Countdown to Fed ‘soft landing’ may be underway By Reuters

Por Howard Schneider

WASHINGTON, July 31 (Reuters) – Throughout the Federal Reserve’s fight to stamp out inflation, policymakers have focused on raising the benchmark overnight rate high enough to achieve their target. and do it fast enough to prevent the public from losing faith.

But in the quest for a “soft landing,” in which inflation falls without recession or major job losses, the flip side—when to lower rates and ease the pressure on households and businesses—will be just as important, and perhaps even harder to hit.

In the three recessions leading up to the coronavirus pandemic (1990-1991, 2001, and 2007-2009), the US central bank peaked at interest rates and began cutting funding costs three to thirteen months earlier than it turned out to be. be the start of the recession. This demonstrates how difficult it is to stop the decline once it has started and how difficult it is to tailor the late effects of monetary policy to what the economy might need months later.

Allowing high inflation to embed itself in the economy is the cardinal sin of central banking, and the Fed’s monetary policymakers would still rather make the mistake of going too far to ensure inflation is in check than fall short and risk for a rally, said Antulio Bomfim, head of global macroeconomics for Northern Trust Asset Management’s global fixed income team and former special adviser to the Federal Reserve board of governors.

“We would all like to be able to slow down the economy ‘enough’,” Bomfim said. “The margin of error is quite high… We are seeing a resilient economy in terms of activity, but also persistent in core inflation… The risk of doing too little, that asymmetry, is still there.”

This may point to at least one more rate hike, even as investors bet the Fed is done, with rate futures markets reflecting at most a one in four chance of another hike. Last week, the Federal Reserve raised its official interest rate to the 5.25%-5.50% range, the eleventh rise in the last 12 meetings.

THE PIECES OF THE PUZZLE ARE FITTING IN

The latest data on wages, growth and prices highlight the dilemma facing monetary policymakers when deciding whether to raise borrowing costs further and how long to keep rates high, a debate that could determine the general direction of the economy—growth or contraction, with unemployment rising or labor markets still strong—in 2024, a presidential election year.

After sixteen months of rapid monetary tightening, the economy grew at an annualized rate of 2.4% in the second quarter, above what is considered its non-inflationary trend, and that momentum is expected to continue in the current quarter. Wage costs rose 4.5% in the 12-month period ending in June, another decline from pandemic-era highs but also above what the Federal Reserve would consider consistent with its inflation target of 2 %.

Although headline inflation has fallen sharply from the 2022 highs, readings of underlying price pressures have moved more slowly. The Personal Consumption Expenditure Price Index excluding food and energy costs slowed notably in June to 4.1% year-on-year, after hovering around 4.6% for months, but remains more than double the 2% target.

Fed Chairman Jerome Powell said last week that the pieces of the low inflation “puzzle” may be lining up, but he still doesn’t see it clearly.

“We need to see inflation come down on a lasting basis…. Core inflation remains quite high,” Powell told a news conference after the Fed’s two-day policy meeting ended. “We think we have “We have to keep working. We think we’re going to have to keep monetary policy at tight levels for some time. And we have to be prepared to go higher.”

Powell recognized the delicate balance needed to beat inflation without restricting activity more than necessary and to preempt any slowdown with lower rates as inflation falls and activity declines.

“You stop raising long before you get to 2% inflation and you start cutting before you get to 2% inflation,” Powell said, pointing to the time it takes for changes in the Fed’s benchmark rate to kick in, up or down. The Fed’s key interest rate influences the economy by changing what banks charge consumers for credit card, car, and home loans or what businesses pay for bonds or lines of credit.

STILL LEFT FOR CUTS

Powell declined to give direct guidance on how the Fed will assess when it’s time to ease policy, saying “we’ll be comfortable cutting rates when we’re comfortable cutting rates.” Still, he said inflation won’t return to target until the economy slows below potential for a while, with direct implications for job numbers.

Things have been moving in that direction. Although the unemployment rate remains low, workers are quitting less frequently, job offers have declined and wage increases have slowed, suggesting a cooling off in the labor market after pandemic years characterized by labor shortages and big salary increases.

But with inflation below its peak and no major disruption to employment, some economists wonder if Powell—by focusing on the need for economic “slack” to get the job done—isn’t making the same mistake as his predecessors and setting the stage for an unnecessary recession.

“Exploring the extent to which low unemployment and low inflation are compatible should be the benchmark… It’s a broad approach that we could test,” said Lindsay Owens, executive director of the Groundwork Collaborative, an economic policy group focused on in employment. “The deadline to discuss cuts is probably around October.”

Although the latest projections from the Fed’s money managers, released in June, show that rates will fall by the end of 2024, the decline is less than the expected fall in inflation, meaning that the inflation-adjusted interest rate it actually keeps going up.

The risk of continued tightening is that the economy will not just slow, but collapse, something former Fed officials know can happen quickly. In December 2000, Federal Reserve staff and monetary policymakers faced increasingly weak data and concluded that the economy was going to slow, but not contract, according to transcripts of the Committee’s meetings. Federal Open Market. A month later, the central bank cut rates, and the recession was finally determined to have started in March 2001.

“I think the economy is in a kind of ‘last gasp’ phase,” said Thomas Simons, US economist at Jefferies, with bank lending slowing, the cost of credit rising and delinquency rising. of lending “in line with the start of every recession we’ve seen since the 1980s.”

“As inflation remains persistent, they’re going to end up with rates that are too high or as high as they are for too long. They’re going to be relatively slow to cut because they need that weakness to play out.”

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao, Spanish editing by Jose Muñoz)