Is Jerome Powell’s Fed achieving a soft landing?

The Federal Reserve appears to be moving closer to an outcome that its own economists considered unlikely just six months ago: returning inflation to a normal level without plunging the economy into a recession.

Lots of things could still go wrong. But inflation has fallen considerably in recent months: it stands at 3.1% on an annual basis, compared to a peak of 9.1% in 2022. At the same time, growth is solid, consumers are spending and employers continue to hire.

This combination surprised economists. Many predicted the cooling of a red-hot job market with far more job openings than available workers it would be painful process. Instead, workers returned from the labor market to fill vacant positions, contributing to a relatively painless rebalancing. At the same time, healing supply chains have helped increase inventories and ease shortages. Goods prices stopped driving inflation up and even started to drive it down.

The Fed hopes for “a continuation of what we have seen, namely a better balanced labor market without a significant increase in unemployment, a decline in inflation without a significant increase in unemployment, and moderate growth without a significant increase in unemployment “. Jerome H. Powell, the Fed chairman, said Wednesday.

As Fed policymakers look ahead to 2024, they are clearly aiming for a soft landing: officials are trying to gauge how long they will need to keep interest rates high to ensure inflation is fully contained without curbing the economic growth to an unnecessarily painful halt. This maneuver is likely to be delicate, which is why Mr. Powell was careful to avoid prematurely declaring victory.

But policy makers clearly see it taking shape, based on their economic projections. The Fed chairman signaled Wednesday that rates were unlikely to rise from their level of 5.25 to 5.5 percent unless inflation causes a surprising resurgence, and central bankers predicted three rate cuts by the end of 2024 as inflation continues to cool and unemployment rises only slightly.

If they can make this landing, Mr. Powell and his colleagues will have accomplished a huge feat within the US central bank. Fed officials have historically tipped the economy into recession by trying to curb inflation from peaks like those it reached in 2022. And after several years in which Mr. Powell faces criticism Because if the scale and duration of inflation had not been anticipated, such success would have a strong chance of shaping his legacy.

“Right now, the Fed is looking pretty good, as far as things are going,” said Michael Gapen, head of the U.S. economy at Bank of America.

Respondents to a regular survey of market participants by research firm MacroPolicy Perspectives are more optimistic than ever about the chances of a soft landing: 74% said no recession was needed to bring inflation back to the Fed’s target in December. 1-7, compared to a minimum of 41% in September 2022.

Fed Staff Members started to anticipate a recession after the explosion of several banks earlier this year, but stopped planning one in July.

People were pessimistic about the prospects for a soft landing, in part because they believed the Fed was slow to respond to rapid inflation. Mr. Powell and his colleagues have argued throughout 2021 that the price rise was likely “transitory,” although some macroeconomists warned that this could last.

The Fed was forced to radically change course when these warnings proved prescient: inflation has now been above 2% for 33 consecutive months.

In response, eleven central bankers began raising interest rates, and they did so quickly, taking them from near zero at the start of 2022 to their current range of 5.25% to 5.5% in July of this year. year. Many economists feared that such a sudden slowdown in the economy would cause whiplash in the form of a recession.

But the transient call seems a little better now – “transient” just took a long time to happen.

The moderation in inflation can largely be explained by healing supply chains, easing shortages of key goods like cars, and a return to something more resembling pre-pandemic spending trends in which Households are buying a range of goods and services instead of just stay-at-home splurges like sofas and exercise equipment.

In short, the pandemic problems that the Fed hoped would be temporary have effectively faded. It just took years rather than months.

“As a founding member of the transition team, it took a lot longer than many of us thought,” said Richard Clarida, a former Fed vice chair who served until the start. of 2022. But, he noted, things have adapted.

The Fed’s policies played a role in cooling demand and preventing consumers from adjusting their expectations for future inflation, so “the Fed deserves some credit” for this slowdown.

While rising interest rates haven’t healed supply chains or convinced consumers to stop buying so many sweatpants, they have helped cool the market somewhat for key purchases like housing and cars. Without these higher borrowing costs, the economy could have grown even more strongly, giving companies the means to raise prices more drastically.

Now the question is whether inflation will continue to cool even if the economy is running at a brisk pace, or whether it will take a deeper economic slowdown to bring it all the way down. The Fed itself expects growth to slow significantly next year, to 1.4% from 2.6% this year, based on new projections.

“Certainly, they did very well, and better than I expected,” said William English, a former senior economist at the Fed who is now a professor at Yale. “The question remains: will inflation return to 2% without the labor and goods markets experiencing a sharper slowdown than we have experienced so far?

So far, the job market has shown few signs of cracking. Hiring and wage growth slowed, but unemployment remained at a historic low of 3.7 percent in November. Consumers continue to spend and growth in the third quarter was surprisingly strong.

While these are positive developments, they entertain the possibility that the economy is a little too buoyant for inflation to completely subside, particularly in key services categories.

“We don’t know how long it will take to get past the last mile of inflation,” said Karen Dynan, a former Treasury chief economist who teaches at Harvard.

Under these conditions, setting monetary policy next year could prove more of an art than a science: if growth slows and inflation falls, cutting rates will be a fairly obvious choice. But what happens if growth is strong? What if inflation stops but growth collapses?

Mr. Powell acknowledged some of that uncertainty this week.

“Inflation continues to fall, the labor market continues to rebalance,” he said. “So far so good, although we kind of assume it will get harder from here, but so far it hasn’t.”

Mr. Powell, a lawyer by training who spent much of his career in private equity, is not an economist and has at times expressed caution about using key economic models and guides too religiously. That lack of dedication to models could come in handy over the next year, Bank of America’s Mr. Gapen said.

That could leave the Fed chief — and the institution he leads — more flexible in their response to an economy that has been devilishly difficult to predict because, in the wake of the pandemic, past experience turns out to be a bad precedent.

“Maybe it was good to hand over the management of the ship to a guy who was skeptical of executives during the Covid period,” Mr. Gapen said.