Fed chair Jay Powell has long contended that the US central bank could tame rampant inflation without tipping the world’s largest economy into a recession, saying as recently as July that he and his colleagues are “not trying to have a recession, and we don’t think we have to”.
On Wednesday, however, that optimism evaporated as Powell delivered one of his gloomiest pronouncements to date about the economic outlook amid what has become the most aggressive campaign to tighten monetary policy since 1981.
“We have got to get inflation behind us. I wish there were a painless way to do that,” he said at the press conference following the Fed’s decision to further extend its recent string of supersized rate rises. “There isn’t.”
Powell’s comments came as the US central bank delivered a third consecutive 0.75 percentage point increase to its benchmark policy rate, a move that lifted the federal funds rate to a new target range of 3 per cent to 3.25 per cent.
Economists interpreted the message as an admission that Powell’s previously stated goal of achieving a “soft landing”, whereby the central bank can cool the economy without excessive job losses, was becoming increasingly unrealistic. The Fed chair himself admitted that the odds of that outcome “diminish” the longer restrictive rates are sustained.
But what they also found striking about Powell’s comments was the uncertainty he expressed about just how severe a recession could result from the Fed’s efforts to root out inflation.
“The news from the press conference is the chair’s acknowledgment that it’s not really just about weak growth,” said Jonathan Pingle, the chief US economist at UBS who previously worked at the Fed. “There is a very real risk of recession and he displays a very real willingness to go through with a hard landing.”
Powell’s stark assessment jolted financial markets, with US stocks erasing an earlier rally to end the day down nearly 2 per cent. The yield on the two-year Treasury note, which is highly sensitive to changes in the outlook for monetary policy, surged to a roughly 15-year high of 4.1 per cent.
Powell’s message was reinforced by a revised set of economic projections published by the Fed on Wednesday, which compiled officials’ individual forecasts for the fed funds rate, growth, inflation and unemployment to the end of 2025.
Officials project rates to rise as high as 4.4 per cent by the end of the year before peaking at 4.6 per cent in 2023. Over that period, the median estimate has the unemployment rate rising to 4.4 per cent as growth slows to 0.2 per cent this year and settles at 1.2 per cent next year.
“Core” inflation, which strips out volatile items such as energy and food, is expected to drop from 4.5 per cent by the end of the year to 3.1 per cent and 2.3 per cent in 2023 and 2024, respectively. In 2025, it is expected to remain just above the Fed’s 2 per cent target.
The revisions — which still stopped short of forecasting an outright economic contraction — marked a sea change from the previous estimates published in June. Those showed a much more benign path for rate rises, far less unemployment and more robust growth even as inflation slowed.
“They’ve written down a forecast that really pretty implicitly has a recession,” said Vincent Reinhart, who worked at the Fed for more than 20 years and is now at Drefyus and Mellon.
He added that when the unemployment rate rises as significantly as policymakers now expect it to, history suggests that an economic downturn takes hold. Moreover, Reinhart said the unemployment rate may need to rise higher than what is currently anticipated for the Fed to achieve its price stability goal.
“They admitted they have a lot of work to do, they admitted there would be pain associated with it, but they did try to downplay the pain,” he said of the new economic projections.
Many economists warn getting inflation back under control may require the unemployment rate rising beyond 5 per cent, with a group of academic economists recently suggesting that it may need to exceed 7 per cent. Some also warn the fed funds rate will eventually eclipse Fed officials’ median forecast, peaking around 5 per cent instead.
Much will depend on what happens to inflation, which has proven far more persistent and difficult to root out than expected.
Powell said the Fed will be closely monitoring incoming data to determine whether it can slow its aggressive pace of 0.75 percentage point rate rises. But according to Gargi Chaudhuri at BlackRock, it is unlikely that both inflation and the labour market will dip sufficiently to warrant a smaller increase at the November meeting.
To pause the tightening cycle altogether, Powell said the central bank would need to be “confident” that inflation is coming down, reiterating the hawkish message he delivered to the annual gathering of central bankers last month in Jackson Hole, Wyoming, that the Fed will “keep at it until the job is done”.
Peter Hooper, a Fed veteran of almost three decades who is now the global head of economic research at Deutsche Bank, said that pledge will become increasingly difficult to stick to as job losses begin to mount and the economic data take a more decisive turn.
“The Fed is in a tough spot here politically,” he said. “They’ve told us it’s going to be painful, but the minute you start getting specific about how much of a recession it is going to take, it starts to generate a lot of opposition.”