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Soft Landing or Recession? Choose your own adventure, Richmond Fed exec says

Mar 8, 2024 | HBAV News

Editor’s note: Since Renee’s keynote, the Federal Reserve has met and kept the funds rate at a 23-year high of 5.25% to 5.5%. Leaders at the Fed say they expect to lower the federal funds rate by three-quarters of a percentage point to 4.5% to 4.75% by year’s end. The latest statements do not otherwise impact any of Renee’s comments from this month.

Where is the American economy headed? 

Thanks to aggressive Federal Reserve policies that have rapidly raised the federal funds rate to combat inflation, did we avoid a recession and make a “soft landing?” Or are we still headed for economic decline?

Renee Haltom, regional executive and vice president of Research communications at the Federal Reserve Bank of Richmond

Renee Haltom doesn’t have the answers. 

But the vice president and regional executive of the Federal Reserve Bank of Richmond does have data, which she brought to the Women Building Virginia Breakfast on Thursday. Her insights allowed the 100 attendees, as Haltom said, to “choose your own adventure.”

How we got here

As demand for goods and services surged during the pandemic, supply couldn’t keep up — creating a recipe for inflation. The Fed began raising interest rates in early 2022, causing supply and demand to rebalance. But rates today remain at 5.25% to 5.50%.

Though a recession was predicted, as can occur when the Fed raises rates, one never came. Noting her keynote was not the official position of the Fed, Haltom presented the data for members of the Home Builders Association of Virginia to allow them to chart their own path forward.

An Argument for a “Soft Landing”

Gross Domestic Product grows at about 2% over time. Anything above that is hot growth, and anything below is weak. 

Growing economy: Post-COVID, growth has been hot as economic sectors played catchup. And despite rising rates, the economy has shown “incredible resilience,” she said, with GDP growth above the long-term trend of 2%. Forecasts suggesting a slowing trend, but not a recession.

“The main reason that the economy has been strong is that the consumer has continued to come out, continued to spend despite inflation,” Haltom said. “The consumer has just showed this appetite to keep spending.”

The Blue Chip Economic Indicators survey showed about 87% of economists anticipate a soft landing for America’s economy. Fed chair Jerome Powell doesn’t see any risk of recession, either, she said.

Labor market health: Job growth has been rapid but is leveling off at a more sustainable pace — a positive sign. As a reference point, she said 80,000 to 100,000 jobs per month must be created to keep up with population growth; January added 353,000 jobs. “Never make too much of the ‘one-month wiggles,’ but the point is that job growth has been rapid,” she said.

Labor market churn has decreased, with fewer job openings and lower “quits rates,” indicating a more stable employment environment. 

Tight labor market: The unemployment rate is at 50-year lows, and claims for unemployment insurance are at historically low levels, suggesting a tight labor market that isn’t poised for mass layoffs.

Inflation trending down: Inflation, measured by the personal consumption expenditures index and core measures of various sectors (which does not include food and energy, which shift regularly), has steadily decreased from its spike, showing progress towards the Fed’s 2% target. Inflation holds around 2.5% to 3%.

“Never before in the Fed’s history have we brought down inflation to this degree without a spike in unemployment,” Haltom said. “This is just a really unprecedented cycle with incredible resilience of the economy.”

The Argument for Recession

But there are potential headwinds.

“The challenge is that you almost never see soft landings in history,” Haltom cautioned. “That tells me that we should be a little bit skeptical, and look for where a harder landing might come from. What’s going to come along that could throw us off our trajectory?”

Consumer spending and savings: Consumer spending represents two-thirds of all economic activity, Haltom said. “Whatever the consumer is doing is the trajectory of the overall economy.” 

Spending has been fueled by added savings during the COVID-19 pandemic due to government stimulus payments, combined with reduced spending on certain items. But that savings stockpile — peaking at $2.1 trillion in August 2021, and last measured in December at $200 billion — is depleting and expected to run out in a few months. “This doesn’t mean the consumer is going to drop off a cliff, necessarily,” she said. “The wealthy segment in particular sitting on a lot of added housing wealth, a lot of added stock market wealth, the job market continues to be strong,” she said. “I would call it a tailwind that’s going away.”

Household distress and delinquency picking up: Signs of household distress, like increasing delinquency rates on auto loans and credit cards, suggest potential financial strain on households, especially among younger age groups. Delinquency rates have ticked up quickly, despite those rates remaining at historic lows. “But the rapidity of that rise is a little concerning,” she said. “Banks are very much watching and taking precautions [to] protect themselves against it.”

Geopolitical uncertainty: A contentious and looming 2024 presidential election. Conflicts in Ukraine and the Middle East. “Suffice to say there are some really scary things happening in the world,” she said. Before U.S. presidential elections, sales “mute a tad” before November. 

The election “is something that’s out there that could have an impact on sentiment and in spending, maybe even business investment,” she said. “I don’t hear a lot of people changing their investment decisions now, but of course, it’s a huge potential source of future shocks to the economy that are just really, really tough to anticipate with any specificity.”

Retail sales are cooling, and consumers are getting more price sensitive. The retail trend is “somewhat downward,” but the data is hard to determine at this time of year as the holiday season rolls off. The point, she said, is to keep watching how consumers act.

Inflation’s last 1% drop will be tough: Inflation considers five sectors: Goods, Services, Food, Energy, and Shelter. With inflation sitting around 3%, and Haltom and team targeting the Fed’s 2% goal, further reduction is going to be difficult because of the inflexibility, in particular, of the Services and Shelter (i.e., housing) sectors. 

  • COVID drove Goods inflation. That’s over, and “anyone who produces goods for the household sector is struggling a bit,” she said. Much of the inflationary reductions have come from goods, such as food. 
  • She’s also watching Shelter costs, especially as homes are in short supply and rents and home prices continue to rise. Shelter “is a very sticky category of inflation. It doesn’t go away quickly,” she said. It’s adding to inflationary pressure and has little flexibility to bring inflation down.
  • Cost of Services are also concerning. Wages are up from a few years ago, and businesses continue to carry those costs and struggle to pass them to consumers. Businesses want to try and hang on to some of the increased costs, but will customers still buy? “That’s the fight we’re seeing play out right now. And that’s going to tell us where inflation goes,” she said.

Labor market tightness and wage pressure: Worker demand (blue line) outpaces the labor force (gray line), creating wage pressure.

“There’s something different about where we are right now. Ups and downs are one thing, but this is a more fundamental, longer-term issue that I believe is a risk for inflation,” she said. “It’s really a question for our whole workforce development system. It’s a question for immigration policy. It’s a question for fertility policy. It’s a question of how we keep older workers engaged in the workforce. We need everybody [working] right now to produce what we need to produce.”

Housing supply shortage. One key ingredient to attracting workers? Giving people a place to live, she said. But supply of housing is nearing historic lows. And housing starts continue to lag pre-Great Recession levels. 

“I cannot tell you how many more conversations I’m in these days about the overall economy and workforce, where housing is now a part of it,” she said. “Those conversations are linked now. That’s beneficial from the perspective of talking as a society, as localities, as a state, about solutions around improving the supply of housing. This is something that everyone is feeling.”

Households are also burdened by housing costs, regardless of urban or rural region. “There isn’t a region I visit that’s not struggling with housing,” she said. The shortage and high costs highly impact economic development and businesses’ ability to attract workers.

Rate outlook: Economic models suggest it takes nine to 24 months for rate hikes to fully make their way through the economy — and those effects may have not been fully felt. “It hits interest rate sensitive sectors like [housing] first,” she said. Longer-term contracts and business decisions take longer to be impacted. “There’s still some heat to feel from the impact of the Fed’s rate increases that we should all be expecting.”

And in Conclusion

Haltom reiterated that she does not have the answers. She said rates may hold for longer in order to meet the 2% rate. If they back off too soon, she said, inflation will return but worse, she said. “You have to deal with the inflation risk,” she said.

If there is a recession? “There’s really good reason to believe it will be mild,” she said. Businesses and consumers are optimistic. Companies don’t plan to cut workers.  And in planning for recession, companies have resiliency plans.

She also reminded attendees that most recessions come not from economic indicators she reviewed, but a shock: 9/11, the 2008 housing crisis, COVID.

“What I do know is that inflation is going to be the Fed’s number one job — regardless of an election year, regardless of if the economy starts to weaken,” she said. “Inflation is what we’ve been congressionally mandated to focus on. So we are going to be diligent about tightening the economy in order to get inflation down.”

Where will rates go?

The Federal Open Market Committee (FMOC), which consists of 12 leaders of the Fed, meets throughout the year to review economic and financial conditions. Their forecast for interest rates — “the dot plot,” shown here — illustrates where anonymous members (one of whom is Richmond Fed president Tom Barkin) project interest rates to land in the future. The median expectation at the end of 2024 is 4.6%, relative to 5.1% today. Committee members expect two or three rate cuts this year.

“As you play along at home, as the year goes on, if you see inflation being more stubborn, maybe mark up your expectation of interest rates,” Haltom said. “If you see inflation being more confined and sustainably coming down, mark your expectation down. That’s the best guidance I can give you.”

The Fed will update its projections in a few weeks.