Jan 29, 2023
Powell’s Narrow Path Would Avoid Routes Taken by Burns, Volcker
(Bloomberg) -- Federal Reserve Chair Jerome Powell is trying to avoid emulating both the derided Arthur Burns and the celebrated Paul Volcker as he confronts intense pressure to rein in inflation and sidestep a recession.
Ex-Fed chief Burns let inflation get out of control in the 1970s by failing to keep monetary policy tight enough for long enough to permanently beat back price pressures. Volcker then conquered double-digit inflation in the 1980s, but the victory came at an enormous expense: A painfully deep economic downturn that pushed unemployment above 10%.
“Powell wants to write his own page in the history books as someone who, unlike Burns, did not blink and reverse too soon, and, unlike Volcker, did not intentionally cause a recession,” said Vincent Reinhart, chief economist at Dreyfus and Mellon who previously spent a quarter century working at the Fed.
The result: After aggressively raising interest rates last year to catch up with a price surge they initially dismissed, policymakers are expected to downshift to a quarter-percentage-point hike this week as they probe for a policy stance tight enough to tame inflation without a recession.
Powell is likely to accompany that with a promise to keep rates elevated for some time and not ease policy before the Fed is certain it has price pressures in check.
There’s a lot that could go wrong with this hybrid strategy. Oil prices and inflation could flare anew — a distinct possibility now that China is reopening the world’s second-largest economy — forcing the Fed to revisit rate hikes later in the year.
Conversely, unemployment could rise by more than the modest amount policymakers expect as they hew to a tight policy stance to combat inflation.
Fed officials from both sides of the policy spectrum have recently sounded more optimistic about the central bank’s chances of engineering a soft landing that moderates price gains without crunching the economy.
Vice Chair Lael Brainard, widely considered a dove, said this month that she saw “slightly better” chances of such an outcome.
St. Louis Fed President James Bullard, a hawk, was more definitive: “The prospects for a soft landing have improved markedly,” he said on Jan. 18.
The Biden administration – which has a lot at stake in the Fed getting policy just right – is also talking up the outlook.
Jared Bernstein, a member of Biden’s Council of Economic Advisers, told Bloomberg Television on Jan. 26 that he saw “a plausible and credible path to what the Fed calls a soft landing and what we think of as a transition to steady, stable growth.”
Behind the optimism: A fall in inflation. The personal consumption expenditures price index – the Fed’s favorite gauge – rose 5% in December from a year earlier, down from 7% in June though still well above the central bank’s 2% goal.
Fed officials have also been heartened by signs of a slowdown in rapid wage growth, which they’re hoping will be confirmed by the release of the latest employment cost index, a broad measure of compensation, at the start of their two-day policy meeting Tuesday.
Most private economists though don’t think the Fed will get by without pushing the US into a downturn. Forecasters surveyed by Bloomberg this month put the probability of a contraction over the next year at 65%.
The housing market is already in recession, hammered by the steep rise in interest rates engineered by the Fed in 2022.
While demand has picked up a bit as mortgage rates have eased from last year’s highs, “we’re probably not at the bottom yet,” said Doug Duncan, chief economist at mortgage giant Fannie Mae.
Manufacturing has also hit the skids, hurt by a slowdown in the global economy and a shift in consumer spending away from goods to services.
3M Co., the maker of everything from Post-it notes to touch-screen displays, said last week that it plans to cut about 2,500 manufacturing jobs after demand tailed off toward the end of 2022.
Consumer expenditures, the bulwark of the economy, have held up in the face of sky-high inflation, as households have drawn on savings built up during the pandemic and seen their incomes boosted by a vibrant jobs market.
“While macroeconomic and geopolitical uncertainty persists, consumer spending has been remarkably resilient,” Mastercard Inc. Chief Executive Officer Michael Miebach said in a Jan. 26 statement on the company’s 2022 earnings.
But there were signs of fraying as 2022 drew to a close. Adjusted for changes in prices, personal spending dropped 0.3% in December, with outlays for services stagnating, the first month without an increase since January 2022.
What Bloomberg Economics Says...
“Despite a soft headline print for December’s personal consumption expenditure deflator, inflation remains heady in core services excluding housing rents... The lack of evidence that the durable inflation component is moderating means Powell will maintain his hawkish message of holding rates higher for longer.”
— Anna Wong, economist
To read the full note, click here
“The consumer spending engine may start to sputter,” said Deutsche Bank Securities chief US economist Matthew Luzzetti, who forecasts the economy will slip into a moderate recession in the second half of 2023.
Moody’s Analytics chief economist Mark Zandi said he expects the US to dodge a downturn, but acknowledged that it’s a close call.
“To avoid a recession, we’re going to need a bit of luck and some reasonably deft policy making by the Fed,” he said.
--With assistance from Katia Dmitrieva, Reade Pickert and Ana Monteiro.
©2023 Bloomberg L.P.