Economic resilience could be good news for President Joe Biden as he heads into a tough reelection campaign, which will largely hinge on the state of the economy.
Federal Reserve officials defied expectations this week by signaling two more interest rate hikes may be coming, but they also had a surprisingly upbeat message on the economy: They’re now more optimistic the U.S. can avoid a recession.
Policymakers upgraded their forecast for growth this year and said they expect unemployment to rise much less sharply, even as they hold borrowing costs at punishing levels to fight high inflation.
That’s because the job market has held up far better than expected in the face of Fed Chair Jerome Powell’s aggressive rate hike campaign, which the Fed paused on Wednesday. That resilience could be good news for President Joe Biden as he heads into a tough reelection campaign, which will largely hinge on the state of the economy.
To be sure, the economy’s relative strength — the Fed is only predicting 1 percent growth this year — could backfire if it means inflation is harder to bring back to the 2 percent target and the central bank cranks up rates even more. But Powell suggested the job market could provide a cushion on the path to a so-called soft landing, where growth slows but the economy avoids a recession.
“There is a path to getting inflation back down to 2 percent without having to see the kind of sharp downturn and large losses of employment that we’ve seen in so many past instances,” he told reporters. “It’s possible. In a way, a strong labor market that gradually cools could aid that along.”
Diane Swonk, chief economist at KPMG, said the Fed appears more hopeful than other central banks around the world that the economy could achieve “immaculate disinflation,” where price spikes ease with relatively little collateral damage. That would be a striking achievement as the Fed has frequently caused recessions in previous inflation-fighting episodes.
“It’s not without foundation,” Swonk said of the optimism. “It’s still not the most probable outcome, given what we know of history, but one thing the pandemic has taught us is to think beyond the constraints of history.”
The European Central Bank raised rates this week even though the eurozone has slipped into recession.
Goldman Sachs also recently downgraded the likelihood of a recession, while the CEOs of large U.S. companies in a survey released last week said they still expect the economy to grow 1.5 percent this year. Still, 63 percent of economists surveyed by Bloomberg earlier this month said the U.S. was likely to see a downturn in the next 12 months.
Avoiding a slump in the U.S. entirely would be a significant break for Biden, but staying out of recession this year because the economy — and inflation — remain strong could simply push back the timing of the contraction until next year, when it could be more costly to his campaign.
And while Fed officials still see a soft landing as a viable option, they’re not counting on it.
“This isn’t our first campfire,” Richmond Fed President Tom Barkin said in a speech Friday. “Inflation hasn’t yet seen a happy ending.”
“Inflation, while down, is still elevated,” he added.
Indeed, Fed staff economists are still forecasting a mild economic contraction this year, and a New York Fed model predicts a 71 percent chance of recession in the next 12 months.
Not only is the central bank planning to potentially raise borrowing costs further, but it also has warned that it doesn’t expect to cut them until next year at the earliest, even if growth does turn negative. They want to make sure that inflation is well and truly tamed.
The message from the Fed has been, “Look, we’re not going to automatically ease just because there is a recession,” said Doug Duncan, chief economist at Fannie Mae, the government-controlled mortgage financing giant.
That could lead to pain. In its semiannual report on interest rate policy, released Friday, central bank officials listed a litany of concerns that they hear from investors.
“Higher interest rates could test the ability of some governments, households, and businesses to service their debt, including in emerging market economies that are exposed to global financial conditions,” the report said. “Ongoing stresses in the banking sector could cause a contraction in the supply of credit to households and businesses, resulting in a marked slowdown in economic activity and an increase in credit losses for some financial institutions.”
Central bank officials are watching prices in key service sectors where wages are some of the biggest costs, one of the areas of inflation that’s proving more stubborn.
But Powell has suggested that the job market gains could moderate, helping slow price increases in those sectors, without a surge in layoffs. He noted that wage growth has already decelerated and job vacancies have dropped, even though the unemployment rate remains low, in part because more people are participating in the workforce.
“There are some signs that supply and demand in the labor market are coming into better balance,” he said at his press conference.
But demand for workers could remain significant, particularly as Americans’ savings are still elevated, thanks to Covid aid and higher wages — fueling spending and supporting the need for plenty of jobs. The San Francisco Fed forecast that these savings could continue to support consumer purchases through the end of the year.
“The tailwind from excess savings continues to be really strong,” said Torsten Slok, chief economist at Apollo Global Management.
And if that continues to feed price spikes, Powell underscored that conquering inflation will be the ultimate priority.
“The [rate-setting] committee is completely unified in the need to get inflation down to 2 percent and will do whatever it takes to get it down to 2 percent over time,” he said. “We understand that allowing inflation to get entrenched in the U.S. economy is the thing that we cannot, cannot allow.”
Source : Politico
