If you’re still holding out hope that the Federal Reserve can engineer a soft landing for the US economy, forget it. A recession is inevitable within the next 12 to 18 months.
In their latest set of projections, the Fed’s central bankers presented a benign scenario, in which the economy continues to grow at a moderate pace and unemployment rises only slightly, even as the central bank raises interest rates significantly to rein in inflation. inflation. While the Fed’s forecasts have become more plausible over time, I see several reasons to expect a much harder landing.
First, persistent price increases have forced the Fed to shift its focus from supporting economic activity to bringing inflation down to its 2% target. The central bank’s employment mandate is now subservient to its inflation mandate. This can be seen both in the performance of central bank chairman Jerome Powell at last week’s press conference, and in the Federal Open Market Committee’s statement in June, which ruled out that the labor market “would continue to being strong”.
Second, the new focus on price stability will be ruthless. Central bankers acknowledge that failing to bring inflation back down would be disastrous: inflation expectations would likely become unanchored, requiring an even bigger recession down the line. From a risk management perspective, it is better to act now, whatever the cost in terms of jobs and growth. Powell doesn’t want to repeat the mistakes of the late ’60s and ’70s.
Third, the current economic expansion is uniquely vulnerable to a sudden stop. In the near term, payroll growth, economic reopening, and healthy balance sheets (supported by the big fiscal stimulus in 2020 and 2021) should support demand, which in several sectors outstrips supply. For example, the cumulative two-year supply shortage in the motor vehicle sector is likely to amount to several million units.
As a result, it will take time and considerable monetary policy tightening to reduce demand and fully translate into weaker output of goods and services.
But when that time comes, the output adjustment is likely to be abrupt, due to tight financial conditions, tight fiscal policy and depleted family savings.
The broad US stock market is down more than 20%, mortgage rates are up more than 2 percentage points, and the dollar has strengthened 10% against a broad basket of foreign currencies (thus restricting US exports). Joined).
The Brookings Institution’s Hutchins Center estimates that fiscal policy cut more than 3 percentage points from annualized US economic growth in the first three months of 2022, a drag that is expected to persist through 2023.
As inflation outpaces wage growth, the personal savings rate has plummeted from 26.6% in March 2021 to 4.4% in April, significantly below its long-term average. Not surprisingly, consumer confidence has fallen to levels last reached after the 2008 financial crisis, and Google searches for the word “recession” are reaching new records.
Finally, economic history points to a hard landing. The Fed has never tightened its monetary policy enough to raise the unemployment rate by 0.5 percentage point or more without triggering a recession. According to Sahm’s rule, when this trigger is reached, the next stop is a deeper recession, in which unemployment rises by at least 2 percentage points.
Like Wile E. Coyote falling off a cliff, the US economy has a lot of momentum, but the support is fading fast. Landing will not be a pleasant experience.