Tags: federal reserve | inflation | stocks

Stock Market Getting Ahead of Itself on 'Soft Landing'

Stock Market Getting Ahead of Itself on 'Soft Landing'
New York Stock Exchange (AP)

Peter Morici By Thursday, 04 April 2024 09:19 AM EDT Current | Bio | Archive

U.S. Federal Reserve Chair Jerome Powell is preparing the financial markets for an economic soft landing. Recently he testified in Congress that the central bank may soon be able to start lowering interest rates.

Powell’s optimism parallels the consensus among economic forecasters. The most recent Wall Street Journal survey has GDP growth slowing to around 1% for both the second- and third quarters of this year and inflation gradually decelerating to about 2% by the fourth quarter.

Slow growth but no recession and inflation at 2% — that’s a soft landing,

The financial press is celebrating the few economists who made this call early. Except the trade-off between growth and inflation may not have become so benign, and inflation may yet prove a painful dragon to kill.

Entering 2023, most economists were screaming that the U.S. economy was at risk of a recession — but GDP growth came in at 2.5% and unemployment stayed below 4%.

Just weeks before fourth-quarter 2023 GDP was released — and most of the data needed to compute that figure were in hand — the Wall Street Journal panel of forecasters predicted growth at 1.7%. The most recent estimate is 3.4% — a huge error.

How did all those PhD’s get it so wrong? Can we bank on the Fed’s Team Transitory recast as Team Soft Landing?

The answer is we don’t know what growth and inflation will do next, and Powell’s confidence about an imminent rate cut sets the economy up for some painful adjustments if things go the other way.

On Powell’s words, markets are anticipating a rate cut by June. If he has to walk that back, as he did when inflation proved so menacing instead of transitory, stocks could tank and push the U.S. economy into a recession.

The problem is the pandemic recession and subsequent recovery have been without precedent. This was the only time in modern history that the U.S. and foreign governments purposefully put their economies to sleep and borrowed to offer massive relief payments to support businesses and workers.

Households had fewer places to spend money other than sprucing up their family rooms and home workspaces, and much of the pandemic relief payments were saved.

Consumer spending is the primary driver of growth. After those extra savings were gone, households could turn to credit cards that were underutilized during the shutdown. That extended the recovery longer than forecasters expected.

Interest payments on consumer debt of various kinds are now as large as mortgage payments, but overall household debt is still low by historical standards. Loan delinquencies, though ticking up, are still below pre-financial crisis levels.

Households can keep on spending but still don’t have enough places to spend their money, which drives up prices. For example, Americans are spending more than ever at sit-down restaurants and fast-food takeout, but last year about 4,600 more independent restaurants closed than opened. Restaurants are turning away groups larger than four to maximize turnover at tables, menu prices rose 7.1% in the past year and 25% since 2019.

For guidance in this area, the Fed most closely monitors the Personal Consumption Expenditures (PCE) Price Index. For the most recent month available, February, the annualized monthly pace of price increases was 4.1%. Excluding food and energy, the PCE advanced 3.2%.

The labor market may no longer be red hot but with 1.4 jobs openings for every unemployed job seeker, it remains reasonably tight.

The posture of monetary policy is far from restrictive.

The Fed is operating on the assumption that the inflation-adjusted rate of interest that would not encourage accelerated growth or increase inflation is about 0.5%. But there are good reasons to believe this has risen to about 2%.

Mortgages, corporate bonds and other long-term credit tend to price off the 10-year U.S. Treasury rate, and that’s running slightly above 4% — making the real rate of interest well-less than 2% and monetary policy hardly tight. With core inflation at about 3%, Powell is taking quite a gamble talking about rate cuts now.

A soft landing is anything but certain.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

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The stock market expects a 'soft landing' from the Fed - but that isn't a sure thing.
federal reserve, inflation, stocks
Thursday, 04 April 2024 09:19 AM
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