ago, if you just drive 10 miles a day less,” Glassman said. “What that tells you is people have the ability to adjust to a changing environment.”
Glassman said the war in Ukraine is sad but also inspiring in the way the world and especially NATO allies have reacted to the crisis. The war is also unlikely to thwart the trend of economic globalization, he added, and shared an insight he gleaned from former German Chancellor Angela Merkel after Russia invaded Crimea in 2014.
“She said we don’t live in the Cold War era anymore. We live in a world that is becoming more increasingly interconnected, more dependent. There’s a lot of people that the internet has opened their eyes to how we live in Europe and the U.S. and Japan, and the world wants that,” Glassman said. “People who do things that might disrupt that process – that’s what she said about [Russian President Vladimir Putin] – are going to find that is going to do more damage to them than it does to this process.”
Glassman said the war in Ukraine is also unlikely to do too much damage to the economic recovery from the pandemic because of all the support from the federal government gave people. Childcare credits, expanded unemployment benefits and other programs gave households “more income that they would have had with no pandemic.”
“And the lower your income, the better you were relative to what you had,” he said. “We went out of our way to help people which is why everything’s happening faster. Which is why the national economy is back to a path it would have been on had there been no pandemic.”
Before pandemic, households were saving in the aggregate about $15 billion a month from incomes and as a result of the $7 trillion pandemic response, people were able to save much more. “We think there’s a reservoir of maybe $2 trillion of money that has not been spent,” Glassman said. “You can see it in the bank. If you look at bank deposits, it’s higher by $2 trillion.”
Although some of that savings will be absorbed by higher energy bills, Glassman said consumers will still be in good shape this year with a “fair amount of money” to spend.
“I give Washington an A-plus for how they responded to this crisis, and what’s really ironic about that it that we are probably more polarized politically than ever before,” he added.
For businesses, Glassman said the pandemic’s “legacy” will be that it sparked another round of innovation.
“When times are good and you don’t have to worry about surviving, there’s no incentive to change how to do things. That only happens when businesses are in jeopardy of not surviving,” he said. “So in the last two years, everyone’s figuring out how to copy how to do what Amazon does to reach the customer.”
The pandemic also pointed out issues with the supply chain, which Glassman said is a result of just in time inventories and catering to the demand side of the economy. Over time, the shock to the supply chain will subside and “looking forward, settle on something a little more sustainable,” he said.
“As an economist,” he added, “[supply chain bottlenecks] “are music to my ears because we would not be having these problems if we were having a hard time getting out of the pandemic.”
Real Estate Market
Glassman said the biggest shift in the economy will be in real estate, which has seen home values go up as much as 20% a year in some markets during the pandemic because of historic low interest rates. With the Fed rate hike, he said he “wouldn’t be surprised if real estate values are flat this year.”
“When mortgage rates go from 4% to 3%, and if your income goes up 3% to 5%, what you realize is you can qualify for a loan that is almost 20% more than you did. That’s what happened across the country,” he said, adding that a downturn in real estate will not have the impact on the overall economy that the collapsing real estate market had in 2008, because that boom and bust in the real estate market was caused by loose standards in lending, and not by favorable mortgage rates.
Another reason Glassman sees the real estate market as still bringing some stability to the economy even as rates go up is that the millennials who “put off life” after the financial crisis are now coming of age and buying homes and moving around the country to newer markets in search of better home prices, which stimulates the economy as infrastructure is built to support shifts in geographic populations moves.
“At the end of the day, interest rates do matter for real estate, but it’s not the only thing,” he said. “It’s the pandemic echo and the shifting of the population flows and what’s happening to people who are starting families that’s really driving this recovery that’s going on in housing.”
Of interest to several people in the roundtable was the difficulty companies were having finding workers. Glassman pointed out that until 2008, the working-age population in the U.S. was growing by 200,000 people a month and now that number has shrunk to 25,000 to 50,000 a month.
“The reason why having so much trouble finding people is because there hasn’t been as much immigration as there used to be and our demographics are changing,” he said. “The problem is because the world is becoming more open and fluid, and if you can’t get the people here, then the work is going to go there.”
As an economist, Glassman said he looks at the labor challenge differently.
“When you look at labor pay for Americans, it’s accelerating. When you look at margins, they’re widening. They’re at all-time record highs right now and that tells you that what we may be looking at is this is an innovation moment,” he said. “When companies can innovate and their working harder to get around this stuff, they have more resources to pay workers, and this is how innovation helps workers.”