Everyone thinks about the risks of a recession, but they do not yet prevail over the risks of inflation in the American monetary debate. For the Fed, reducing inflation is an absolute priority at this stage. This requires weighing on demand. To choose one of two evils, the Fed prefers, without saying it directly, a recession in the inflation economy, which continues to deviate further and further from its goal. Medium-term inflation expectations, which are detailed here, have risen and are now slightly above the norm. Not enough to conclude that they are not anchored, but enough to seriously worry the Fed.
Focus US Bruno Cavalier, Chief Economist and Fabien Bossy, Economist
During a congressional hearing this week, Jerome Powell was asked if the Fed’s key rate hike would affect gas or food prices. He had to agree that it wasn’t. These insidious questions, coming from Senator Elizabeth Warren, were intended to emphasize that the Fed’s war on inflation would miss the mark, changing nothing about rising prices but risking a recession (see page 2). Of course, the Fed has never said that tightening monetary policy will have a direct impact on current inflation, in particular on prices, which are partly dependent on global commodity markets. Its purpose is to influence the formation of prices in the future. If the Fed decided at the last minute to raise rates by 75 bp. instead of 50 bp, this was partly a reaction to the growth of certain inflationary expectations. The Fed chairman explained this, referring, in particular, to expectations taken from a study by the University of Michigan, as well as to a synthetic index calculated by the Fed staff (Common Inflation Expectations). In the first case, five-year household inflation is expected at 3.3%, or +0.3 points in a few months. This is a significant increase for a variable that has ranged from 2.5% to 3.0% since the mid-1990s. As for the CIE index, which has been almost stable at 2% for two decades, now it is 2.2%. The analysis can be extended to other indicators (table). Apart from differences in level, which reflect certain biases, the results are similar. All indicators of expected inflation exceed the historical norm, but in a rather small proportion. We cannot conclude that inflation expectations are not anchored. If the economy were to turn into a hard landing scenario, the Fed would therefore not necessarily have to tighten monetary policy even further.
“A recession is not inevitable,” Treasury Secretary Janet Yellen said June 19 in an interview with The Associated Press. Joe Biden said the same thing the next day. They can’t be completely wrong, because according to Benjamin Franklin, there are only two certain things in life – death and taxes, not economic recession. Recession forecasting is a complex exercise that can lead to many approaches (See Focus-US June 17. : “What do our recession models say? However, when officials of this rank make these kinds of statements, it is because they are on the defensive of an opinion (households, markets, CEOs, forecasters) that is increasingly committed to a recession scenario, even if everyone remains careful about its exact start and, more importantly, its duration and severity When you want to show off without getting too wet, you write like Bill Dudley, former president of the Federal Reserve Bank of New York: “A recession is inevitable in the next 12 18 months” (Bloomberg column, June 22). It remains time to see what comes next. Let’s take this opportunity to recall here some of the characteristics of US recessions. They last an average of ten months and, with the notable exception of the pandemic, are more severe the they last longer.During a typical recession, the unemployment rate increases by an average of 0.25 points per month.
The Conference Board has an indicator that identifies ten variables that have exhibited early reversal property with respect to the business cycle in the past. In May, this indicator fell for the fourth time in five months, but in a proportion too modest (-0.8% YTD) to give a stable signal. Moreover, the pullback of the leading indicator is not very blurry. In other words, it does not arise from a large number of its components, but primarily reflects a drop in household morale and a correction in the stock markets.
Weekly jobless claims, while still low, continue to rise slowly. As of June 18, the four-week average is 224,000 and the lowest point was at 171,000 in early April.
In June, the manufacturing PMI fell 4.6 points to 52.4 points, its lowest level since summer 2020.
Monetary and fiscal policy
Following the release of the semi-annual monetary policy report, Jerome Powell answered questions from senators on June 22 and questions from representatives the following day. A week after the FOMC, the discourse has not changed. The Fed intends to reduce inflation to 2% and for this will continue to raise the key rate. The economy is considered strong enough to withstand this, but the Fed chairman acknowledged that a relapse into a recession is possible. Michelle Bowman (Board of Directors) favored a 75 basis point increase in July, as did Charles Evans (Chicago). Faced with the risk of a recession, the markets are less aggressive. Yields on 2-year bonds fell 20 bp over the week.
Continued this week
There will be plenty of data in the coming days to help refine the estimate of real GDP growth in the second quarter of 2022. The Atlanta Fed’s most recent June 16 forecast points to stagnant real GDP. Recall that such a mediocre result is due to the negative contribution of inventories and foreign trade, which reduced growth by 1.8 points. The same thing happened in the first quarter, but to an even greater extent, as real GDP even fell by 1.5% qoq y/y. General expense report (30 June) will be a welcome addition to the retail sales data as we will see if services spending remains flat while goods spending shows signs of weakness. On the supply side, there will be shipments of durable goods (the 27th), a measure of business equipment spending and construction spending (July 1). Also watch the Conference Board Consumer Survey (the 28th) and an ISM survey of purchasing managers in the manufacturing sector (July 1).