Eleven million unfilled jobs. Still-strong consumer balance sheets. Inventory of unsold houses so low that bidding wars break out as FOMO (fear of missing out) spreads. Rising wages, plentiful jobs, record-low lay-offs, drive consumer sentiment up by the largest amount since 2006 to a three-month high. The economy to grow at an annual above-trend rate of 3.7 percent this year, 2.7 percent next year, and 2.3 percent in 2024 according to forecasters surveyed by the Federal Reserve Bank of Philadelphia. “The U.S. economy is strong enough to withstand the [Fed’s] suggested rate hikes …”, opines Jack Kleinhenz, chief economist at the National Retail Federation. “At the end of the day,” says Jake Jolly, senior investment strategist at BNY Mellon “the US economy is still in a very robust position.”
The Fed Dips Into Its Limited Tool Kit – At Long Last
Still, talk of a recession fills the air as the Fed prepares to end the era of negative interest rates. No worries, as Aussified Americans now put it. Federal Reserve Board chairman Jerome Powell says, “The historical record provides some grounds for optimism” that a recession can be avoided as the Bank managed to do in 1965, 1984 and 1994, although “it may take longer than we would like…”. Powell is battling to restore the Fed’s credibility. The Lindsey Group points out that the Bank’s admission that we need a massive policy shift was a stark reminder of just how wrong the Fed has been about inflation. If FOMC [policy committee] members admit they were wrong, maybe they are even more wrong than we imagined.”
The Fed must rely on its limited tools: an increase in interest rates, probably in half-point increments, and reducing its holdings of assets (quantitative tightening). Fed governor and deputy chair Lael Brainard says “getting inflation down is going to be our most important task”, and promises the Bank’s monetary policy committee “will continue tightening monetary policy methodically … at a rapid pace…”.
History Doesn’t Repeat Itself But It Often Rhymes
Unfortunately, the past is not necessarily prologue. It has been four decades since inflation as experienced by consumers hit an annual rate of 8.5 per cent, as it did last month (10 per cent for groceries), up from 7.9 per cent in February. It has never waited until producer-price inflation hit 11.2 per cent, a record, before launching an inflation fight. That increase will find its way into at-store and online prices no matter what the Fed does from here on out.
Unfortunately, too, inflationary expectations have become un-anchored. Surveys show the public expects the inflation rate to be 6.6 per cent at this time next year, far above the Fed target. Which means that workers will continue to press for large wage increases to keep their families’ heads above the incoming inflationary tide, that worker-short employers will pay those higher wages, and raise their prices to offset those increases.
A Tool-Limited Fed Uses The Power Of Announcement
In addition to starting off so far behind the curve, the Fed faces challenges a central bank is not well equipped to meet.
· It cannot repair broken links in supply-chains, some created by Covid lockdowns in China, others that will outlast the pandemic according to the latest annual Report of the President’s Council of Economic Advisers, released last week.
· It cannot force Putin to end his war, or Western allies to relax sanctions.
· It cannot prevent Biden from pouring gasoline on the inflationary fires by forgiving billions in student loans, or raising tariffs on imported goods and materials.
· It cannot control commodity prices as weather shrivels citrus crops; avian flu drives up egg and poultry prices; war prevents normal wheat plantings in Ukraine.
· It cannot prevent elevated oil and gas prices from cascading through prices of plastics, fertilizers, transport, chemicals, utilities, and a host of other products.
· It cannot force Biden to remove or lower tariffs on imported goods, especially steel.
Fortunately for Powell, there are some signs that the mere announcement of tightening is having a cooling effect.
· A jump in interest rates on 30-year mortgages from under 3 percent last year to 5 percent today has triggered a 30 per cent drop in applications for new mortgages at major banks. George Ratiu, an economist at Realtor.com, tells The Wall Street Journal that mortgage payments on the median-priced house have risen from $1,223 last year to $1,700 this year, a 38 percent increase.
· Higher interest rates have caused bond issuance by state and local governments to drop 8 percent in the first quarter compared with last year, with reduced spending to follow.
· Buyers of bonds backed by loans to subprime borrowers are demanding premiums not seen in almost two years.
Some Help From Markets
Powell & Co. can also count on some help from developments on both the demand and supply sides of the economy. On the demand side, cooling. After seven consecutive months of declines in their inflation-adjusted, after-tax incomes, to the lowest level in two years, Americans are dipping into excess savings to keep pace with inflation. When those piggy banks are empty, or perhaps sooner, they are likely to cut spending even more than they have already done (in inflation-adjusted terms), since generous government handouts are, at least for now, a thing of the past. According to columnist Greg Ip, reporting on a study by the Hutchins Center on Fiscal and Monetary Policy, fiscal support that added 7.6 percentage points to GDP in the first quarter of last year, have subtracted 2.1 points this year.
The Fed might also get some help from developments on the supply side that might ease wage pressures. The drop in Covid-related problems, and the re-opening of schools and child-care centers should release many care-givers to re-enter the labor force. Hundreds of thousands of retirees who find it impossible to stretch their pensions any further are re-entering the jobs market, in many cases re-inserting much-missed skills and work attitudes. More than 480,000 persons over the age of 55 have entered the labor force in the past six months, compared to 180,000 before the pandemic struck.
Sorting The Incoming Data Ain’t Easy
To be fair to Powell, we should note the road to a successful policy is not clearly marked by incoming data. Some 80 per cent of adults say they expect a recession this year, but consumer sentiment in April rose to a three-month high. The cost of financing a car, and operating it, has soared, and Ford is not the only carmaker that can’t produce enough vehicles, especially the most expensive SUVs and small trucks, to meet demand. The same is true of new homes. Nervous consumers are coping with their fear of recession and other anxieties by spending more on travel.
Two Powerful Chairmen And A Big IF
Still, Jay Powell, chairman of the world’s largest central bank, believes he can engineer a soft landing for the high-flying economy. Goldman Sachs’ Chief Economist Jan Hatzius says the Fed faces “a hard path to a soft landing,” and puts the probability of a recession at 35 percent.
Jamie Dimon, chairman of America’s largest private-sector bank, says, “If the Fed gets it right, we can have years of growth, and inflation will eventually start to recede.” And if, when we hit the inevitable rough spot en route to Powell’s “longer than we would like” and Dimon’s “eventually”, Powell can keep his head when all about him are losing theirs and blaming it on him. Big Ifs.