Kyla Scanlon’s ‘Shrugflation’ Triangle

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0:09 There's all of these pain points across the economy. I think a lot of people feel like they're just, you know, a duck where they're looking okay on the surface but paddling like crazy underneath.

0:25 I'm Sarah Holder and this is The Big Take from Bloomberg News. Today on the show, the Fed voted to hold rates steady this week, despite evidence that inflation isn't slowing down. Ahead of the meeting, I sat down with the author and economic commentator, Kyla Scanlon, to unpack what she calls the shrugflation triangle and how it explains what's happening in the U.S. economy. Well, Kyla, the reason I wanted to have you on the show today is because I wanted to talk about your latest piece. We've heard about skimflation, stagflation, greedflation, shrinkflation.

1:06 Yeah.

1:07 And now you've coined this new portmanteau, shrugflation. Can you define shrugflation for me?

1:15 Yeah, so I don't know if it's exactly the right word. I mean, I wanted to capture this idea that both the AI companies and the U.S. government are are sort of shrugging at the financial conditions in the market. The ad companies were just, I mean, they still are. They're borrowing a ton of money.

1:32 The U.S.

1:32 Government is borrowing a ton of money, both of them being relatively rate insensitive. The ad companies, because they have so much money. And then the U.S. government obviously has to borrow because if there's a deficit, they have to close it. Right. And so that was sort of the idea is that we have these two really rate insensitive borrowers shrugging at the market. And that makes everyone else like the people in the economy have to carry that that burden because they're not able to shrug. Like a person who's trying to get a mortgage isn't able to shrug at higher mortgage rates. Person who's trying to borrow for an auto loan can't shrug at higher auto loan rates.

2:09 And you also talked about this kind of triangle, right? There's the AI companies, the treasury market, and oil. How do you see these three factors interacting right now in the economy?

2:24 Yeah, I mean, so part of the reason that the Federal Reserve had to hike rates in order to battle inflation was because energy has gotten so expensive due to the war in Iran. And so the three are just pretty interconnected with energy markets causing higher rates. AI and treasuries, you know, pushing rates up even more. And then we find our way back because AI companies are so reliant on energy.

2:47 So energy prices are rising, interest rates are rising. And still, as you've said, the U.S. government and AI companies keep borrowing. They're shrugging it off. I want to dig into a little bit more about why. AI companies, why are they willing to keep borrowing?

3:00 Yeah, so the AI companies feel like they have to borrow a ton of money in order to keep up, in order to beat each other, in order to beat China. So there's just this massive need to just keep building, building, building. And the companies have gotten to the point where they have, like for Google and Amazon and Meta, where they're having to borrow more and more because they can't keep pulling from their cash coffers. And so they're turning to the debt market and saying, well, we're going to borrow a There's this like massive race to kind of know where it seems to win.

3:31 So, I mean, this dynamic that you're describing seems to pose a big structural challenge, right? If big economic actors aren't like reacting rationally to economic constraints, if they're not stopping borrowing even when rates are rising, does that mean rate hikes matter less? I guess I'm wondering, can raising interest rates still cool inflation if it doesn't stop borrowing anymore?

3:54 So I had the chance to interview Chicago Fed President Austin Goolsbee, and he talked about this sort of rate hike dilemma in And the point that he made is that the Fed will have a toolkit to use if they do need to slow down AI-driven demand rate. Like they can raise rates even further and maybe that'll cool off certain parts of the economy. But I think the challenging part about the current inflationary environment is that the Fed can hike rates, but they can't really go and reopen the Strait of Hormuz. Many people have made this point.

4:31 And so that makes it very challenging as you can slow down certain parts of the economy. But if the inflationary problem is energy prices, that's really a supply story needing more energy.

4:42 I am curious about what small businesses and consumers are doing right now because you mentioned they're not able to shrug in the same way. What are you seeing?

4:54 Yeah, I mean, I think that consumers are having a pretty hard time. You know, it's funny, like a lot of people will point to consumer spending and compare that to sentiment and be like, well, you know, people are still spending, so clearly they're not that sad. And I find that to be a pretty... Pretty unfair statement.

5:13 Yeah, say more about that.

5:14 Well, I mean, just because people are spending money doesn't mean they're happy, right?

5:18 Or doesn't mean they're confident about the future.

5:20 Yeah. And so I find that to be really short-sighted. And, you know, I think we need to be like, well, OK, so what are their expectations? Like the Nobel Prize winners in economics showed us how important... expectations are. We want people to feel like they have a solid economic future. And it feels like, you know, Natasha Sarin, I believe her last name is pronounced, she wrote a really good New York Times opinion piece on the affordability crisis. And she pointed out that this is really like an economic security crisis. Like a lot of people are you know, struggling with housing and child care and elder care and grocery prices. But like, they're also really worried about none of that ever getting better.

5:57 Well, it seems to present a tricky problem for the Fed, right? Because raising interest rates is squeezing the kinds of borrowers who are actually less responsible for the kind of inflationary pressures that the Fed is trying to cool. Is there a risk that the Fed makes the economy more unequal by trying to control... I mean, I.

6:16 Think that a lot of the spending done in the economy is done by older folks. So over the age of 65, they've accumulated a ton of wealth in the economy. The Fed's conservative consumer finances came out. People over the age of 75, their wealth has gone up by like 40 percent, almost 40 percent. Under 35, it's gone down by 23 percent. And I think older folks tend to be a little more insulated from rate hikes. They usually own their home. They're usually benefiting from higher yields, right, because they're able to invest and take advantage of that.

6:49 And they're not borrowing as much. Like, they probably own their car. Right.

6:52 Maybe they've paid off their house.

6:53 Yeah, exactly. Yeah. So I think in terms of the Fed raising rates, like, what we see truly driving the economy forward— our older folks and this energy crisis, raising rates isn't going to maybe slow down older folks at the rate that we might expect, as well as it's not going to fix some of these energy problems that we have.

7:13 More from my conversation with Kyla Scanlon after the break. Well, I want to stick with higher rates and talk about how those rates are interacting with other corners of our economy, like the housing market. So the average 30-year fixed rate mortgage is about 7.3% right now. We're hearing the words deep freeze being thrown around in relation to home sales, which is never good. And higher borrowing costs can also discourage new construction, which we're seeing in the most recent housing starts numbers, which are down. So higher rates mean demand is taking a hit. New supply could be constrained.

8:01 I'm sensing another sort of vicious cycle. How worried are you about the housing market?

8:06 I mean, I think part of the problem is home sellers are sort of stuck in 2022. So a lot of them don't want to lower prices. I think that can be a bit challenging. And then, yeah, we have sort of this double crunch in the higher mortgage rates and then higher home costs. And so if you're trying to buy a house right now, it's very, very complicated.

8:24 And 85% of consumers say it's a bad time to buy a house. Over 60% of them blame interest rates, according to Umesh. And so I think there's a lot of negative sentiment about housing. And it just seems like Until we expand supply or figure out this inflationary situation so the Fed can start cutting rates, it just seems like we're going to be in a situation where the sellers are going to have to lower their prices. But that's very unpopular because housing in the U.S. is both a speculative asset and a place to live, as Derek Thompson has described it. So people want their homes to be worth a ton of money.

9:02 I also want to talk about the labor market because Fed officials can look to the relatively stable unemployment rate as an indication that there's still room to raise interest rates without causing too much pain in the labor market. But even though companies aren't necessarily firing that many people.

9:17 They're also not hiring that many. Yeah.

9:20 I mean, I think that this is a low-fire, low-hire environment. And so that makes it very difficult for younger folks that are just trying to get their foot on the first rung of the economic ladder. And I think it makes it really difficult for people who want to switch their job.

9:35 It's another deep freeze happening, but in the labor market.

9:37 Yeah. Yeah.

9:38 Right.

9:38 It just feels like the whole economy is kind of on hold except for the AI build-out, which is just coming at us seemingly no matter what we do. And so I think it's, yeah, just another sign of everybody, whether it be because of higher health insurance costs, because of the tariffs, because of general uncertainty, it just feels like everybody's just waiting for something to change.

10:00 And on the AI spending front, we got a handful of big tech earnings last week, which we talked about at length on The Big Take. We got Meta, we got SpaceX, we got Tesla, Texas Instruments. I am wondering, as someone who's been thinking a lot about the investment these tech companies are making in AI relative to the actual results that we're seeing in the revenue, what are you looking out for in company earnings and what has stood out to you?

10:27 Yeah, I mean, it's been interesting. I feel like the market is really pressure testing the companies. It's not letting them get away with as much. It just feels like investors are really taking stuff seriously and not letting the companies kind of skirt the corners as much.

10:42 It's like kind of a moment where people are not able to shrug as much anymore. Like you saw the market actually react pretty intensely to the news that Meta was going to be spending a lot more on AI in the coming years. Like that wasn't a shrug and move on.

10:56 Yeah, totally. Investors are like, well, okay, so you're spending all this money, you're borrowing all this money, you know, Are you making as much as you thought you would? There's been really awesome writing on the AI build-out. Greg Epp has written about this over at the Wall Street Journal, where in order for all of this to be paid back, consumers are going to have to spend more on AI than they do on food. There was a wonderful paper called Financing the AI Build-out out of Brookings, where the author pointed out that this would have to be like $ 10 trillion worth. And revenue in order to pay back everybody.

11:32 And so I think investors are kind of looking at this. And we saw this, I think, in some of the responses to the earnings where they're like, OK, well, you know, you've taken all this money. So show us the results. And I think that's the big question with AIs. Like, what will the results look like?

11:47 Kyla, I want to turn back to another term you coined, vibe session. You were talking about, of course, how people's experience of the economy didn't match the data. Are we in an even deeper vibe session than we were in 2022? Did we ever leave the vibe session? How do you think about that?

12:04 Yeah, so the vibe session is this gap between consumer sentiment and economic data. So economic data is telling us one story, how people feel about the economy is telling us another story. I first heard about it in 2022, and it's been very persistent since then. And I think there's a lot of reasons for that gap. You know, structural affordability is a big reason. Elder care costs, child care costs, the standard generation, housing costs, you know, price level variation, I think, is also kind of complicated. You're not really sure how much milk is going to cost when you go to the store. And in terms of like where we're at with the Bob session, you know, sentiment is just cratering. But when you look at the

12:39 economic data, inflation is reaccelerating. The labor market does have these soft spots. Mortgage rates are above 7%. And so I don't know if it's necessarily that the vibes aren't matching the data anymore. I feel like the data is starting to match the vibes. And the concern is that, you know, this will be somewhat of a self-fulfilling prophecy.

13:01 But I think it's a very different economy than 2022.

13:12 This is The Big Take from Bloomberg News. I'm Sarah Holder. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. Thanks for listening. We'll be back tomorrow.