Americans are going to feel “some pain” because of a slowing economy, the Federal Reserve has warned. But what the Fed won’t do is predict a painful recession.
The central bank is set to jack up U.S. interest rates again next week as it tries to stamp out the highest inflation in four decades. At the same time, the Fed will update its forecast for the economy for the next three years.
The forecast is expected to show lots of clouds, some thunder, maybe a touch of rain, and then clearing skies by 2024 or 2025.
What the forecast won’t show is mass unemployment, a sharp recession or persistently high inflation lasting beyond this year.
“The company line almost has to be soft landing,” said chief economist Stephen Stanley of Amherst Pierpont Securities.
A soft landing refers to an ideal scenario in which the central bank cools off an overheated and inflationary economy by raising interest rates, but not so much as to trigger a recession. It’s a goal the Fed has rarely achieved.
The Fed has never predicted an outright recession, however, in its relatively brief history of regular forecasts. The 108-year-old central bank only began publishing quarterly forecasts 15 years ago.
The September forecast isn’t going to show a looming recession, either. While Fed officials haven’t ruled one out, they are still trying to project confidence in the economy.
“Their recent comments suggest they still think they can pull off a soft landing, avoid a recession and put inflation on a sustained downward path,” said senior economist Sal Guatieri of BMO Capital Markets.
The rate of inflation using the Fed’s preferred PCE price gauge has risen at a yearly 6.3% clip — more than three times faster vs. pre-pandemic levels. The consumer price index is running at an even higher 8.3% pace.
The Fed aims to restore inflation to an annual rate of 2.5% or less.
To get there, the Fed needs to cool off the hottest labor market in modern times. So investors are sure to pay close attention to the Fed’s new forecast for unemployment.
“The unemployment rate has never gone up more than a 1/2 point since World War Two without an ensuing recession,” noted Luke Tilley, chief economist at Wilmington Trust and an former Fed economist.
In June, the Fed forecast the unemployment rate would rise from an estimated 3.7% in 2022 to 3.9% in 2023 and to 4.1% in 2024.
The Fed might slightly raise its forecast for unemployment, economists say, but not enough to clearly signal that a recession is coming.
Instead, the pain that Fed Chairman Jerome Powell has predicted will show up in estimates of how fast the economy will grow.
The optimal speed of economic growth in the long run is an estimated 1.8%. That’s how fast the U.S. is seen as capable of expanding without stoking high inflation.
The Fed will probably lower its forecasts for gross domestic product in 2022 and 2023 below its current 1.7% annual pace. “More likely you will see a reduction in expectations for GDP,” Tilly said.
Just how low? U.S. GDP was negative in the first and second quarters, so a sub-1% estimate for 2022 is possible. And the Fed’s 2023 GDP forecast could be trimmed to 1.5% or less
Those numbers are low enough to suggest the U.S. would suffer a so-called “growth recession” in which the economy underperforms for a short spell.
Yet that’s probably as far as the Fed would go, analysts say, in telling Americans how much pain they’ll have to endure.
Whatever the case, an increasingly number of economists are skeptical the Fed can pull off a so-called soft landing and avoid a recession, especially if unemployment begins to climb.
“Once the unemployment rate starts to rise, it tends to keep going up,” Stanley said. “It would be great if we could have a soft landing, but even a short and shallow recession wouldn’t be a bad thing given where we are .”
Guatieri agreed. “There is a general sense to break the back of inflation were going to have to see some more pain.”