Reduced Inflation Boosts Prospects of a Soft Landing
Economic concerns about recession and inflation are intertwined in the US. The more persistent inflation is, the more a recession is needed to curb it. However, recent data suggests decreasing risks. Headline inflation dropped from 9.1% in June last year to 3% in June this year. Despite upcoming months possibly seeing an increase due to last year's pricing anomalies, underlying inflation's slight decrease signals improving chances for a soft landing, bringing inflation near the Fed's 2% target without a recession. Also there's been a significant slowdown in private rent increases in the past year, which should contribute to pushing the official inflation rates lower in the near future.
Two forces have influenced inflation since 2021: temporary supply chain, energy, real estate, and labor shocks due to the pandemic, stimulus, and war, and underlying factors such as supply, demand, and expectations. Transitory impacts are subsiding with energy and housing costs, and used car and airfare prices returning to normal. This offers hope for inflation rates to decrease in the coming months.
To understand underlying inflation, economists analyze indexes excluding components prone to unusual shocks. Core CPI, excluding food and energy, rose 4.8% in June, down from 6.6% nine months earlier. Jason Furman, Harvard University economist, observes different underlying inflation indexes and adjusts them to resemble the Fed's price index. His analysis indicates a fall to 2.8% in June from 4% in April.
While the struggle with inflation continues, encouraging signs exist. Unemployment remains low, vacancies and voluntary quits have fallen, and consumer inflation expectations have dropped significantly. Despite the Fed raising interest rates, the impact seems to have faded, with the stock market near a record high and housing activity rebounding. Nevertheless, wage growth still exceeds the rate consistent with 2% inflation, and the unpredictability of the economic situation over the past three years warrants caution.
Unraveling Fed's Fall Rate Hike Conditions
The Federal Reserve’s July meeting is focused on deciphering triggers for another rate hike in the fall. Many officials back a quarter-percentage-point increase in July, pushing rates to a 22-year high, but recent inflation slowdown hints this might be the final upward move in the Fed’s inflation campaign.
The Fed paused after ten consecutive increases since March 2022, holding its federal-funds rate steady between 5% and 5.25%. Officials forecasted two more rate hikes in 2022, given steady economic growth and easing inflation. However, stronger than expected economic activity since May supports a rate hike this month. Some officials want confirmed inflation easing before halting increases.
A key concern is determining whether the recent inflation slowdown isn't a fluke. Jerome Powell, Fed Chair, has called for patience and more time to assess past actions' impact and understand potential economic implications from higher bank funding costs. So-called hawkish officials advocate further increases due to concerns about controlling inflation if economic activity and hiring don't sufficiently decelerate. Officials are also wary that maintaining rates steady in July might fuel a market rally easing financial conditions, thus complicating inflation management.
Should inflation not continue its decline and if there isn't a significant economic slowdown, some officials favor a second rate hike in September. However, if consumer- price index reports suggest progress, data might suggest halting further hikes. Officials believing the full effect of rate increases hasn't manifested may suggest waiting until November or December to decide on a second rate hike. If economic activity slows, officials could move to hold rates steady as inflation slows.
The September and November meetings will be backed by additional employment and inflation data, guiding decisions on rate hikes. Neutral positions are expected in the Fed's outlook, emphasizing that progress is being made, albeit at a slower pace than preferred. The shift in rate policy can hinge upon diverse influences, including the impact of three midsize institution failures and the subsequent increase in bank funding costs earlier this year. Policymakers remain concerned about maintaining a delicate balance to not disrupt economic stability while aggressively combating inflation.
Adapted from WSJ, FT, NYT, Reuters, CNBC