Navigating by the Stars – August 28, 2023
Recent economic data has pointed to a stronger economy than previously expected, yet the current business cycle contours still signal an eventual downturn, the Fannie Mae Economic and Strategic Research (ESR) Group reported. The group’s analysis coincided with Federal Reserve Chair Jerome Powell’s speech at the Kansas City Fed’s annual retreat in Jackson Hole, WY.
“Although inflation has moved down from its peak — a welcome development — it remains too high,” Powell said in prepared remarks Friday. “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”
Given the recent flurry of strong consumption data combined with two consecutive months of annualized Consumer Price Index measures coming in close to the Fed’s 2% inflation target, the ESR Group said the odds of a “soft landing” have increased. However, the group noted that the full lagging effects of monetary policy tightening are still working their way through the economy.
Wage growth also remains too high to be consistent with 2% inflation over the long run, a circumstance that the ESR Group believes will keep monetary policy tight. Additionally, the group projected that the recent rise in medium- and longer-term Treasury yields will likely weigh on interest-rate-sensitive sectors in coming quarters.
Although the ESR Group noted that both the “if” and “when” of a recession are uncertain given the strength of recent economic data and decelerating inflation, their baseline forecast continues to call for one. It’s now expected to begin in the first half of 2024.
“It is easy to run your forecast ship aground by underestimating the American consumer,” said Doug Duncan, chief economist at Fannie Mae. “Despite reduced saving, increased rollover credit card balances, and rising credit costs, consumers are sustaining consumption, supported by a decline in inflation.
“Nonetheless, tightening monetary policy takes a toll. Will it result in a recession? Our base case forecast is a mild recession, and it looks as though the alternative is a soft landing, which is slow growth with only a small increase in unemployment.”
Powell acknowledged the challenges of policymaking amid the complications of the current cycle. “These uncertainties, both old and new, complicate our task of balancing the risk of tightening monetary policy too much against the risk of tightening too little,” he told the Jackson Hole audience. “Doing too little could allow above-target inflation to become entrenched and ultimately require monetary policy to wring more persistent inflation from the economy at a high cost to employment. Doing too much could also do unnecessary harm to the economy.
“As is often the case, we are navigating by the stars under cloudy skies.”