Fed sets monetary policy amid mixed signals on US economy

After trying to tame inflation over the past year with an urgent policy change amid relentlessly rising prices, the Federal Reserve now faces a more nuanced decision on whether the economy is strong enough to support even higher interest rates or is on the verge of collapse.

The financial market and professional analysts seem prepared for the last option. US investors, from the boldest to the most conservative, have lost more than $8 trillion this year as the market withers under the Fed’s fastest rate hikes in 40 years.

The bond market seems convinced that a recession is coming, and economists, in Reuters polls and elsewhere, agree.

But this apparently stressed environment is also sustaining unemployment rates that are at record lows for Latinos and near record lows for blacks. Wage gains are strong and consumption, the mainstay of US economic growth, continues to grow even after adjusting for inflation.

Many factors influence when and if the economy enters a recession, but it will invariably involve rising unemployment and falling consumption.

“The economy has never been more unloved than it is now,” wrote Bob Schwartz, a senior economist at Oxford Economics, in a recent analysis that exposed the “bipolar” set of circumstances that Fed officials will consider at their two-day policy meeting. this week.

Consumer confidence is abysmal, worse than when the economy was at the height of the pandemic, but bank accounts and spending remain healthy; manufacturing is contracting, but the services sector roars with monthly job and wage growth to prove it; there is some evidence that inflation is easing, with gas prices back where they were a year ago, but it is still higher than many have seen in their lifetimes and continues to strain household budgets through food and other increases costs.

There is enough evidence of weakness to fuel an impending recession narrative.

But there’s also enough evidence of strength to tell a story of continued growth.

Fed officials will receive new consumer price data when their meeting begins on Tuesday, and expect it to show a continued slowdown in price hikes after annual inflation fell below 8% for the first time in eight months in October. .

They signaled plans to continue raising rates at this time as they try to cool the economy and keep prices in check. But they also plan to move forward with smaller increases. After a series of big 75 basis point hikes this year pushed the benchmark rate from near zero in March to a range between 3.75% and 4%, Fed officials are likely to stick to 50 basis points during the two-day meeting that ends on Wednesday.

The decision to move forward in smaller steps is an acknowledgment by Fed officials that they may be close to a stalling point after this year’s aggressive rate moves and that every step from here increases the risks of going too far.

So far, Fed officials don’t feel they’ve crossed the line.

That doesn’t mean they won’t. Alongside the latest rate decision, the Fed on Wednesday will provide updated projections on how policymakers think rates may need to move, how long they will remain stable and how the economy will respond. It’s an outlook that will show whether the central bank still believes it can curb inflation without doing serious damage to the job market, and will set the tone for the US economic debate in the early stages of the 2024 presidential campaign.

Bond investors appear to have placed their bets, with interest rate yield curves “inverting” in what is traditionally seen as a sign that a recession is coming.

Either way, 2023 is likely to tell the story.

Fed Chair Jerome Powell declined to bet on the outcome, saying only that a soft landing remains “plausible”.