Interview: Chief Economist at Moody's Investor Service
>> earnings are likely to dominate headlines again next week, but we are getting a sleuth of important economic indicators as well. fed chairman alan greenspan is scheduled to testify before congress on november 3, just two days after the fed meeting on interest rates. joining us now with an economic preview is john lonski, chief economist at moody’s investor service. john joins us from the american stock exchange in downtown manhattan. welcome, john.
>> thank you.
>> some economists i’ve talked to say inflation pressures related to the hurricane are clearly a concern for the economy. we have big economic reports next week. which are you watching and what do you think most closely measure inflation?
>> i think the fear is regarding inflation are overblown. the truth is it’s not a bad idea to have a somewhat faster rate of core inflation and order that companies be compensated for now higher energy costs as well as earlier runups by industrial materials costs.
>> so you’re―so you’re saying a limited rise in inflation can actually benefit profitability?
>> oh, most definitely.
>> how can that be?
>> oh, because it allows final product prices to grow relative to cost. it widens profit margins. that’s what it does. those equity analyst that is are fearful of a higher rate of inflation, are really fearful of a runaway rate of inflation, the type of inflation we had back in the late 1970’s and maybe early 1980’s. and i think that’s quite unlikely to happen. if inflation was really becoming such a problem for the u.s. economy, we would look at sharply higher treasury bond yields and that’s simply not the case.
>> so where do you see inflation heading? are we going to see companies increasingly passing on higher costs to the consumers?
>> to a limited degree. we think the core rate of inflation that was understated at only 2% in september perhaps will peak at a range of 2.5% to 3% in 2006. and i might add that when we last had more corporate credit rating upgrades than downgrades, we had a core rate of inflation of 2.8%. thus far in the current recovery we have a lower average rate of core c.p.i. inflation, and with that we still have more corporate credit rating downgrades and upgrades. it’s that inability for companies to more fully pass on cost that explains the lagging performance of corporate credit.
>> now, john, we’re getting closer to the fed decision on november 1. the general consensus among economists for another 25 basis points rate hike, do you think the fed might be overshooting there?
>> i think we’re quickly approaching neutrality as far as monetary policy is concerned.
>> what do you call neutrality? why do you say that?
>> if in 2006 nominal g.d.p. rose as expected by 5.7% in core inflation is no higher than that range of 2.5% to 3%, then 4.5% ought to be the peak for fed funds. that’s where neutrality lies.
>> ok. so you’re saying neutrality is at 4.5%. do you think that’s where the fed will pause?
>> i believe so at this point in time unless the fed is compelled to tighten more aggressively because of a rise in inflation risk that forces not only treasury yields sharply higher but significantly weakens the dollar exchange rate. remember, like never before, the u.s. economy depends on foreign credit and if foreign creditors get frightened about a runaway inflation, you can be sure that will hurt both bonds and the dollar.
>> let me ask you this. earnings are strong. oil is down. but we don’t see any rally in the market . are we having a scenario where the fed is actually beating earnings? that is to say are investors waiting for the fed to be done with raising rates?
>> i think that’s absolutely right. and i would also add that my impression is if the fed funds peaks at 4.5%, the equity market is overreacting to what remains in terms of rate hikes. but you can’t blame shareholders from becoming or taking a cautious view, being risk averse, until this latest series of fed rate hikes is finally over.
>> now let me ask you, federal greenspan is scheduled to testify a couple days after the fed’s decision, what are your expectations there?
>> i think greenspan will admit that he’s pleased with the performance of the u.s. economy. he’ll recognize that inflation risks have risen but he’ll add that inflation appears to be well contained from the perspective of most financial market participants, in particular the credit market and the foreign exchange market . therefore, the fed can continue to move towards neutrality at a measured pace. not at a pace that risks slowing the u.s. economy.
>> john, before we go, do you see a successor and who do you have as a frontrunner of successor for alan greenspan?
>> cohn, larry lindsey with an outside shot.
>> all right. john lonski, chief economist at moody’s investment service. thank you for joining us, john. up next money and sports. homecoming takes on a whole new meaning for florida college students. and, it seems, that even the people who live in chicago are not that excited for the world series.
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Listen Market briefing --- Derek (slow)
G.M. --- Brian (slow)
Market wrap --- June (slow)
>> welcome back. this is “ after the bell.” i’m derek davis. thank you for joining us. general motors said today it has a short list of possible buyers for a stake in the general motors acceptance corporation, g.m.’s finance unit. analysts say the sale may raise as much as $15 billion. rick wagoner in part two of an exclusive interview with bloomberg’s brian sullivan said g.m. is already in discussions with several companies. that would make the most sense for a strategic partnership to buy a stake in gmac. he wouldn’t identify potential buyers. brian asked wagoner about justifying job cuts at g.m. and when the sale of gmac would mean the company would be sitting on a lot of cash.
>> what we’re going to do is come up with a transaction or try to come up with a transaction that boosts gmac’s credit rating n. doing so, that’s going to help the auto business and their other businesses to grow more. we don’t know what the financial proceeds might be. we haven’t made any calls on how to use those proceeds. and so premature for me to guess how my―how it’s going to affect our relations with other parties. i just go back to say again i think u.a.w. has a clear understanding of the challenges being faced by the domestic auto industry and my sense is they’d be glad to see moves which strengthen the company. it’s good for us and them.
>> part of the plan you announced was recently future layoffs and plant closings. you make about 80 models in north america, correct?
>> right. depending on how count them but 75 to 80.
>> how do you continue to make that mod wind chill fewer plants? it would some logically some models have to go.
>> i think what we’re trying to do, a critical part of our strategy is improving manufacturing flexibility because the one thing even the last 60 days have shown us that you just can’t even with the smartest people forecasting very―in a very exacting fashion, we can’t forecast all the events that may affect demand patterns, and so we really have to build in a robust and flexible capacity. we want the capacity to be tight because excess capacity is incredibly expensive but we do have to be able to use the capacity and that means we have to be able to build at least in the whole manufacturing system the full array of products that we need to offer to competitors. so we don’t have a specific strategy to significantly reduce models. in fact, what we’re going to do is drive through a global product development process being able to keep the same number of models at a much lower cost and frankly we think shorter life cycles and better products as we proceed with that and we need to be able to build those in a flexible manner and that’s the plan we’re laying out.
>> i spoke with an analyst who described the auto industry -- not g.m. in general but ford, also, as the bad movie syndrome. that you’re sitting there and you’re hoping it gets better at some point and maybe it only gets better when it ends. is the u.s. or ford or g.m. auto industry in the middle of a bad movie syndrome?
>> i think we’re obviously in a tough time but this industry is filled around the world with ups and downs for companies. and it’s not u.s. companies alone, by the way. it’s european companies, it’s japanese companies, too. so i think we all have our better periods and our weaker periods. obviously it’s a tough, tough time for us here. i’m highly confident we’ll come back strong and get u.s. business on track and then build on some strengths we have in the rest of the world like asia. so don’t think it’s a bad movie but certainly the slot we’re in is the challenging one for us.
>> and that was bloomberg’s brian sullivan with general motors c.e.o. rick wagoner. here is a look at g.m.’s stock at the close. down over .4% or 12 cents to $28.26. stocks suffered a third straight week of losses with concern about inflation. higher interest rates and slower earnings growth pushing share prices. bloomberg’s june grasso has this week’s “market wrap.”
>> benchmark indexes have failed to sustain either advances or declines for more than one day this week. on thursday the dow and s&p 500 erased wednesday’s gains almost exactly. the dow followed a 100-point gain with a 100-point loss for the first time since march of 2004. while the s&p erased a 1.5% gain with a drop of the same size. investors have focused on the affect of energy prices on consumer spending and the strength of earnings. crude oil fell below $60 a barrel for the first time since july.
>> there has been somewhat of a pullback in that price. if we continue to see that, that will have an obvious effect on psychology and spending going into the winter. but, that said, the earnings season is coming along just fine. total earnings are up like 17% but it’s a much more modest 9%-type number.
>> but concerns continue to weigh on the market . a government report the start of the week showed the biggest jump in producer prices in 15 years leading some investors to expect faster inflation and pfizer posted weaker earnings and withdrew its forecast for next year. caterpillar and radio shack reinforced speculation that earnings growth will slow. some analysts say a bear market may develop soon.
>> we see really resumption of what happened in 2001 and 2002. we had such an overvaluation in the market and we’ve not yet seen the―what we would see the absolute lows that would have washed the bear market out.
>> thanks to the drop in oil prices this week, energy stocks tumbled, utilities also plunged, and health care companies slid. for the week, the dow is down .7%, the s&p dropped .6% putting it on course for its third weekly decline which would mark its longest retreat since march. only the nasdaq has gained .8%. back to you, derek.
>> thank you very much, june. still ahead, a view of the economy. we will preview next week’s important economic indicators with the chief economist at moody’s investor service. his name? john lonski.
