What does the Fed’s latest move hide?
The Fed seems confident in a soft landing, but there is no shortage of risks: here are what they are. Analysis by Tiffany Wilding and Allison Boxer of PIMCO
The Federal Reserve's latest economic projections indicate that central bankers are increasingly confident that the US economy can achieve a soft landing in 2024. However, we observe several macroeconomic risks that could challenge this outlook.
With growing economic and political headwinds this fall, and inflation trends still uncertain, we believe the outlook presented by the Fed is optimistic. The U.S. unemployment rate will likely have to rise more than the Fed expects to achieve its price stability goal.
The updated projections paint a brighter picture
Although Fed Chair Jerome Powell said during the press conference that he did not want to characterize the underlying outlook as a soft landing, the Fed now expects core inflation to cool from an estimated 3.7% at the end of 2023. to 2.6% by the end of 2024, with the unemployment rate rising to 4.1% and growth only slightly below trend of 1.5% in 2024. Observers are free to call it “soft” or “soft-ish” or whatever, but what matters is how politics manifests itself in the real economy.
We believe that the Fed's new projections, presented after the September meeting, imply an acceleration in productivity, together with a higher neutral rate (r*) in the short run, which would be sufficient to bring inflation back towards target without a significant increase in unemployment or serious damage to economic activity and growth. While improvements on the supply side (highlighted by Chairman Powell), along with moderating inflation and continued resilience in the labor market, have been positive developments for the U.S. economy this year, history suggests that these trends could do not continue.
The Fed remains focused on controlling inflation: Officials have signaled their intent to keep rates tightening for longer than previously expected, leaving the additional rate hike implicit in their projections for 2023 unchanged and raising their forecast for the federal funds rate at the end of 2024 by 50 basis points compared to the previous projections in June (the latest projections imply two cuts of 25 bps after the peak). However, given the economic headwinds, we believe central bankers may struggle to implement further rate hikes this year, and we expect rates to ease more quickly than the Fed expects in 2024.
History is not on the Fed's side
Although Chairman Powell highlighted positive developments both on the supply side (with the easing of pandemic-related complications and restrictions) and on the rebalancing of the labor market, the Fed's forecasts for 2024 appear unlikely in the context historical.
In the past, episodes of sharp monetary policy tightening, such as the one we have witnessed over the past year, have rarely marked the start of a sustained expansion. In a sample of 140 rate hike cycles over the last 70 years of developed market history, a recession followed a rate hike cycle 75% of the time, rising to 90% for cycles characterized by high inflation at the time of the onset of the rise.
The risks of recession
A soft landing for the US economy is certainly possible, but recession risks are still high, in our view. Post-pandemic supply chain improvements should continue to moderate inflation, but tight labor markets and sticky wages could well exert inflationary pressure in the absence of a productivity boom. Other near-term trends, including the resumption of student loan repayments, rising gas prices and California's income tax deadline, could sap the strength of otherwise resilient U.S. consumers.
Historically, a prolonged period of restrictive policies has very rarely (if ever) ended in rising unemployment and economic contraction. While history doesn't always repeat itself, it often rhymes.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/fed-atterraggio-morbido-rischi/ on Sun, 24 Sep 2023 05:59:04 +0000.