Inflation: ‘The Fed is scared’ and so are markets, economist says

Beth Ann Bovino, S&P Global Ratings Chief U.S. Economist, joins Yahoo Finance Live to discuss the outlook for the U.S. economy, Fed tightening, and how markets are weighing recession risks.

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BRIAN SOZZI: But back in the economy. From rising rates to falling stocks, it's been a wild week for both the US economy and Wall Street. Our next guest says, while the Fed's aim to bring inflation under control is necessary, it may feel like the cure is worse than the disease. Joining us now is Beth Ann Bovino, S&P Global Ratings chief US economist. Beth Ann, always nice to get some time with you. Look, it's been a wild week here for the markets, for the economy. As we look out to the rest of the June, where do you think we might see the economy heading?

BETH ANN BOVINO: Out through just this month? I mean, this month, I think things are going to hold up relatively well. We are starting to see signs that consumers are pulling back. that's not just on low end-- low income households. You're starting to see-- well, you mentioned the crash in the equity markets. That usually has an impact on the wealth effect, affecting higher income households, as well. So we expect to see that slowing down. But generally, the US momentum in the economy at this point in time will hold up. It doesn't mean it'll last forever. And that's where we're concerned going into 2023.

BRAD SMITH: Beth Ann, markets will typically price in a recession prior to it actually showing up in the economic data. But a question, particularly, is how deep of a recession might markets be trying to price in.

BETH ANN BOVINO: I would say that markets are fearful, understandably. We're talking about the Fed moving much more aggressively than that they had earlier indicated. And indeed, they came out with a 75 basis point rate hike without really pre-- without giving us any guidance beforehand. So that seems to say that the Fed's scared. And when the Fed's scared, the markets are scared, pricing in a much more aggressive Fed policy. And that means an aggressive response to a recession.

Now, whether the markets are right or wrong on the recession remains to be seen, but there's a lot of headwinds. Now we see the risk of a recession increasing rather dramatically. We had it at 35% for 2023. It looks like it's climbing higher. But the size of the recession is the real question. And given we do have buffer, both with the household balance sheets and business balance sheets, we suspect that the recession might not be as severe as markets fear right now.

BRIAN SOZZI: What is that ultimate trigger point, Beth Ann, that tips us into a recession?

BETH ANN BOVINO: Watch what the consumer does. The consumer makes up close to 70% of economic activity. We're watching them. It looks like they've blinked. And with-- and that's understandably so, when you have food and fuel making up the biggest size of the consumer basket, meaning there's not much left to spend on discretionary items. You mentioned toys. I felt bad for the children. But that might be one area that's cut. And that means that when people stop spending, the economy weakens.

I also watch as a near-term indicator what happens with the jobs front. Those initial jobless claims numbers is a leading indicator, according to our business cycle barometer. And that's something that we're keeping a sharp eye on.

BRAD SMITH: Even with his comments this morning, Fed Chair Jay Powell tossing a big question mark into today's tape. And we've seen that play out as the Dow has kind of waffled in and out of negative and positive territory. With all of this in mind, this week for the Fed in aggregate, the recession concerns that have been brought up within the conference call, this is the same committee that said inflation was transitory at the end of the day. Did Wednesday's decision and the press conference do enough to, I guess, alleviate some of the credibility concerns coming into this FOMC meeting?

BETH ANN BOVINO: I think the Fed will hopefully be able to pull back the reins and get control of the narrative. But right now, there is a lot of-- there's a lot of challenges they face. They also noted in that press conference that, indeed, a lot of things are out of their control. And that's true and understandable, meaning that their tool is basically interest rate policy and monetary policy, which affects the demand. They can't control the supply chain response. And that, while it's very true, it's certainly not very comforting for markets, I believe.

BRIAN SOZZI: Beth Ann, how damaging is it to consumer wealth if gas prices stay above $5 a gallon, looking out over into the-- let's say into year end?

BETH ANN BOVINO: I think that with-- on the low end of the income bracket, food is food and fuel, particularly food, which is-- I mean fuel, which is, as you mentioned, a new record high, is going to squeeze the low income households. We saw it before, is that if you look at disposable income-- again this is from 2019. It's gotten a lot worse since then. We saw that about 12% went to energy spending. For high income households, it's a lot lower. It's closer to 2%. This goes back to 2019.

But it's still about the same. It's all gone up because of these prices. That means less money for these households to spend. And that's a real squeeze. You mentioned the equity crash. We're in a bear market now. That also is a leading indicator for recessions as well if it lasts long. And right now, it feels like it will.

BRAD SMITH: Beth Ann, always great to get some of your time and really discuss what some of these macro impacts are and what everybody's navigating through right now. Beth Ann Bovino, who is the S&P Global Ratings chief US economist, thanks so much for the time. Have a great weekend.