The rising interest rate environment of the first half of 2023 have many fearful recession is on the horizon, but, simultaneously, there are some indicators that inflation is beginning to subside. Curt Long, Chief Economist and Vice President of Research at NAFCU (National Association of Federally-Insured Credit Unions), shares his expectations as well as his suggestions on key economic indicators to watch for the future. 

Join us as we discuss: 

• Impacts of inflation on the auto and home markets today
• The Federal Reserve’s approach and the FIA-FIT
• Predictions and how to prepare for what is yet to come

Impacts of inflation on the auto and home markets today

If we crack the hood of today's market, we see deflationary trends in two main areas: automobiles and housing, both key players for setting the overall tone of the economy. 

The auto market has been a sizable source of inflation, and we’ve been waiting to see where the dust settles. 

“We've had three months in a row of much better numbers on the production side than what we've been getting. In June, the number was down a little bit, but still roughly in line with where we were pre-COVID,” Long says.

There may still be a deficit regarding the number of autos not produced in the last few years, but the trend is on the upswing in numbers, and production is improving. 

“Housing is a similar story. We've been waiting to see. It's sort of by construction, the way that the government statisticians develop their estimates of housing inflation, it operates at a lag,” Long shares.

Rents are starting to cool down and continue to lower, but that information takes time to work its way to the official stats. The bright side of this shift happening on a lag is that it creates certainty around the path forward for housing inflation. 

How does this affect loan-to-value?

Credit unions are more conservative with their auto lending in light of noise around a possible recession, and the inflation numbers feed into the rate outlook. 

“Some of the inflationary worries have subsided a bit,” Long says. “And some of the recessionary concerns have subsided, too. I expect rates to remain elevated for maybe a longer period, and some were concerned about that —but I don't think a recession is right on our doorstep.”

Long predicts July 2023 will be the last rate hike of the year, making for a more stabilized fourth quarter.

The Federal Reserve’s approach and the FIA-FIT

For the better part of a decade, before the COVID-19 pandemic, the United States was below the Fed's 2 percent target. Yet, there wasn't much effort to get back up to that target. Now, there's a sizable tone difference between being above the target versus right below it. 

“The Fed — they did make some measures to try to address this asymmetry. It was interesting. If they had it to do over again, they might not have done so,” Long said.

The Federal Reserve announced a change in its framework right before the pandemic. They called it FAIT (Flexible Average Inflation Targeting), and the idea was to average the inflation over a stretch of time with a payback period. 

With this model, if U.S. spends some time below the target or above the target, they must shoot to the other side of it so that, over time, it can average out.

“The obvious motivation for this was to convince people that they were recognizing and dealing with this asymmetry,” Long said. “So we're not going to spend the next decade below 2 percent, we're going to make that target over time. And of course, we all know what happened.”

Things did not go according to plan. Now that the U.S. has spent quite a while well above the Fed's 2 percent target, the natural question is: Does that mean the U.S. has to be below target for a set period of time once inflation is back under control? 

The Fed — in so many words — has implored the U.S. to forget the new model for now and start from scratch once we’re back at 2 percent. They may keep the FAIT model going forward, but Long does not believe that will cause them to feel the need to spend time under the 2 percent target.

Predictions and how to prepare for what is yet to come

Long predicted a mix of challenging and positive economic times ahead. He also encouraged the practice of “boring banking” in the frame of stability.

“When banking is good, it means it's boring. When banking is interesting, that means something's going wrong,” he said. “A lot of times — I find this in our work — we want to find the most interesting corners of the market, but sometimes those are the most dangerous corners. So, sometimes, boring is good.”

That said, the current administration has been leaning into the message that things are looking up and should be evening out in the coming year. This remains to be seen.

“Even though I think the risk of recession has receded, I do think there's a real risk of inflation coming back. Maybe next year,” Long continued. “If that happens, I suspect that's going to show up in consumer sentiment numbers, and that can be a real problem for the current administration.”

Stay tuned for new episodes every week on the Leaders in Lending Podcast.