America appeared to be headed for an economic fairy tale that would end at the end of 2023. The painfully rapid inflation that began 2021 appeared to be subsided in earnest, and economic growth was starting to taper off after a series of Federal Reserve interest rate hikes.
But 2024 has brought a series of surprises. The economy is expanding rapidly, employment growth is unexpectedly strong, and inflation is showing signs of slowing. Add it up and you might arrive at a completely different conclusion.
Instead of the “soft landing” that many economists thought was underway (a situation in which inflation slows as growth moderately settles without causing a painful recession), analysts believe the U.S. economy is landing at all. There is growing concern that the government is not doing so. The economy appears to be booming rather than calming as prices continue to rise faster than usual.
A “no landing” outcome may feel pretty good to a typical American family. Inflation is not as high as it was at its peak in 2022, wages are rising and jobs are plentiful. But this poses a problem for the Fed. The Fed is determined to fight to get inflation back to its 2% target, but at a slow and steady pace that the Fed believes is consistent with price stability. Policymakers sharply raised interest rates in 2022 and 2023 in an effort to squeeze growth and inflation, pushing rates to their highest levels in 20 years.
If inflation remains high for months on end, that could prompt Fed officials to keep interest rates high for an extended period of time to cool the economy and bring prices under full control.
“The continued strength in inflation numbers should give Fed officials pause to think that perhaps the economy is too hot to cut rates now,” said Kathy Bojancic, chief economist at Nationwide. ” he said. “Right now, we're not even seeing a 'soft landing'; we're seeing a 'non-landing'.”
On Wednesday, Fed policymakers received new signs that the economy may not be landing as smoothly as expected. Prices rose more than expected in March, according to a major inflation report.
The consumer price index, which excludes food and fuel costs, is moving at an annual rate of 3.8%. Inflation has been hovering at just under 4% since December, although it has been steadily declining for months.
Although the Fed officially targets another measure of inflation, the Personal Consumer Expenditure Index, the report makes clear that price increases remain stubbornly strong. A few days earlier, the March jobs report showed employers added 303,000 workers, more than expected, as wage growth remained strong.
Neil Dutta, head of economics at research firm Renaissance Macro, said the combination of strong growth and persistent inflation could say something about the state of the U.S. economy, saying the U.S. economy is always in one of four situations. He said that there is a possibility of falling into.
If economic growth declines and eventually inflation rates decline, the economy may fall into recession. This could lead to stagflation, where growth rates decline but inflation rates remain high. Growth and inflation may slow, resulting in a soft landing. Or there could be an inflationary boom, where growth is strong and prices rise rapidly.
At the end of 2023, the economy appeared to be on track for a steady slowdown. However, recent data has been less benign and more momentum-filled.
“There were a lot of chips in the soft landing bucket, but that has been steadily eroded and the possibility of an inflationary boom is back,” Dutta said. “This strengthens the Fed's framework that it has time before deciding to cut rates.”
Fed officials entered 2024 and expected three rate cuts by the end of the year, which would reduce borrowing costs to about 4.6% from the current 5.3%. Officials maintained this assertion in their March economic forecast.
But investors have been steadily scaling back their expectations for rate cuts as inflation and the broader economy show resilience. Looking at market pricing, it appears traders are currently betting big on just one or two rate cuts this year. The market also expects cuts in 2025 to be smaller than previously expected.
Fed policymakers have been increasingly cautious when talking about when and how much to lower borrowing costs.
Federal Reserve Chairman Jerome H. Powell has repeatedly emphasized that strong growth allows central bankers to be patient in cutting interest rates. With an economy this strong, there is less risk that the United States will fall into recession even if borrowing costs remain high for a while.
Some of his colleagues are even more wary. Minneapolis Fed President Neel Kashkari has suggested a scenario where the Fed doesn't cut interest rates at all in 2024 is possible, he said.Kashkari won't be voting on interest rates this year, but he has a seat at the policy-making table. .
The Fed's policies are pushing up borrowing costs across the economy, which could be bad news for households hoping for lower mortgage and credit card rates. It could also create political problems for President Biden heading into the 2024 election, unless higher borrowing costs leave voters feeling worse about the housing market and the economy.
Biden said Wednesday he stands by his expectation that the Fed will cut interest rates this year. It was an unusual comment from a president who normally avoids talking about Fed policy, out of respect for the central bank's independence from the White House.
“This might delay it by a month or so, but I don't know about that,” Biden said.
Many Fed watchers think today's high interest rates could last quite a while. Many economists and investors had previously expected interest rates to start cutting in June or July. This week's inflation report has investors increasingly betting that interest rates won't start cutting until September.
Brelina Ursi, chief U.S. economist at T. Rowe Price, said the longer inflation stays flat, the longer it could take to cut interest rates. Officials are likely to want to see convincing evidence that progress towards reining in inflation has resumed before cutting borrowing costs.
And with the looming possibility that the economy may not actually be landing, some economists and officials are even suggesting the Fed's next action may be to raise rates rather than cut them. Fed Director Michelle Bowman said the Fed remains aware of the risk that “if inflation stalls or even reverses, we may need to raise interest rates further.” Ta.
Bojančić believes that further rate hikes are unlikely at this point. Most Fed officials are still talking about cutting rates. Still, recent data suggests that a long period of stable borrowing costs may be needed for the economy to subside and progress toward lower inflation to resume.
“We'll probably just keep rates at this level for a long time,” he said.
