(Bloomberg) – For Rick Plympton, there is no going back to the pre-Corona economy. The CEO of precision lens maker Optimax Systems Inc. sees “sandwiches” in many aspects of his business.
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It's difficult to find enough workers, the prices of essential supplies fluctuate more, and the time between ordering equipment and showing it at the company's Ontario, New York, workshop is longer. There is also increased support in Washington for the US chip industry using Optimax lenses as politicians sense a changing geopolitical landscape.
Plympton believes many of these changes are not temporary. Tight labor markets “will be with us for decades to come,” he says.
But Federal Reserve Chairman Jerome Powell is not ready to make such conclusive statements. “The pandemic is still writing the history of our economy,” he told House Democrats on March 6. “We should just be prepared to be surprised by the next chapter.”
And the long-term economic forecasts from Powell and his Fed colleagues show that not much has changed despite the supply chain, labor market and geopolitical shocks of recent years.
Central banks act as a nation's economic narrators, describing economic trends and explaining why their policies are appropriate at a particular time. The Fed's lack of an overview of why U.S. growth has proven resilient to high interest rates is creating volatility as investors must gauge how they will react. Price volatility makes planning difficult for households and businesses.
“Powell keeps talking about normalization and rebalancing, but you can’t go back to 2019,” said Jim Bianco, president of Bianco Research. “Whenever we have a big shock to the economy, like in 2008 or 2020, the economy changes.”
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Bianco, who has been analyzing the U.S. economy and financial markets for more than three decades, ticks off a list of features of the economy that appear to be new.
Consumers appear to have a higher propensity to spend – perhaps due to greater confidence in job security or even a generational shift away from precautionary saving as the aftermath of the 2007-2009 financial crisis is now more distant. The personal savings rate averaged less than 4% over the past two years, compared to more than 6% in the decade ending in 2019.
Companies now appear to be stockpiling precautionary inventory, with wholesale inventories now at a higher ratio to sales than before the pandemic.
Then there is the job market.
At Optimax, even salary increases and a profit-sharing plan that distributes 25% of profits to employees failed to attract enough employees. “After the pandemic, we have more jobs than workers,” Plympton said in a telephone interview.
Drew Greenblatt, president of Marlin Steel Wire Products in Baltimore, faces the same challenge. As he walks through his cavernous workshop, pointing out new precision tools that can produce more parts per hour, he worries about finding qualified people to operate them. “It’s killing me,” he says. “I have all this technology and it’s just sitting there.”
Such anecdotes help illustrate why the U.S. unemployment rate is near historic lows, below 4%, despite what Fed officials call a “restrictive” interest rate. Wage growth continues to exceed 4% per year, compared to an average of 2.4% in the decade to 2019. As demand remains solid, companies may raise prices as they contend with higher salaries.
For many investors, the economy looks more inflationary in the long run, requiring higher interest rates. Futures trading points to a Fed rate of 3.5% in a few years – a full percentage point higher than Fed policymakers' latest long-term forecast, which is scheduled to be updated at the March 19-20 policy meeting.
Monetary policy works both by communicating the outlook and by raising or lowering interest rates. Understanding how the Fed thinks about the state of the world reduces overall volatility and the additional return investors pay for risk.
Historically, Fed guidance has helped shape expectations. As economic growth picked up in the 1990s, then-Fed Chairman Alan Greenspan emphasized a structural acceleration in productivity that meant inflation risks had diminished.
Today, Powell has enormous resources to draw on to assess what post-pandemic shocks will mean for the U.S. economy. The Fed board has two divisions that produce domestic and international economic forecasts, as well as a policy division in Washington. In 2023, there were more than 700 full-time employees with a budget of $202 million.
Still, there is great risk for a central bank to jump to big conclusions in the wake of an economic hurricane like the pandemic and the billions of dollars in fiscal and monetary support that followed.
Fed officials still have scars from saying in 2021 that inflation was largely a phenomenon of temporary supply chain blockages, only to see it expand and exceed almost all expectations.
Today's statement that the economy can sustain faster growth thanks to a new investment boom could be interpreted as an endorsement of President Joe Biden's policies as the November election approaches. Alternatively, saying that the US is now facing higher inflation and higher interest rates in the long run could play a role in Republican arguments. Powell saw the political sensitivity firsthand this month when he mentioned at a congressional hearing that immigration had eased some pressure on the job market. Lawmakers peppered him with comments on the point.
Lou Crandall, chief economist at Wrightson IC` LLC, says that “in my opinion, staying away from a coherent view of structural economic changes is absolutely the right way to do policy.”
“At a time when trends are evolving faster than expected, it would be difficult to say clearly what this means for policy,” Crandall says.
Still, not all central bankers have shied away from pointing out new developments in the economy.
Powell's counterpart at the European Central Bank, Christine Lagarde, believed that the global economy may be “entering an era of shifts in economic relationships and breaks in established regularities.” When Lagarde spoke at the annual conference in Jackson Hole, Wyoming, last August, she pointed to three such disruptions: changes in the labor market and the way people work, a transformation in energy markets and the fragmentation of the world competing blocks. While it's unclear whether the changes are permanent, they have been “more persistent than we originally expected,” she said.
Fed policymakers will have a chance to provide a fresh assessment of underlying changes in the economy when the central bank begins a new strategic review later this year. The last meeting in 2020 discussed how to counteract the persistent undershooting of the 2% inflation target. It proved to be a bad time because it ended just before the cost of living began to rise.
Whatever approach Fed officials take this time, today's challenges are, if anything, greater than the years before Covid hit.
The bottom line for Julia Coronado, partner at MacroPolicy Perspectives LLC: “We are in the middle of something that is still incredibly difficult and volatile” to predict.
– With assistance from Edward Bolingbroke and Alex Tribou.
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