WASHINGTON, Dec 12 (Reuters) – After catching up on inflation last year in a policy shift urgently needed by relentlessly rising prices, the Federal Reserve now faces a more subtle assessment of whether the economy is strong enough is to get through even higher interest rates or is on the verge of collapse.
Financial markets and professional forecasters seem set for the latter. US investors from crypto rebels to index fund loyalists lost over $8 trillion this year as markets collapsed under the Fed’s fastest rate hikes in 40 years; bond markets appear convinced that a recession is imminent; Economists agree in surveys by Reuters and others.
But this seemingly stressed environment is also keeping unemployment rates at record lows for Latinos and near record lows for blacks. Wage increases are strong and consumption, the mainstay of US economic growth, continues to rise even when adjusted for inflation.
Many factors influence when and if the economy enters a recession; but it will inevitably be accompanied by rising unemployment and falling consumption.
“The economy has never been more unloved than it is now,” wrote Bob Schwartz, senior US economist at Oxford Economics, in a recent analysis detailing the “bipolar” circumstances that Fed officials described at their two-day policy meeting will analyze this week.
Consumer sentiment is abysmal, worse than during a pandemic, but both bank accounts and spending remain healthy; manufacturing is contracting but the service sector keeps roaring with monthly job and wage growth to prove it; There are signs that inflation is easing, with petrol prices back to where they were a year ago, but they are still higher than many have seen in a lifetime and continue to weigh on household budgets with rising food and other costs .
There is enough evidence of weakness to fuel the narrative of an imminent recession.
“It’s probably starting now,” said Dana Peterson, chief economist at the Conference Board, who cited a steady decline in the group’s list of leading economic indicators this year and the near-unanimous opinion in a recent CEO poll.
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‘DO NOT CRACK’
There is also enough evidence of strength to tell a story of continued growth.
“There are signs the labor market is cooling — a little eroding, definitely not fracturing… It doesn’t look like a recession,” with continued job growth of more than 250,000 a month and some industries facing chronic labor shortages, said Guy Berger, chief economist for LinkedIn.
Fed officials are due to receive fresh consumer price data at the start of Tuesday’s meeting, hoping it will show a continued slowdown in price gains after annual inflation fell below 8% in October for the first time in eight months.
They have telegraphed plans to keep raising interest rates for now while trying to cool the economy and keep prices under control. But they also plan smaller steps. After a series of large three-quarter-point rate hikes this year pushed interest rates from near zero to a range of 3.75% to 4% in March, US central bankers are expected to hike half a point over a two-year period. Daily meeting ending on Wednesday.
A new policy statement is scheduled for release at 2 p.m. EST (1900 GMT) and a press conference by Fed Chair Jerome Powell is scheduled for 2:30 p.m.
The decision to take smaller steps is both a realization by Fed policymakers that they may be close to a breakpoint after aggressive rate moves this year, and that any step from here increases the risk of going too far.
So far, Fed officials don’t feel like they’ve exceeded it.
“For all the talk of the economy crashing and the financial markets collapsing, it hasn’t done that,” Gov. Christopher Waller said of the Fed’s monetary policy change this year, the most aggressive since former Fed Chair Paul Volcker opposed a tighter one Inflation erupted in the 1980s.
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“PLASIBLE” SOFT LANDING
That doesn’t mean it won’t. Along with the latest rate decision, the Fed is due to provide updated forecasts on Wednesday about how much interest rates officials think they may need to rise, how long they will stay there and how the economy will respond. It’s an outlook that will reveal whether the central bank still believes it can lower inflation without serious damage to jobs and set the tone for the US economic debate in the early stages of the 2024 presidential campaign.
Bond investors appear to have closed their bets as yield curves are ‘inverted’, traditionally seen as a sign of an impending recession.
Economists in separate polls from Reuters, the National Association for Business Economics, and the Philadelphia Federal Reserve have all forecast near-zero growth for 2023 and a high probability of an outright slowdown.
Whatever happens, said the NABE panel of 51 professional forecasters, the Fed will take center stage.
“Two-thirds of panelists say the biggest downside risk to the US economic outlook out to 2023 is ‘too much monetary tightness,'” the group said. “The main upside risk also comes from monetary policy action” as the Fed navigates the economy to its targeted “soft landing” that avoids a recession.
Either way, 2023 will likely tell the story.
Powell has declined to speculate on the outcome, saying only that a soft landing remains “plausible”.
It will depend on how inflation develops. Developments such as falling rents hint at disinflation in the pipeline. It will also depend on how the labor market adjusts, whether at the fringes through slower hiring and wage growth or, at its core, through layoffs large enough to raise the unemployment rate significantly.
Some, like Berger, insist there is a way.
“If the optimists are right, we have an adjustment in the labor market, the Fed is happy where inflation is going, and they stop slamming on the brakes so hard,” Berger said. “It’s definitely within the realm of possibility.”
Reporting by Howard Schneider; Edited by Dan Burns and Andrea Ricci
Our standards: The Thomson Reuters Trust Principles.
Howard Schneider
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