Coal in the Fed's stocking last year turned to sugar plums in 2023
Send a link to a friend
[December 18, 2023] By
Howard Schneider
WASHINGTON (Reuters) - The U.S. Federal Reserve started 2023 on a grim
note, with staffers calling a recession "plausible," and policymakers
penciling in growth near stall speed and rising unemployment as the
costs of quashing inflation with rapid-fire interest rate increases.
But it ends with the Fed registering faster-than-expected progress on
inflation that occurred with virtually no rise in the jobless rate and
an economy that grew fully five times faster than the 0.5% policymakers
anticipated a year ago. Rate cuts are now in the offing.
“We were very fortunate,” over the course of the year, Atlanta Fed
President Raphael Bostic told Reuters last week.
What just happened?
Over the year a series of things turned the Fed's way, sometimes
unexpectedly and not necessarily due to monetary policy. Just as 2022
was a year of bad forecasts and bad breaks, including war in Europe, the
2023 economy began looking more normal after pandemic-era excesses. It
redeemed, to some degree, early Fed thinking that high inflation would
ease over time without the central bank squelching growth altogether.
Actions taken by the Fed included an emergency lending program for banks
that helped ease financial sector tensions at a key point. There were
also legitimate surprises like a rise in productivity, and other
developments tied to the economy’s underlying performance, like the
increase in the labor force.
“Institutions have evolved and opportunities have become sufficiently
attractive that people have come back in strong. I was not expecting
that. That's very positive,” Bostic said.
The forecasts still weren't great through an uncertain and volatile
period. But this time the surprises were mostly to the good.
MONEY FOR NOTHING, CHIPS FOR A FEE
Fed Chair Jerome Powell stopped using the word "transitory" to describe
inflation long ago, but last week he described, without saying it, why
that belief took hold.
The pandemic had dumped trillions of dollars of aid into consumers'
hands, stoking demand that hit a wall as the global goods supply chain
became stilted by that same pandemic. Shortages of basic industrial
goods like computer chips kept inventories bare and allowed rising
prices to ration what was available.
This year saw supply pressures unwind as inventories rebuilt, perhaps to
excess. Goods prices began to drag headline inflation lower, as was
often the case before the pandemic.
Labor supply also surprised to the upside. After concerns early in the
pandemic that women's ability to work had been permanently scarred, the
number of women in the workforce hit a record high. Rising immigration
helped even out what had been a historic mismatch between the number of
open jobs and the number of people looking for work. The boost in the
labor force and drop in job openings have helped slow wage growth that
some top economists worried was on the verge of driving inflation
higher.
HOUSEHOLDS HOLD THE FORT
While the gusher of pandemic aid may have helped push up prices from
high demand, the financial buffers built by households and local
governments had more staying power than many economists expected. Over
2023, long after pandemic benefit programs had ended, there were still
estimates of hundreds of billions of dollars left to spend.
That showed up in consumer spending that consistently beat expectations.
Though recent data suggests demand has finally begun slowing, the
surprising resilience of household spending was a key reason the Fed's
initial growth forecasts proved low.
[to top of second column] |
The Federal Reserve building is seen in Washington, U.S., January
26, 2022. REUTERS/Joshua Roberts/File Photo
A PRODUCTIVITY BONUS
All things equal, that unexpectedly strong jump in gross domestic
product should be inflationary. The Fed estimates the economy's
underlying growth potential is around 1.8% annually, so 2023's
estimated 2.6% expansion seems out of kilter.
But "potential," at least for now, may have been lifted by a jump in
worker productivity. Rising productivity is manna for central
bankers, allowing faster growth without inflation because each hour
of work yields more goods and services at the same cost.
It is also something they are reluctant to predict or rely on. In
this instance, however, it helped Powell drop what had been steady
references to the "pain" needed to subdue inflation through rising
unemployment and instead talk more openly of the relatively
pain-free disinflation apparently underway.
Today's unemployment rate is 3.7% versus 3.6% when the Fed began
raising interest rates. It has been below 4% for 22 months, the
longest such run since the 1960s, and roughly what prevailed just
before the pandemic, a period Powell heralds frequently.
THE BANKING CRISIS THAT WASN'T
A final surprise is how contained the spring's round of bank
failures proved to be after the rapid collapse of Silicon Valley
Bank. Those tremors prompted new caution among Fed policymakers
about the speed of further rate increases, and led to warnings of a
deep financial fracture as banks took stock of the fact their
holdings of government and mortgage securities had lost value due to
Fed rate hikes.
Certainly there was stress. But it didn't evolve into a broader
crisis and stayed in line with what the Fed was trying to do anyway:
Tighten credit to cool the economy.
Indeed, following what proved to the Fed's last rate increase in
July, markets began doing some of the central bank's work for it by
driving borrowing costs higher than the Fed anticipated doing with
its own rate.
Market rates are now falling, some dramatically, as the Fed pivots
towards rate cuts. Will the markets go too far?
Fed officials are conscious of the time it takes for changes in
financial conditions to work into the real economy. Recent weeks
have seen increases in loan delinquencies and other signs of
household stress, while there was also worry about the amount of
corporate debt that needs to be refinanced, and the trouble that
could cause companies if rates are unaffordable.
The Fed's "soft landing" scenario won't be assured unless the
central bank, as Powell noted, doesn't "hang on too long" to its
current restrictive policy.
"We're aware of the risk," Powell said last week.
WILL THE GOOD NEWS CONTINUE?
Powell also said he thought some of the forces working in the Fed's
favor, particularly supply improvements, have "some ways to run."
Inflation for the past half year has only been about 2.5%, with
strong arguments for it continuing to fall.
In the Fed's most recently released policy documents, officials
tucked in a subtle statement about their faith in the economy's
return to normal. An index of risk sentiment fell towards a more
balanced view, with inflation even seen by a number of officials as
more likely to fall faster than to move higher.
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea
Ricci)
[© 2023 Thomson Reuters. All rights
reserved.]
This material may not be published,
broadcast, rewritten or redistributed.
Thompson Reuters is solely responsible for this content. |