Fed believes the US economy will have a soft landing, experts are cautious

At this time last year, most economists predicted that in 2023, the US Federal Reserve (Fed) would face a US economic recession as it continued its fight against strongest inflation wave in more than 4 decades.

But in fact, the world’s largest economy this year has posted stronger growth than any other major economy, the unemployment rate has held near record lows, and price pressures show There are many signs of de-escalation, with the yearly inflation rate gradually receding towards the 2% target set by the Fed. That string of better-than-expected economic data prompted Fed Chairman Jerome Powell to close out 2023 by betting on the reputation of the Federal Open Market Committee (FOMC) that next year will be nearly as good. like this year.

THE FED’S PERFECT SCENARIO FOR 2024

During the December monetary policy meeting, the Fed announced updated economic forecasts showing that FOMC members – the decision-making body within the Fed – forecast there will be three federal funds rate cuts in 2024. , for a total cut of 0.75 percentage points. The federal funds rate, the Fed’s operating interest rate, is currently around 5.25-5.5%, the highest in 22 years, after 11 consecutive increases in the tightening campaign starting in March 2022. .

The FOMC forecast is based on the belief that the US economy will have a soft landing – with inflation falling toward the Fed’s target, growth slowing only slightly, and unemployment remaining reasonably low. .

“No one can map out a more perfect economic scenario than what the FOMC forecasts,” said Santander bank’s chief US economist Stephen Stanley. “If that scenario becomes a reality, it would be a wonderful thing. But the possibility of that scenario not becoming reality is very high.”

According to the Financial Times, some economic experts believe that Mr. Powell’s belief is somewhat hasty and that the Fed’s softness may make it more difficult for the central bank to move forward. A smooth way from the period of high interest rates that has lasted for many months.

“The Fed’s forecast for the economy in 2024 is clearly optimistic. That is certainly the result they want, but we are not sure whether they will achieve it or not,” said TD Securities head of global macro strategy, Mr. James Rossiter.

Many experts were surprised by the FOMC’s new optimism about the economy.

“Mr. Powell has a difficult mission, and over the past 18 months, he has made a good impression. But recently, the Fed’s policy direction has become very unstable,” said Chairman Gavyn Davies of asset management company Fulcrum Asset Management.

Just in November, Mr. Powell also commented that the process of reducing inflation in the US could be “bumpy”. By mid-December, he described the final stage of the fight against inflation as looking flatter. “Inflation is continuing to decline. The labor market continues to return to equilibrium. Everything is fine so far. We see that things will be more difficult from now on, but not yet,” the Fed Chairman said at a press conference on December 13.

After positive information about inflation in recent months, Fed officials forecast that the core personal consumption expenditures price index (PCE) – the Fed’s preferred inflation measure, excluding energy and food prices – will grow at a rate of 2.4% next year, before decelerating to 2.2% in 2025 and to the target of 2% in 2026.

This smooth deceleration in inflation – along with FOMC members’ forecasts that the Fed could cut interest rates three times in 2023 – suggests that policymakers believe this wave of inflation is mainly Weakness is a phenomenon caused by supply problems. To be more specific, high inflation in the US recently stems from the scarcity of labor and goods during the Covid-19 period, instead of due to the super loose state of fiscal policy and monetary policy during the pandemic. pandemic.

If that assessment is correct, barring supply shocks – such as a spike in oil prices or another disruption to global trade – price pressures will continue to decline even if the Fed eases up. no matter what.

WARNING FROM EXPERTS

Many analysts agree with Fed officials and their forecasts on prices. “The overall inflation picture shows that inflation is quickly returning to normal. That gives the Fed a little comfort,” TD Securities expert Rossiter said.

However, others warn that the risk of increased inflation is still there.

“If disinflation progress falters and it appears that the path to reducing inflation to the 2% target becomes less clear, the Fed’s tone will have to change,” Mr. Stanley said. “I was a little skeptical. I do not think we will continue to see the rapid improvement in the inflation picture as we have seen in the past few months.”

Mr. Davies said that core PCE figures for the first three months of the year will be the deciding factor in whether the Fed can cut interest rates in the spring or not. “Compared to 6 months ago, at this time, the possibility of a soft landing of the US economy is higher thanks to the improvement of core inflation. But nothing is certain yet,” he said.

After the December meeting, Fed planners said that in 2024 they planned to focus more on full employment in their mission to fight inflation. One of the surprises about the US economy this year is the solidity of the labor market, with the unemployment rate remaining low, just 3.8% in November. The FOMC forecasts the unemployment rate to be only rising slightly to 4.1% next year – a level still considered within the threshold of full employment – as price pressures continue to ease.

Such periods of “pure disinflation” – with price increases kept in check without unemployment rising – are rare.

Some economists say the Fed’s forecast is little more than a wish. “If the Fed avoids pre-emptive interest rate cuts, and keeps interest rates unchanged through the second half of 2024, unemployment will increase significantly. To reduce inflation to 2%, we think the wage growth rate must decrease to 3.5% and the unemployment rate must increase to about 4.5%,” Vanguard economist Andrew Patterson commented. .

“We expect there will be a US economic recession in 2024. It will not be a deep recession, but the unemployment rate will rise to 4.6%. That would be a pretty sharp increase from the current unemployment rate,” said Mr. Rossiter. “All central banks are hoping for a perfect soft landing for their economies. But it is difficult to believe they will achieve that in an environment with so many geopolitical risks. Everything has gone smoothly until now, but we realize 2024 will be a bumpy ride.”

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