How's This Movie Going to End?
Chief Economist Scott Brown discusses current economic conditions.
As expected, the Federal Open Market Committee raised short-term interest rates, signaled more to come, and announced the start of its balance sheet runoff. Stock market participants were relieved (briefly) after Fed Chair Powell signaled that the FOMC was unlikely to move more sharply (75 basis points) at the next couple of policy meetings. Still, the labor market is extremely tight and inflation pressures remain elevated (despite a dip in gasoline prices in April). A soft landing is possible, but the odds of a recession have increased (30-35%, which is relatively high), and the Fed is prepared to go full-Volcker (raising rates enough to cause a downturn) if that is what it takes to get inflation down. While there may be some pain in the near term, the long-run prospects for the U.S. economy remain positive.
Nonfarm payrolls rose by 428,000 in the initial estimate for April, about as expected and well beyond a long-term sustainable pace. The unemployment rate (accurate to ±0.2%) held steady at 3.6%. Looking at a graph of the unemployment rate over the last several decades, one sees that low unemployment is always followed by a recession. That’s because the Fed raises short-term interest rates to keep inflation in check. Can the Fed avoid a similar fate this time?
As widely expected, the FOMC raised the target range for the federal funds rate by 50 basis points (to 0.75-1.00%) and said it anticipates that “ongoing increases in the target range will be appropriate.” The FOMC also announced it would allow a maximum of $47.5 billion per month to run o- the balance sheet starting in June, stepping up to $95 billion per month in September. Asked whether the FOMC was considering more aggressive action, Chair Powell responded that “75 basis points is not something the committee is actively considering.” He added, “there’s a broad sense of the committee that additional 50-basis-point increases should be on the table for the next couple of meetings.” As my dad used to say, “Rome wasn’t burnt in a day.”
High inflation reflects strong demand and restrained supply. The Fed cannot do much about supply constraints, but it can work to slow demand. The current federal funds target range is still accommodative (a neutral policy rate is seen as 2.25-2.50%). However, the Fed’s forward guidance (the management of expectations of future rate increase) will be doing the heavy li0ing. Mortgage rates are substantially higher that they were at the start of the year. Credit is still easy, but should tighten.
The Volcker-led Fed raised short-term interest rates sharply in the early 1980s, pushing the economy into a recession to bring inflation down. Inflation is currently lower than in the early 1980s, but the Fed is starting from a low policy rate. The Volker Fed had some luck with falling energy prices. The current Fed faces prolonged supply chain issues and de-globalization.
Powell has said that the Fed will do what is necessary to bring inflation down. That means much slower economic growth and a possible recession. We don’t appear to be in a situation where a downturn would do prolonged financial damage (as the late William Safire once quipped, “nothing recedes like recession”). The economy’s long-term prospects remain hopeful. Peace Out
Recent Economic Data
Nonfarm payrolls rose by 428,000 in the advance estimate for April, about as expected, while the unemployment rate held steady at 3.6%.
Nonfarm productivity fell at a 7.5% annual rate in 1Q22 (-0.6% y/y), while Unit Labor Costs (a key gauge of inflation pressure) jumped 11.6% (+7.2% y/y).
The April ADP estimate of private-sector nonfarm payrolls showed job losses at small firms, which are facing greater difficulty in hiring and retaining workers.
The March Job Opening and Labor Turnover Survey (JOLTS) data showed job openings rising to a record
11.5 million in March, while 4.5 million workers quit.
The U.S. trade deficit rose to a record $109.8 billion in March. Imports jumped 10.3% (+27.0% y/y), partly reflecting higher prices, but consistent with strong domestic demand.
Unit motor vehicle sales rose 6.6% to a 14.3 million seasonally adjusted annual rate in April (-21.9% y/y). The ISM Manufacturing Index fell to 55.4 in April (from 57.1 in March) and the ISM Services Index slipped to
57.1 (from 58.5), with details from both reports indicating strong demand, supply constraints, and elevated inflation pressures.
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