Thursday, February 2, 2023

Federal Reserve keeps faith in a US ‘soft landing’

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Fears of a 2023 US recession have been rising as the Federal Reserve attempts to tackle the country’s worst inflation problem in decades.

Far more persistent price pressures than expected have led the US central bank into its most aggressive campaign to tighten monetary policy since the early 1980s.

Top Fed officials concede that bringing inflation back under control will require a “sustained period” of below-trend growth and job losses. No policymaker, however, has yet said a recession is inevitable.

Jay Powell, the bank’s chair, has said there remains a path to a “soft landing” — but it is a path that gets more narrow the more stubborn inflation proves to be, and the higher the Fed has to push up borrowing costs to quell it.

“I don’t think anyone knows whether we’re going to have a recession or not and, if we do, whether it’s going to be a deep one or not,” Powell said at his final press conference of 2022.

Economists across Wall Street and academia share his view of an uncertain outlook but are notably more pessimistic about the path forward.

“It’s very, very difficult to fine-tune this huge $20tn-plus economy and cool it off just enough,” says Kathy Bostjancic, chief economist at financial services company Nationwide Mutual. “We have pretty high conviction that a recession is likely in 2023.”

A consensus forecast by Bloomberg — reflecting the view of more than 80 institutions — indicates a contraction in the US economy of 0.1 per cent in both the third and fourth quarters of 2022, with unemployment nearing 5 per cent. But it is forecast to be offset by stronger growth in the first half of 2023, resulting in a 0.4 per cent expansion this year.

However, in a survey last month by the Initiative on Global Markets at the University of Chicago Booth School of Business, in partnership with the FT, 85 per cent of the academic economists polled expected the private non-profit National Bureau of Economic Research to declare a recession this year.

Federal Reserve economists have conceded that such an outcome is as plausible as a soft landing.

On the town: service sector prices are elevated as Americans continue to spend © Bloomberg

The NBER characterises a recession as a “significant decline in economic activity that is spread across the economy and lasts more than a few months”. More often than not, this follows Federal Reserve attempts to cool an overheated economy.

Since the 1950s, the US economy has tipped into a recession within two years every time inflation has exceeded 4 per cent and unemployment has fallen below 5 per cent, research shows.

Inflationary pressures have cooled recently but consumer prices are still rising at an annual rate of 6.5 per cent. Unemployment hovers at 3.5 per cent.

Whether a recession happens, and its severity, depend largely on global factors, says Gregory Daco, chief economist at consultants EY-Parthenon.

Further inflationary pressure — be it from additional supply chain pressures linked to Covid complications in China, or a resurgent spike in energy prices stemming from the war in Ukraine — could force the Federal Reserve to damp demand further.

Most officials back a rise in the federal funds rate — at which commercial banks borrow and lend their excess reserves to each other overnight — from its present 4.3 per cent to above 5 per cent, with no rate cuts until 2024.

Michael Gapen, the head of US economics at Bank of America, says the federal funds rate may need to surpass 5.5 per cent should price pressures continue to linger.

Much depends on the trajectory of the labour market, which remains tight as employers compete to fill vacancies amid a worker shortage.

Wage growth, while slowing, is well above a level consistent with the Fed’s 2 per cent inflation target. Service sector prices, including dining out, personal care and transport, are also elevated as Americans continue to spend.

Mark Zandi, chief economist at Moody’s Analytics, refers to the upcoming period as a “slowcession”.

Nevertheless, a full recession could be “self-fulfilling”, he adds. “Recessions are ultimately a loss of faith — a loss of faith by consumers that they will hold on to their jobs . . . a loss of faith by businesses that they will be able to sell what they produce.”




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