Morgan Stanley's Jim Caron Talks CPI Report, Fed

**SPEAKER_1** (0:02)
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**Tom Keene** (0:07)
Our interview of the day on fixed income, James Caron. Jim Caron joins us with Morgan Stanley, CIO, Cross Asset Solutions. Jim, you know I love your note where you review nominal GDP.
When you talk to your accountants, your economists, excuse me, when you talk to your economists, do you see a sustained nominal GDP? Or can it come down from the 5% level?

**Jim Caron** (0:32)
Oh, good morning, Tom and Paul. Listen, you know, nominal GDP is really, if I'm talking to my accountant, he sees only nominal dollars, right? We all get paid in nominal dollars, right? So what we observe in the world is a nominal world. We don't observe, like we don't get paid in real dollars. So, you know, the fact that nominal GDP, first quarter of this year was running at 6%, which is significantly above the average over the last, you know, many years, which was closer to four. And in the second quarter, nominal GDP, if you look at the GDP deflator, nominal GDP was running closer to 7.9%.
If you use PCE as your inflation measure, it's closer to 6.5%.
But the point here, Tom, is that if you're in a higher nominal GDP world, you tend to get higher earnings. No surprise there, we can take a look and see what's going on with second quarter earnings and even with first quarter earnings. And that's the kind of connection that we should draw. So when I talk about higher nominal GDP, think about that as higher equity earnings and earnings per growth and earnings per share growth.

**Paul Sweeney** (1:39)
So Jim, how does our Federal Reserve adapt to this type of economic environment and growth environment?

**Jim Caron** (1:47)
Well, I mean, part of this is the inflation element to it.
So nominal GDP is real growth plus the inflation. So what's driving the higher nominal GDP is that we are living in a higher inflation world somewhere around 2.5%, 3%. Let's say, I guess we'll find out more on Wednesday.
So the question is, is inflation accelerating higher? Can we sustain a 2.5% inflation to 3% for the time being until it settles back down? Yes, I don't think that that is going to be overly corrosive for the Fed. As long as they believe that inflation and inflation expectations are not becoming ingrained where it becomes something that becomes more destructive going forward. But so at this point right now, I think it's sustainable. But I guess we'll find out more on Wednesday with CPI.

**Paul Sweeney** (2:44)
How do you expect here, just kind of interest rates in general, just feels like we're higher for longer here, Jim. Is that the world you think we're in or we're going to see some moderation?

**Jim Caron** (2:55)
Yeah, I do think that we're in a higher for longer environment. So one of the correlations that you can draw and you can go back over a long period of time is nominal GDP versus the 10-year yield. Those two usually sit pretty close to each other. And I'm not calling for 10-year yields to go up significantly. I think that we're primarily in a range and we're going to go pretty much sideways into the end of the year. But the ability for rates to move down sharply right now, particularly at the back end, outside of having a recession or some really sharp slowdown in the economy, I think is somewhat limited.
Because in the environment that we're in at the current moment, it just seems that nominal growth is going to be higher, which means that it just alleviates the risk of yields moving down sharply.

**Tom Keene** (3:43)
So, Jim, the Gloom crew is going to step in and say, okay, there's all this fancy Jim Caron talk, but the question is the fiscal state we're in. How do you pull in our debt and our deficit into that ancient worry, oops, price down yields up bigly?

**Jim Caron** (4:04)
So this is a great question, Tom.
So let's connect the dots on this. So the idea is that if you have higher nominal growth, which we do, that's what pays down your deficit, right? That is the number one thing that pays down your deficit. So you're absolutely right. The deficit is too high. It's around 6% of GDP. It's been coming down. By some measures, it's slightly under 6
I'm sorry, that's the fiscal deficit, not debt to GDP. Debt to GDP is still a little bit high, depending on what metric you're using, around 120%. Now, that's likely to come down as long as you have higher nominal growth. That's what brings that down the fastest. That's what we did after World War II, right? We had yield curve control. We capped 10-year yields at 2.5%. We allowed nominal GDP to get above 6 And that's what paid down the deficit after World War II. So in some ways, we're doing something similar to that right now with higher nominal growth.