S&P Global Inc. (SPGI) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to today's webinar, Inflation and Rates in U.S. Banks, Oh My! My name is Maureen McKenna, Senior Product Manager for Commercial Banks at S&P Global Market Intelligence. We're excited to have this opportunity to discuss the current economic environment in the U.S. with Nathan and Beth Ann, particularly given that inflation is at a 40-year high. But before we get started, I have just a few housekeeping items to cover. First, feel free to ask questions, submit questions through the Q&A widget at the bottom of your screen. You can do that throughout the presentation or during the Q&A portion of the webcast at the end. I also wanted to point out the related content widget, where you'll find more information on S&P's products and services. As I mentioned, we're excited to have Beth Ann Bovino, Chief U.S. Economist with S&P Global Ratings joining us today. And in the related content widget, you'll find a research piece on the yield curve and recession risk that she wrote last week. So check that out. We also have more information on our Ratings Direct product, which is all of the S&P ratings content for global issuers can now be found in Ratings direct on the Market Intelligence Capital IQ Pro platform. So if you're interested in learning more about subscribing to Ratings Direct, you can find information in the related content widget. There's also a survey widget. We kindly ask you to take a few minutes to complete the short evaluation at the end. We value your feedback and appreciate you taking the time to fill out the survey. Lastly, the recorded version of today's webinar will be available shortly after the webcast. So we encourage you to share it with your colleagues. I also wanted to remind you about our upcoming Community Bankers Conference taking place next week. Our Community Bankers Conference is our annual event where we gather community bank executives, investors, technology providers and other industry participants to discuss the most strategic issues facing community banks. So we hope to see some of you all there. Before I begin, please note that the activities of S&P Global Market Intelligence are independent and separate from S&P Global Ratings. S&P Global Ratings maintains a separation of analytical and commercial activities. Now I'd like to introduce Nathan Stovall, principal research analyst for U.S. commercial banks here at S&P Global Market Intelligence, who will lead us in this discussion today with Beth Ann Bovino, Chief U.S. Economist at S&P Global Ratings. Nathan has been covering the bank industry for 17 years. So he keeps the pulse notes -- is aware of the pulse that's going on in the industry. Be sure to check out his podcast and blog, Street Talk, where he talks with prominent experts in the banking industry on topics such as balance sheet strategy, interest rates, the economic environment, M&A, technology and more. Nathan, I'll turn things over to you.

Thanks, Maureen, and thank everyone for joining us today for the webinar. What is also serving as live episode of The Street Talk broadcast. We're going to talk about the outlook for the economy, inflation in U.S. consumer, the labor market, and what all those factors can mean for actions by the Fed in rates in general. Joining me today is a great guest. Second time we've done this, S&P Global Ratings U.S. Chief Economist, Beth Ann Bovino. Beth Ann, thank you for being here.

Nice to be here.

I have lots of questions for Beth Ann, but people who are here with us today can also submit questions through the Q&A, which you'll see on your screen, and I'll keep an eye out for those. But I'm going to jump right in and start off talking about the first quarter GDP print that we saw. Beth Ann, it surprised to the downside and got some headlines. Do you think that, that number was concerning or any way change your outlook for the economy?

Well, there's no -- I'm never happy to see a GDP number that basically says that the U.S. economy shrunk in size. That's not good news. I do want to say, though, and I'll give you an example of what that does to our forecast. If we held everything for the following quarters, the same, that 1.4% drop for the fourth quarter shaves off about 70 basis points off of growth for the year. We have -- we had a 3.2% forecast for 2022. Now it's just with that number, it's now about 2.5%. That really hurts. However, I do want to point out some caveats and why that doesn't necessarily change our forecast just yet. One thing is that what really drove the drop was inventories as well as trade. The domestic side of the equation was holding up really well, consumers got out and spent. And businesses invested. In fact, we saw equipment spending in double-digit territory, suggesting that the production levels and activity was holding relatively well. Finally, I also want to note that trade reading, the reason why it was so weak as people were sitting on so much money and the dollar was strong. We bought a lot of stuff abroad. That was another factor at play. And the last thing I do want to mention is inventories. We think that the inventories is not because businesses don't want to fill up their shelves, I think a lot of that is tied to supply chain disruptions, which has been an occurring problem, and that's an issue, but it doesn't mean that business is -- decided to shut their cheque books at this point in time.

So if you could somehow normalize activity, let's say, take out supply chain issues and sort of look at it. The other reads that you saw in there, the other indicators continue to see underlying strength it would necessarily alter your view of where the economy stands. Is that kind of a fair way to think about it?

That report on its own would not necessarily change my position. Of course, a lot of things have happened since then. So -- and that takes us forward to what the Fed does and many other things. But that report on its own wouldn't necessarily change our forecast. Indeed, seeing that the domestic side was still healthy, we saw that as a positive.

So while the headline number came down, we continued to see elevated inflation just continues to rise sort of print after print. The U.S. is a consumer-driven economy. And from the bank standpoint, we often look at it, consumer activity is a harbinger of loan growth. It didn't sound like you already addressed this a little bit, but has elevated inflation impacted consumer spending or really bled into consumer sentiment thus far?

Well, let's take a step back and think about where -- I only touched on it, but let's take a step back and see where the economy is and why it does look like the momentum in the United States is still holding up, and then we will get to consumer spending as well. Think about the jobs report that just came out. Over 400,000 jobs were gained for the month. And if you take it back for a year, the United States has averaged about 400,000 job gains per month as well. That's a positive piece of news. We know that wages are climbing. We're certainly not keeping up with those in those inflation ratings. But at least we know it's a strong jobs market for households and people are getting paychecks. Finally, I also want to point out another reason why consumers are still able to spend. They're sitting on a lot of cash for a number of reasons. One of the -- a couple of reasons is, one, the quarantine. People didn't go out. Discretionary spending was basically -- wasn't spent, so it ended up in savings accounts. And that's not just for high income households. It's across most groups in the United States. That brings me to the consumer and why we do see that they continue to spend. We're looking at numbers that go out. We look at weekly numbers for the -- I guess, it's change to our sales on a weekly basis. There, you're seeing on a year-over-year basis come down but still rather healthy. And of course, we know, as you mentioned, those inflation numbers, which at 40-year high and across most products means that people aren't getting much for their money, but it does hold it for the U.S. at least at this point in time.

And you just alluded to the savings, the consumer stockpile during the pandemic. I know you've tracked that. We've kept a close eye on that, too, and the number being nearly $3 trillion -- well in excess of $2.5 trillion in terms of excess savings. It seems like that number is starting to stabilize a little bit, if not even decline a little bit. Could that be seen as kind of a good thing if we continue to draw down on the savings. How do you think about that? Is that a way to sort of provide read-through that maybe we're getting greater comfort to put cash to work, at least the consumer is.

Well, I think it's a cushion, and that's a real support for households as they get through this very painful time. We're talking about overall inflation at a 40-year high. Not to mention gasoline prices like many folks who are listening on the call is at a record high. People are really feeling the pain. And the good news is that at least at this point in time, there is cushion. We talk about overall cushion, as you mentioned. Now, it's below a 2.5 trillion. It's $25 trillion more than what we had U.S. consumer households had in 2019, but it is starting to come down. I mean we're starting to see a little bit of that being taken away, that cushion is being spent. The question is, when will people start to feel like they've gone too much into their savings and they closed their pocket book. that's when we would see this slowing down economy become much more severe and a problem that the Fed will have to face as well.

You also talked about wages rising and maybe not quite keeping up with the level of inflation that we've seen. And you've done some great work highlighting labor shortages out there and showing how the labor participation rate continues to actually decline, I think, last month and is really a multi-decade low. We certainly heard the guys we follow talking about pressure on expenses through -- including through higher labor costs. I've heard some folks go out as far to say, we're witnessing a wage spiral. And remember when we last spoke about this in December, you think that we were quite there. How do you feel about that right now in terms of the wage growth situation?

Well, I'm glad I didn't bet on it. I can tell you that. Certainly, the risk is there for a waste spiral situation. Think about what's happening here. You have -- as I think I mentioned, wage gains on a year-over-year basis are at record high, just based on the Atlanta Fed wage tracker for those of you who are interested, what's to say that it won't go higher. You have job openings based on the BLS data. near its record high, and there's a lot of demand out there for more hires. So what would keep that from climbing higher and higher, and that certainly is a concern. We were talking about that first quarter GDP report. I didn't mention some of the downside, and I did say that the domestic was falling up, that's a real positive. One of the downsides and this kind of goes to the wave story and also the inflation story is that our productivity dropped dramatically. And what that means is that, that means that the product that per every hour worked, we're getting -- the businesses are getting less and less product out of it, meaning that slowdown is certainly a concern. Back to the wage story. We would say right now, I mean, the Fed does seem to be saying that they're going to fight this, they're going to fight it hard. And I would also say one side where -- why I don't think we're quite there yet, inflation expectations still haven't become de-anchored, they are higher, and we can talk about that. This is looking at long-term inflation expectations, both on the forward rate for the 10-year, for example, which is at a 19-year high, but it still hasn't quite shot out to the roof. It's very close to where it was just a month or 2 ago. And so that's one of the reasons why we think we're not at that place. And one of the reasons why I feel it's -- still not going to bet on it, but a little bit more comfort in that wage spiral wouldn't happen. The last thing I want to mention is why we're much different than where we were in the 1970s and '80s when we had the wage spiral situation and the stagflation developing back then when team came to shut everything down. The reason why there's -- we are a bit different structurally is one thing, far less unions. That's one factor and unions and the union contracts, which climb higher in terms of wages. The other thing to note is these contracts back then had what was in an automatic inflation adjustment. Inflation went up, wages went automatically up as well. We don't have that today. And that's why while people are hurt and wages are much lower than what prices are, we only have wage built in today.

Yes. We actually just had a question coming from the audience asking about the probability of a stagflation environment developing in the next few years. And it sounds like you're not really including that any forecast you have right now based on what you said.

Well, this person, I'm sure he can he or she can reach out to me when we are in that situation and say hi. But again, let me tell you, one of the things that we look for and why we're not necessarily in the stagflation environment at this point in time. Now things can change. That is not -- we'll see what happens in 2023, where I see more risk for the U.S. economy. But the reason why I don't see it right now is if you look at the definition of stagflation, one thing, high inflation. Well, yes, check. We certainly have that with a 40-year high. You also see slowing growth, lower growth, low growth. Given the first quarter GDP reading, I can see why people are concerned, could that continue? We don't think that's the case largely because the domestic side is holding up, but I get it. The third thing we need to see is the unemployment rate climb higher. Right now, the unemployment rate is at -- I think it's at 3.5, which is basically back to precrisis levels and incredibly low. So we don't see all the 3 components. Now let's see what happens next year. And certainly, those are risks. But right now, it's not the case, in my opinion.

Another risk, people have talked a lot about lately is fears of recession and the idea that maybe the Fed is going to be worried to tighten too much. So they're fearing a recession out there, and so they're going to be hesitant to tighten because of supply chain issues, geopolitical concerns in the war Ukraine and just that maybe they're going to push us in there. And the yield curve reverted in early April and people often point to it as a recession indicator. And in my space, your bank stocks started to take further hits. Is that talks have grown. Are you worried about a recession right now? Do you -- or maybe even sort of secondly, do you put much thought into that inversion?

I don't -- the -- look, I'm a true believer of the yield curve. I think it is a strong signal. Now for whatever the reasons, and also I'd also recognize that signal, if the Fed responds to the signal, it can be reversed as we saw, I believe, in 1998, I believe, and maybe earlier and another year going back. So there is -- but I do think -- I do feel that there is a signal there, whether it's accurate -- whether it happens into fruition, it depends on what the Fed does. But in terms of what we look at and one of the reasons why we dismissed those inversions of the 10 to 2 year in April was because it was a daily inversion. I think it happened maybe 2 or 3 days of April. That is -- there's so many technical reasons why you could see an inversion. In fact, if you're looking about false positives, I believe -- and in that report that you have on the website -- in that report, I believe we had the 10 to 2-year over a certain period. I think over trying to signal at 1 year, a recession, 1 year out. I think they had 153 false positives on a daily basis. What we look at is we like to see first that it's a monthly average inversion. That's 1 thing. And we also like to see that is confirmed for the second month. That way, in my mind, that seems to be a more solid signal. And there, we also talk about it in the report shows that there's more losses in those readings. Now you talked about the recession risk. I'd say quantitatively, as we were talking about these strong numbers on a quantitative assessment, based on the yield curve, our recession tool that we look at says that the -- we're looking from the 10-year to 3 months, we're looking at maybe a 6% risk of recession, very small. But as many of these folks in the audience are certainly well aware there's a lot of uncertainty out there. You mentioned the Russia-Ukraine crisis. Could that make inflation -- could that spread to other regions making this crisis even worse. Could we see the supply chain disruptions exacerbated even more by the Russia-Ukraine crisis, pushing that on that inflation rate even higher than 40 years than the full year higher than it is. There are many factors that could go wrong We did push up our recession risk to 30% at this point in time. Just last year, it was between 5% and 10%. That's why -- that just goes to show how much uncertainty there is there. We would say also that the risk is not necessarily in the near term. Much of what we see is more in the 2023 area, largely because, particularly with policy, monetary policy, that acts with a lag and the weight from that likely will be felt in early 2023 or beyond.

And the yield curve piece, I strongly encourage listeners to look out. It was a very, very good one. Reminding me of a long hurdle-line in I've heard of that the yield curve is predicted 12 of the last 5 recessions or I might be messing up.

You got that wrong on the yield curve. Again, I got my -- I'm a card-carrying member. I think you're talking about the -- I think you're talking about the stock market, which predicted 9 out of the last 3 recessions. Maybe I'm wrong, and you and the audience can school me and put it out there on the chat room -- on the chat, if I'm wrong.

I want to shift to the Fed before we have the Q&A and specifically on what your view is of their plans for their balance sheet. I know they've come out and given some guidance of how quickly they're going to wind down. What do you have baked into your forecast sort of pace and maybe how much of a wind down can actually occur. And I ask the second part because they didn't get all the way the last time.

Yes. What is the balance sheet is $8 trillion plus? I don't remember.

Nearly $9 trillion.

Yes. huge. I would say that they -- what they've said now is that they're talking about starting off -- starting in June pretty much a broadcast earlier on. So that wasn't so much a surprise. In fact, the March FOMC meeting, the one good news about it wasn't -- I'm sorry, the May FOMC meeting, the one good news about it. A lot of that was expected. They already kind of got the information out there beforehand with a 50-point basis rate hike as well as the move that they were going to unwind. So what we're expecting, we think that they're going to start off, as they say, they're going to start off slow, I think they're starting off with half of the $95 billion a month that they plan to do. So say cut it half initially, and they move out to $95 billion. And I think they're going to stay there. Until they -- in a sense, they want to make sure that the markets don't react dramatically. They certainly don't want to throw out the baby with the [indiscernible] in other words. So I suspect they're going to hold off a little bit and basically drive the car around the block before they start to get on the highway. We're looking for, say, $95 billion a month for several months, then ratcheting up even further. But I also think that as you get closer to what they think would be what is the required reserves that are needed in order to keep this economy afloat and balanced, not just the U.S. but the rest of the world, that's where I think they're going to have -- that's where I think they're going to have to walk a very fine line. What you were talking about, I think, was in 1918 -- I was sorry, 2018 when the Feds starting to push the envelope and they found very much, unfortunately, too quickly that they went too far. I think they're going to be very cautious this time around.

Got you. And sort of building on that and before we turn to audience Q&A, how long -- when do you expect inflation to get under control? What is sort of baked in your forecast? And I don't know what we define is under control. But I mean, maybe closer to that 2% target rate that the Fed has been going for?

I would say that for the Fed -- well, first of all, the question about the Fed getting to it's a 2% target rate for that year-over-year, they're walking a fine line because as we talked about, there is a concern that the Fed could go too aggressively. And the economy, the near-term economic growth will be the cost of controlling inflation. We know this has happened. We talked about in the late '70s, early '80s, those double dips weren't any surprise when you know how aggressive Volcker was at the time. It doesn't want to go that route, but unfortunately, I think they probably they would probably the cost of the economy, the near-term economy, thinking about the near-term economy or the growth in the near-term economy for -- to control long-term inflation. Why? Because I think this is good for long-term economy going forward. What do we think the Fed is going to do? We think that, first, we think the Fed, the question is, if they go too slowly, as you had mentioned, that some people are worried about, that makes it the inflation problem even worse next year. That stagflation story that people are worried about, the Fed doesn't go fast this time around. That's what they're going to have to face most likely in 2023. So we think that the Fed, we expect it to be rather aggressive in moving in terms of interest rates, expecting a pretty significant -- we're expecting 358 basis point high back-to-back trifecta, if you will. And we're not rolling out a 75 basis point hike as well. For this year, they want to move everything forward. With that said, since policy doesn't work -- kind of works with a lag, we're not expecting the Fed to get inflation back to where they'd like it to be their target of around 2%, not until sometime in 2023. The risk, of course, is also that maybe they will overshoot, and that means where we'll get back to where they started, where the risk was low inflation back in 2019. I think no one wants that job.

Me either, but aggressive tightening, and I mean, you're painting a picture which the futures market is certainly there as well, pretty much getting back to the terminal rate that we saw last time just this year. We saw a really short period of time that we saw in the last rate hike cycle. So that's pretty aggressive. Well, I want to look at some questions that came in through the audience. I think we're sitting on a polling question to you now as well. I appreciate participation in that. But one of the questions that came in related to housing. And the question would be with higher rates -- with rising rates expected to continue do you -- at what point do you anticipate a decrease in home prices? I might ask it differently, do you think that higher rates could lead to a decrease in home prices? Is that anything that you've embedded in any of your forecast?

So what we're looking at in terms of housing demands, housing demand has suppressively held up with home prices going so incredibly high. A lot of the big reason for that is because of the lack of supply. That hasn't really changed. That story hasn't really changed too dramatically. So what I expect to see is that with the Fed raising rates aggressively, you hit it right on the nail. With our forecast for hedge fund rates being -- sorry, with the Fed being very aggressively impressive in monetary policy, particularly this year, we think the federal funds rate is going to reach around 3% by year-end. That is well above what they consider to be their exit rate. So they're overshooting that really largely to deal with inflation. So what does that mean for housing? We already know that the mortgage rates hit 33-year mortgage is now at the lowest -- the highest since 2009. That's going to certainly dampen demand, squeeze a lot of people out of the market. Those people -- it's going to question the question of affordability that was already challenged with those high prices. It's going to make a lot of that housing market much less affordable for many people who were interested beforehand. So that means -- so what that means is with demand slowing down, that's going to likely have -- likely to put a dent on home prices. We don't expect to see at this point in time to see an unraveling like we saw back in 2006, but we do expect to see home prices starting to get soft through most of this year because demand dries up. Well, sellers tell us if they want to sell, we're going to have to reduce prices to meet the contract happen. That's what we're expecting at this point in time.

And to your point on supply, a number that I've looked at is just sort of the number of units being built and looked at what the term average was pre-housing bubble and then compare it post-Great Recession. We've been underbuilding for what? About a decade. So I mean, it just -- that the lack of supply kind of keeps us from getting to a really dangerous place.

Absolutely. One of the things that we -- while look, this -- the high prices certainly squeezed and the expectation that you could see prices go lower because well demand dries up, you got to make those 2 lines crossed with supply and demand, you could expect to see home prices coming down. But to your point, because supply is so tight, that actually gives it a floor. That kind of gives it some floor for those sellers, meaning that the prices won't necessarily fall too far because isn't -- there's just not that much to live out there.

I think we have time for one more and had a question come in. You talked a few times about the Fed potentially overshooting. And I feel like I ever you alluding to that in one of your recent pieces saying that you've kind of baked in the idea that they are going to overshoot by '24. Did I remember that correctly? What is your sort of view there? Do you think that they will over tighten and slow us down too much?

Yes, I do. I think they're going to over tighten. We're looking -- well, just by the fact that we're saying that the interest rates will -- we expect pushed -- everything we expect to push everything forward to this year to get ahead of it. We're looking at the Fed funds rate get to over 3% by year-end and into 2023. We expect maybe 1 or 2 more rate hikes in 2023, that's looking at -- that's looking just a guesstimate, probably getting close to 3.5%. Now historically, that wouldn't be much of a big deal. But in these times, when now the ex -- the so-called exit rate or the neutral rate that you mentioned that the Fed likes to get to is considered to be around 21/4 to 2.5 Nobody goes for sure exactly, but say around 2.5, to me, sounds like an overshoot. We think the economy will slow, hopefully not go into a recession, which we don't have in our base case, but if they as a slow and inflation comes down as well and maybe even overshoots on the inflation aren't going too low, that means the Fed will be able to pull back some of this tightening. And that, in a way, is a good thing. Not the slowing of the economy, but the fact that they'll be able to pull back their policy because the inflation gets in line.

Great. Well, I think that's a great place for us to leave it. Beth Ann, thank you so, so much. Great insight.

Thank you.

Thanks so much, everyone. Just a quick reminder to complete the evaluation that you'll be directed to at the conclusion of the webcast. And thanks, everyone, for joining us. We look forward to seeing you all soon. That concludes today's webcast.