David Gitlitz has been predicting for some time now that the economy will stay robust and that inflation’s still a problem. The bond market may be forecasting recession and falling inflation, but that’s a bet that will be proven wrong, says the chief economist for TrendMacrolytics.
A few weeks back, Gitlitz’s view looked mistaken. In late September, the yield on the 10-year Treasury dropped to under 4.6%–the lowest since February. With Fed funds at 5.25%, a 4.6% 10-year yield created an inverted yield curve in no uncertain terms. Recession, in other words, was coming, the fixed-income set predicted, and inflation was winding down.
But in the wake of yesterday’s report on consumer prices for September, investors are again wondering if inflation is still a threat. Yes, top-line CPI fell 0.5% last month, and the yield curve’s still inverted. But the 10-year’s yield has been rising of late, and so is core inflation. In fact, core CPI advanced 2.9% for the year through September–the highest in nearly a decade.
With the latest inflation report hot off the government’s press, we thought it was a timely moment to chat with Gitlitz and get the details on his latest thinking. What follows is an edited transcript of our phone conversation from late-yesterday afternoon.
Q: What’s your take on the consumer price report for September? The top-line measure of CPI fell, but CPI ex-food and energy advanced by 2.9% for the year through last month, the fastest pace since 1996.
A: The suggestion that somehow…there’s nothing to worry about [regarding inflation] is off the mark.
Q: Why?
A: Because a 2.9% annual core inflation rate…can hardly be considered benign. The top end of the Fed’s comfort zone [for core inflation] is 2.0%.
Q: We’re way above the Fed’s comfort zone.
A: That’s right. I think it’s likely to get worse before it gets better.
Q: Why?
A: Because the price pressures that are embedded in the system, as a result of the Fed being as easy as it’s been for as long as it’s been, are feeding through. Within the next year there’s a very good chance that we’ll be running something like a 3.5% core. And that’s just based on what the Fed’s already done. There’s basically nothing they can do to reverse that. The only thing they can do is get to an equilibrium posture so that they don’t continue to make it worse. And from everything we monitor, they’re still not [at equilibrium]. So we think the Fed will be raising rates.

Q: You’ve been saying for some time that you think the bond market’s been underestimating the future strength of the economy.
A: Yes. Bond yields are now running on the order of 25 basis points above where they bottomed out a few weeks ago. At that point the bond market was discounting two or more Fed rate cuts over the next year. Now they’ve cut that down to one or more. But I think even that’s still going to end up being the wrong bet. Not only is the Fed not going to cut rates, I think it’ll go back to hiking rates again sometime within the next several months.
Q: Where do you see Fed funds topping out in the current cycle?
A: Probably at something like 6%, maybe even higher, depending on how bad the data gets.
Q: To revisit a point you made, you’re convinced that a future of higher core inflation is virtually a done deal. The Fed can’t change that future because it’s a byproduct of its “easy” monetary policy of recent years. Monetary policy, in other words, takes a long time to play out, and the monetary chickens are now coming home to roost.
A: Monetary policy works with long lags. Once it’s there, once the Fed puts in the kind of inflationary impulses that’s already embedded in the system, it’s there. All you can do is wait for it to feed through the system and get to a point where you’re not continuing to feed additional impulses into the system.
Q: How concerned are you that the housing market will continue to soften and perhaps trigger a recession?
A: I’m not concerned about that at all. I think it’s a non-issue. The bond market’s bet that housing was going to be a disaster that pulled down the rest of the economy. But that’s not happening. And, frankly, I thought it was the wrong bet right from the start.
Q: Even though the yield curve is inverted? Traditionally, that’s a sign that a recession is coming. What does the inverted yield curve say to you?
A: It says that there’s a bond market bet that the economy’s going to crater, and so the Fed’s going to have to cut rates. But that isn’t going to happen. We’re going to see a steepening of the yield curve in the next several months.
Q: If the economy’s growing and continues to remain strong, that makes it easier for the Fed to raise rates.
A: Yes. In the Fed’s model, if the economy’s growing more than they expect, they regard that as an inflation risk, and that adds to the pressure to raise rates again.
Q: On the other hand, if the economy weakens, the Fed will be in a bigger bind because it’ll be tougher to raise rates under those conditions.
A: If the economy turns out to be weaker at the same time that inflation continues rising, that puts the Fed in a tough spot. Eventually, they’re going to have to choose inflation as the problem to deal with. When push comes to shove, there’s no way out for central banks on that issue. But I don’t really think that’s the way it’s going to play out; I don’t think the economy’s going to weaken much going into the fourth quarter and into next year.
Q: What are the signs that support your prediction?
A: Well, there are very few signs that don’t support it. Consumption is strong, investment is strong. I look carefully at indications of risk preference in the system. When you have signs that investors are willing to bear risk, it suggests that they see a pretty positive growth outlook. If they weren’t positive on growth, they wouldn’t be putting capital at risk, especially in high-risk instruments like junk bonds. All those signs tell me that growth expectations remain solid. When growth expectations are solid, it becomes a self-fulfilling prophecy because people do things to realize those expectations. They put capital at risk to reap the available return. That’s what creates growth. All those things tell me that the economy is chugging along nicely.
Yes, you get a number here and there that’s a little soft. But that doesn’t tell me there’s anything to worry about. We had an industrial production number earlier this week that was a little soft. But if you look beyond the headlines for that data, there’s a lot of good stuff going on within the world of industrial production. The technology sector’s growing at a very rapid pace. That’s part and parcel of the risk-preference notion that when you see that kind of activity strengthening it means that people are putting capital at risk…and you have to have pretty good expected returns to justify the investment. That tells me that the basic foundations of this economy remain very healthy.
Q: So, in your view, there’s no recession on the horizon.
A: The chance of a recession is nil based on what we see with current conditions and current indicators.


  1. Paris ib

    I agree with the yield curve steepening and the higher short term interest rates. I also agree that inflation is still a problem. What will be interesting is we can have all of the above AND a recession. And that certainly looks like a possibility right now. What happens to the USD from here on in should be watched very closely. The U.S.’s position as a country dependent on foreign capital inflows to keep thing ticking over should not be ignored. And those capital inflows are not guaranteed.

  2. Paris ib

    Steeper yield curve? Yes absolutely. Higher short term interest rates? Again yes. But while I agree with the financial market view I don’t think this necessarily will come in a non-recessionary environment. What’s missing are the U.S. external accounts, the USD and the need to attract foreign capital inflows. So what you could end up with is a repeat of the 1970s Nixon-era STAGFLATION environment. The worst of all possible worlds and the result of poor past policy choices.

  3. KP

    The gentleman foresees raising interest rates and still anticipates no coming trouble for the housing market? How is this logical? There are plenty of risky ARMs that are going to be reseting in the coming years. Do higher interest rates not put pressure on these mortgages? This will affect everyone, to what degree is completely unknown at this time. To discount it is not wise. IMHO.

  4. Glenn

    I have no idea if Mr. Gitlitz prediction will pan out, but these two thoughts came to me as I read the interview:
    1. he is associated with Don Luskin, who’s opinion I followed closely for a while until I realized it was not worthy of my time.
    2. He has a pretty definitive opinion, so time will tell definitively whether he is right or wrong…sooner rather than later I suspect…then we’ll know if he has an opinion worth hearing.

  5. kharris

    In a world full of economists, why does a guy whose story is basically “the Fed is wrong because I say so” deserve this much attention? Back in July, he insisted the Fed had to hike one more time. Next week’s FOMC meeting will be another occasion on which his view doesn’t pan out.
    There is also a real lack of anything that looks like serious economic thinking in his comments. More trader speak than analysis. The Fed anticipates higher inflation at the end of the cycle, with lags suggesting better inflation news some quarters after policy turns neutral or slightly tight. This guys comments do not address this central feature of Fed thinking, insisting instead that today’s data and his own views of the future are more important.
    The Fed under Greenspan routinely stopped hiking rates before inflation peaked, and inflation under Greenspan was routinely lower at any given point in the business cycle than at a similar point in the prior cycle. This guy insists that the Fed has to keep hiking because core inflation hasn’t peaked. No apparent sense of monetary policy history.
    He admits to specific recent bad news (two months of weak industrial production data, not one) buts invokes vague “good stuff” on the way to ignoring the bad news.
    I think there is room for a diversity of views in this business, but there are lots of people out there doing good work. I don’t see any real substance here. Why bother?

  6. Jim Picerno

    The world is definitely “full of economists.” Over time, readers will find that The Capital Spectator interviews and quotes a wide spectrum of dismal scientists without regard to outlook, politics, race, age, hair color or shoe size.
    The dirty little secret of this web site is that on any given day we reserve the right to seek out those economists who, for one reason or another, intrigue us. Sometimes those economists will echo the mainstream, sometimes they won’t.
    Readers, as a result, may find our editorial inclinations agreeable or not. So be it. At least they’re free to post a comment (within reason) to that effect.
    We may or may not agree with the people we quote, but we’ll continue to highlight people with interesting and/or provocative analyses and thoughts. In a world where a sea of ideas is uncorked every day on the web, and virtually everyone has access to posting their views to a global audience, we feel no compulsion to feed and nurture anyone’s agenda other than our own.
    In any case, thanks to everyone for reading. Let the debate continue. Somewhere along the way we hope to stumble upon the truth every now and again.

  7. Tinxx

    The most pertinent part of this interview is the focus upon the risk appetite and investment as a driver of growth going forward. The Bond market may or may not be right to fret about the housing market – but it does seem to be a case of the bond markets constantly trying to find a cause for their preconceived view of impending recession every time. There are plenty of economists out there who have been calling for a slowdown for so long that it is embarassing. When the housing “bubble” doesn’t burst the economy, the default position for the bond bears will be the “unsustainable” current account as a reason for collapse. The Fed knows that rising core inflation is a problem that it needs to address. The difference is that it doesn’t have the same time frame in mind to reduce it as the market likes to think. Rates are not going to be cut because the bond market want them to be – rates will only be cut in the face of a very sharp reversal in growth and on current evidence that isn’t going to happen. Similarly, rates will only rise significantly from here against the backdrop of sharply higher core inflation or a rapid expansion in growth that threatens that. Absent either extreme, the Fed will look at the behaviour of core inflation over the next year or so before rushing to judgement… well that is my take on it anyway.

  8. kharris

    Your response was a non-response. I don’t care whether the guy is right or left. I don’t care whether he echos the mainstream. I don’t care about any of the other hokey shoe-size stuff. You claim to offer “people with interesting and/or provocative analyses and thoughts.” My entire objection was that this guy doesn’t qualify. If he thinks the future is sunny, fine, buy based on what, for goodness sakes?
    In science, there is the notion of “falsifiability”. Any assertion should be able to be falsified – proven wrong – if it is in fact not supported by data. One form of bad science is scienced that cannot be shown to be wrong, no matter how the data develop. Investment is strong, he says. Compared to what? To when? This ain’t science. It also ain’t economics.

  9. Jim Picerno

    Thanks for your kind response to my “non-response.” I’m encouraged that The Capital Spectator continues to warrant your attention.
    As to your last comment, it’s worth reminding that this is not an academic journal, nor is it an on-line classroom. As a result, I don’t require sources to prove their assumptions or predictions or send me copies of their models. In fact, I pretty much let sources say anything they want, as long as it’s related to the topic at hand. Such is the reporter’s life. In a perfect world, I’d have my staff of research assistants fact check the comments. Alas, the staff here at the world headquarters of The Capital Spectator is populated by exactly one.
    As readers may have guessed at this point, CS is not a formal journalistic enterprise (I already enjoy that experience at a dead-tree publication). Rather, this is a more relaxed effort to opine and otherwise highlight sources and ideas that have crossed my path in my day job as a journalist. That’s how it is, and that’s how it shall be; no apologies will be forthcoming.
    Meanwhile, blogs shouldn’t be confused with The Wall Street Journal, The Quarterly Journal of Economics or Katie’s evening news show. Accordingly, the interviews here will vary widely (we emphasize “widely”) in depth, focus and content. This, in short, is a web site dispensing an uneven mix of content (along with a “hokey” comment along the way). That, as they say, is the nature of the beast.
    To the extent that anyone interviewed here doesn’t offer a full and complete argument in support of their commentary, the fault lies exclusively on the shoulders of the CS staff. That said, having read dozens of Gitlitz’s research reports in recent years, I believe he’s an informed thinker on matters economic. And since he’s espoused a somewhat contrarian bullish outlook on the economy for some time, I was inspired to give him a call and hopefully learn a bit more. It’s as simple as that. Yes, I had many more questions, and he no doubt had many more answers. But the time ran out, as it always does. There’ll be that many more questions to ask the next time.

  10. kharris

    There are two ways exchanges such as ours can go. They can be substantive, or not. I didn’t ask for the WSJ. I didn’t ask for a classroom. Tossing nonsense like that into your response is suggestive of the non-substantive class of exchange. Your comment that you let contributors say pretty much what they want is similarly suggestive of a standard that does not require substance.
    Many of the sites to which you link maintain higher standards, some higher by far. I recommend such standards to you. The internet doesn’t need one more website pretending to offer insight into financial markets. The Capital Spectator will no longer warrent my attention.

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