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Friday, June 24, 2022
Federal Reserve officials are sticking to their script that there’s still a window – however narrow – for the economy to achieve a soft landing as the central bank raises rates.
But this week, Fed Chair Jerome Powell offered some acknowledgment that the chances of bringing down inflation while keeping economic growth steady have somewhat diminished.
A recession is “certainly a possibility," Powell told the Senate Banking Committee on Wednesday, while emphasizing this is not the central bank’s “intended outcome” as it raises interest rates to address rising prices.
Some economists, however, believe there remains a path for the Fed to still meet its "soft landing" goal.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, offered a three-pronged argument in a recent note on how the Fed can balance inflation and growth risks. In Shepherdson's view, margins, savings, and wages are the crux of how the Fed can thread this needle.
"First, we think that a big part of the disinflation story will be margin re-compression – from extraordinarily high levels – due mostly to rising supply, not falling demand," Shepherdson said. "That’s the opposite of the usual late cycle story, when margins are squeezed by a combination of rising labor costs and falling demand."
In other words, much of the leg work in bringing down rising prices could come from the supply-side, as retail and wholesale inventories have surged to pre-COVID levels or higher as supply chain pressures moderate. This is in contrast to inventories rising from sunken demand, which could augur a downturn and is most commonly seen ahead of recession.
While the demand side has started to soften, as Philadelphia Fed President Patrick Harker told Yahoo Finance this week, Powell clarified that lower demand growth is not necessarily synonymous with a recession.
“I am trying to lower demand growth, we don’t know that demand actually has to go down, which would be a recession," Powell told the Senate Banking Committee Wednesday.
Second, Shepherdson said still-robust private sector cash holdings will “provide an unprecedented cushion against the hit from soaring food and energy prices, the drop in the stock market, and – soon – the correction in home prices.”
Businesses’ excess cash is about $300 billion with debt service costs still “rock-bottom,” Shepherdson said, making the case for capital expenditures to continue growing.
"Finally," Shepherdson said, "the moderation in wage growth in recent months already is exerting downward pressure on the sequential core price numbers, in contrast to the usual late-cycle story, which sees faster wage gains."
In Shepherdson's view, these factors will likely bring down inflation prints in the coming months, and that by the Fed's September meeting, investors may see these risks as notably less acute.
"Economic growth likely will be modest in the third quarter," Shepherdson said, "but our base case remains that a recession is unlikely.”
Many of Shepherdson's peers on Wall Street, however, are growing skeptical that recession can be avoided. In the past week alone, Goldman Sachs raised its probability to 30% over the next year — up from 15% previously — while Citigroup now sees a 50% chance of a global recession.
“It is, unfortunately, uncomfortably possible that the Fed is going to slam on the brakes and push us into recession,” economist Mohamed El-Erian told Yahoo Finance Live in an interview Thursday.
Still, not all the economic data have yet backed up these fears.
On one hand, housing market activity has tumbled, and US manufacturing and service sector purchasing managers’ indexes have deteriorated to multi-month lows. But the labor market remains robust, with jobless claims still hovering near pre-pandemic levels, and the unemployment rate holding at its lowest since February 2020.
“The strength of payroll employment growth, which is averaging close to 400,000 per month, is particularly hard to square with claims that a recession is imminent,” Capital Economics economists wrote in a note Thursday.
“Admittedly, with inflation rampant, that is likely to keep the Fed raising interest rates aggressively, including another 75bp [basis point] hike in July," they added. "But with underlying demand still strong, a slowdown in growth is still the more likely outcome.”
What to Watch Today
University of Michigan Sentiment, June final (50.2 expected, 50.2 in prior print)
University of Michigan 1-Year Inflation, June final (5.4% expected, 5.4% in prior print)
University of Michigan 5-10-Year Inflation, June final (3.3% expected, 3.3% in prior print)
New Home Sales, May (590,000 expected, 591,000 during prior month)
New Home Sales, month-over-month, May (-0.2% expected, -16.6% during prior month)
CarMax (KMX) is expected to report adjusted earnings of $1.53 per share on revenue of $9.05 billion