The Fed’s soft landing could still be possible


On Wednesday, the Federal Reserve raised its key rate by 0.5%, to a range of 4.25% to 4.5%, in line with expectations. But the message accompanying the announcement raised some eyebrows. The central bank’s new projections show slightly less growth, more unemployment and higher inflation in 2023 than its last announcement suggested, as well as an expected “terminal rate” – or the point at which policymakers stand. expect to halt the rise – at just over 5%, slightly above its previous estimate.

In short, the Fed says it has more to do.

Tuesday’s inflation report convinced some investors that the central bank could afford to ease monetary policy. Prices excluding food and energy rose 6% for the year to November, compared to 6.3% for the year to October. For the second month in a row, this is a bigger drop than expected. Signs of easing inflationary pressures also appeared across a wider range of price components.

Taken together, this data suggests that price increases have peaked. Still, the Fed is right: it’s too early to say that the inflation rate is firmly on track to return to its 2% target. In his remarks on Wednesday, President Jerome Powell stressed that the labor market is still tight. Businesses are reporting a ‘huge’ excess of vacancies, he said: ‘It’s as if the economy is facing a ‘structural labor shortage’. A steady decline in wage growth compatible with a gradual return to 2% inflation is still not apparent and cannot be taken for granted.

Time will tell if a terminal rate of just over 5% will suffice. If so, the soft landing that the central bank and everyone else is hoping for might still be possible. The median of Fed policymakers’ projections for output growth next year is 0.5%, with a fourth-quarter unemployment rate of 4.6%. This seems consistent with a policy rate which, until then, would be (slightly) restrictive. It’s slow growth, of course, and doesn’t rule out a technical recession during the year, but the Fed doesn’t expect a sharp drop.

If things continue to go as planned, the bank will deserve credit for a job well done, despite its admitted mistake of not starting to raise interest rates sooner.

Another point deserves to be underlined. During his press conference, Powell was asked if the Fed might consider changing its inflation target if the return to 2% proves too difficult – an option that some economists favor. The president strongly rejected the idea. This was something the Fed had not discussed and would not discuss, he said: the inflation target is 2% and that’s it.

If core inflation threatens to settle between 3% and 4% next year, he can expect to be pressed more aggressively on the matter. Yet here, too, Powell is right. Things are pretty much on track as no one doubts the Fed’s commitment to keeping inflation low. If this changes, all bets are void.

More from Bloomberg Opinion:

• The real risk of higher inflation is lower wages: Tyler Cowen

• The Fed should not raise its inflation target: Bill Dudley

• Can the Fed pull off a soft landing? : Jonathan Levin and Leticia Miranda

The editors are members of the Bloomberg Opinion Editorial Board.

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