There's hope for the Fed's "soft landing" but economists are nervous

Bringing inflation down without a recession can be done, but the Fed's only tool is blunt.
Looking for the signal in the noise. 
Looking for the signal in the noise. 
Photo: Elizabeth Frantz (Reuters)
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Whether the Federal Reserve can curb inflation without triggering a recession remains an open question. But fresh economic data suggests a “soft landing” for the US and global economy is entirely possible.

A key measure of US inflation, the personal consumption expenditure (PCE) price index, moved up by only 0.2% in October, a big deceleration from the 0.5% increase reported for September. Along with the good news for US inflation, the pace of EU inflation retreated in November for the first time in 17 months.

The US also added 263,000 jobs in November, according to data from the US Bureau of Labor Statistics. October’s jobs growth was also revised up from 261,000 added to 284,000. This pace of job growth is well above pre-pandemic trends, and shows a labor market that’s fairly resilient to interest rate hikes.

Meanwhile, another BLS report released this week showed US job openings declined by 353,000 in October, while the percentage of workers quitting dropped from 2.7% to 2.6%. Earlier this week, Fed chair Jerome Powell said that the Fed aims to lower the number of job openings, while keeping the unemployment rate from rising.

An opening for the Fed

While the softest of soft landings—which would be inflation moving down without any economic slowdown—is no longer an option, the moderating of job growth along with a decline in the pace of inflation would give the Fed an opening for bringing inflation back down to 2% without triggering a recession, said Guy Berger, principal economist at LinkedIn.

The earnings measure in November’s jobs report showed hourly earnings moving up by 0.6%. This is faster than the 0.4% increase in October earnings, and will cause Fed officials to lean towards pushing interest rates higher.

While Powell has argued that wage growth is not the primary cause of inflation, he has said it’s a major driver. We can assume the Fed is more likely to raise rates to a level that increases unemployment if earnings remain high.

Future interest rate hikes already look to be slower

The Fed already has signaled that it is shrinking the size of interest rate increases (likely from 75 basis points down to 50 basis points in December) so it can assess the cumulative effect of its hikes while deciding how high rates should go and how long it should keep them high.

Either way, the Fed’s only inflation-fighting tool is blunt, and works by breaking things in the labor market.

What economists are looking out for now is anything that would suggest the labor market is turning quickly, Berger said. This could mean the US unemployment rate moving up to 3.8%, a level that it hasn’t been in months, or only 100,000 jobs being added in a month, which would be a sizable slowdown compared to recent gains.

If that happens, the Fed can’t do much outside of cutting rates to reverse the downward momentum.