If the last few weeks are any guide, the coveted soft landing for the economy may be coming into view. But even if the perfect scenario presents itself, that doesn’t preclude policymakers at the Federal Reserve from squandering the opportunity.
Consider the almost fairy-tale sequence of economic data published since the start of the month: Inflation has been ebbing at both the wholesale and consumer levels; average hourly earnings have been moderating to lay the groundwork for easing price pressures going forward; and retail sales have been consistently decent. That final development is critical. To achieve a soft landing, policymakers need consumer spending — the engine of the US economy — to stay buoyant just long enough for inflation to ebb and central bankers to reverse interest-rate increases.
And buoyant it has been. The value of overall retail purchases jumped 1.3% in October from the month earlier, the most since February, according to Commerce Department data released Wednesday. Control group sales — a cleaner measure of the underlying signal that excludes food services, auto dealers, building materials stores and gasoline stations — rose 0.7%, far exceeding the 0.3% median expectation of economists in a Bloomberg survey.
Central bankers have been fighting the worst inflation in 40 years by raising the federal funds rate to the highest absolute levels since the financial crisis in 2008. Higher interest rates are supposed to cool demand, and history shows that such efforts almost always lead to recessions. But there’s been a lingering hope that perhaps this time is different. Understandably, many traditional economists and market participants have slammed that view as naive, and there’s still a strong case that the doomsayers will ultimately be vindicated. Yet even the most starry-eyed optimists couldn’t have scripted a more perfect run of macroeconomic data than the one so far in November.
Of course, there are several important caveats to consider.
First, the strength in consumption hasn’t necessarily been broad-based. The uptick in the recent retail sales numbers came to a significant degree from online and other non-store retailers, and there’s a good chance that it was Amazon.com Inc.’s Prime Early Access sale that juiced the control group figures in the latest retail sales report. On the other hand, physical retailers like big box stores and home improvement purveyors are experiencing notable weakness. For specifics, look no further than Target Corp., which said in an earnings report on Wednesday that its shoppers are pulling back, which triggered a 13% drop in its stock. Walmart Inc., which also reported earnings this week, posted better results, but perhaps not for the most encouraging reasons: It owes its recent success largely to trade-down shoppers squeezed by inflation and a robust food retailing business. Macy’s Inc. raised its earnings forecast for the year on Thursday. But its low-end outlook expects slow sales trends and high promotions to intensify through January, while its more optimistic outlook assumes a return to 2019 levels.
Next, consider that this is only one month of good data. That’s especially true on the inflation front, where central bankers have been head-faked a couple of times already by spurts of improvement only to see inflation reaccelerate. One good month does not a trend make. What’s more, there were some technical issues in the latest consumer price index, which benefited from an idiosyncrasy in the medical care sub-index that is clearly making the numbers look better than they might otherwise be. Excluding that, the numbers certainly improved, yet not enough to justify a wholesale reassessment of the path of interest-rate policy.
Finally, there are the famous “long and variable lags” of monetary policy. Traditionally, many economists believe that the maximum impact of rate increases comes 12 to 24 months after the Fed actually raises interest rates, which could indicate that trouble is around the corner whether or not inflation ebbs and the Fed changes tack now. By that way of thinking, the damage is already baked in. There’s a counterargument that policy is transmitted more quickly these days because the Fed has made managing expectations an explicit part of its strategy. Well before the Fed raised interest rates in March, yields on Treasury notes and interest rates on mortgages were already rising swiftly. That’s a compelling argument, but the jury is still very much out; basically, policy lags remain a great mystery.
But if the inflation improvements become an incontrovertible trend, there’s a real chance that the soft landing may well be the Fed’s to squander. Of course, that’s a big “if,” and what does incontrovertible look like anyway? The haziness around that question may well mean that policymakers unwittingly push the country into a recession while they’re waiting for confirmation that inflation has truly been vanquished. That’s why a soft landing still looks like a bit of a long shot, but the past several weeks of data have moved the odds meaningfully in the right direction.
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