The Federal Reserve and the art of navigating a soft landing ... when economic data sends mixed signals

With inflation easing and the U.S. economy cooling, is the Federal Reserve done raising interest rates? After all, gently bringing down the trajectory of prices without crashing the economy was the central bank’s objective when it began jacking up rates over a year ago.

Gross domestic product, the broadest measure of an economy’s output, expanded at an annual pace^[1] of a mere 1.1% in the first quarter, according to data released April 27, 2023 – down from 2.6% recorded in the final three months of 2022. And the latest consumer price data, from March, shows inflation slowing to 5% on an annualized basis, the least in about a year^[2].

Unfortunately for consumers and businesses weary of soaring borrowing costs, the Fed’s not likely done hiking rates quite yet. Financial markets are predicting another quarter-point hike^[3] when the Fed meets for a two-day meeting that ends May 3, 2023. And there could be several more increases to come.

But this does raise another important question: With all the recent, often conflicting, data and narratives regarding inflation^[4], bank failures^[5] and layoffs in the tech sector^[6], is the Fed close to engineering the “soft landing” it’s been hoping for?

The economy zigs then zags

The GDP data is a mixed bag and provides some clues to the answer.

Overall, the recent GDP figures suggest a likely economic slowdown going forward, due largely to a drawdown in inventories – that is, rather than ordering new goods, companies are relying more on stuff currently in storage. Businesses seems more inclined to sell what is on hand rather than order up new products, likely in anticipation of a slowdown in consumption. And business investment declined 12.5% in the quarter.

At the same time, consumer spending, which represents about two-thirds of GDP, grew at a healthy 3.7% pace, and investment in equipment such as computers and robotics increased by 11.2% – though this category is quite volatile and could easily turn in subsequent quarters.

Other data also points to a slowdown, such as a decline in new orders for manufactured goods^[7]. This, combined with the drawdown in inventories in the GDP report, might suggest that businesses are anticipating a slowdown in demand for goods and services.

When we look at the labor market, while job increases have been strong^[8] – 334,000 over the past six months – job openings have been declining. After peaking at about 12 million in March 2022, openings dropped to about 9.9 million^[9] as of February, according to the Bureau of Labor Statistics.

Inflation: Is it high or low?

In terms of inflation, we can also see conflicting numbers.

The headline consumer price index has indeed slowed steadily^[10] since peaking in June 2022 at 9.1%. But the core preferred consumption index, the Fed’s favored measure of inflation^[11], has remained stubbornly elevated^[12]. The latest data, released on April 28, 2023, showed the index, which excludes volatile food and energy prices, was up 4.6% in March^[13] from a year earlier and has barely budged in months.

Meanwhile, wages, which when rising can have a strong upward push on prices, climbed at an annualized 5.1% in the first quarter^[14], also according to data released on April 28. That’s down from the peak of 5.7% in the second quarter of 2022 but is still about the fastest pace of wage gains in at least two decades.

More hikes to come

So what might all this suggest about Fed actions on interest rates?

The next meeting is scheduled to end on May 3, with the market odds greatly favoring^[15] another 0.25 percentage point increase – which would be the 10th straight hike^[16] since March 2022.

With the inflation rate still well above the Fed’s target of about 2%, combined with continued job growth and a low unemployment rate, the central bank is likely not done ratcheting up rates. I agree with the market odds pricing in a quarter-point hike for the May meeting. Future data will guide any future rate increases beyond that.

The good news is that, I believe, the larger rate increases are well in the past.

Landing softly – or at least mildly

That brings us back to the big question: How close is the Fed to sticking a soft landing, in which the U.S. economy manages to tame inflation without a recession?

Sadly, it’s too early to tell. Labor markets can be very volatile and political and international events – such as potential gridlock on debt ceiling talks^[17] or further escalations in the Ukraine War^[18] – can turn things upside down. That said, we are either looking at a mild recession or a growth recession.

What’s the difference? A growth recession^[19] signals a weak economy but not enough to significantly drive up unemployment – and that’s preferable to even a mild recession of multiple quarterly drops in GDP and much higher unemployment.

We just don’t know which is more likely. What I think is true now, though, is that, barring any catastrophic and unpredictable events, a severe recession has been avoided.

References

1. ^{^} expanded at an annual pace (www.bea.gov)
2. ^{^} least in about a year (fred.stlouisfed.org)
3. ^{^} Financial markets are predicting another quarter-point hike (www.cmegroup.com)
4. ^{^} inflation (theconversation.com)
5. ^{^} bank failures (theconversation.com)
6. ^{^} layoffs in the tech sector (techcrunch.com)
7. ^{^} decline in new orders for manufactured goods (www.census.gov)
8. ^{^} increases have been strong (www.bls.gov)
9. ^{^} about 9.9 million (www.bls.gov)
10. ^{^} has indeed slowed steadily (www.bls.gov)
11. ^{^} Fed’s favored measure of inflation (www.bloomberg.com)
12. ^{^} has remained stubbornly elevated (fred.stlouisfed.org)
13. ^{^} was up 4.6% in March (www.bea.gov)
14. ^{^} climbed at an annualized 5.1% in the first quarter (www.nytimes.com)
15. ^{^} market odds greatly favoring (www.cmegroup.com)
16. ^{^} would be the 10th straight hike (www.federalreserve.gov)
17. ^{^} potential gridlock on debt ceiling talks (www.brookings.edu)
18. ^{^} further escalations in the Ukraine War (www.bbc.com)
19. ^{^} growth recession (www.investopedia.com)