Consumer Spending and Economic Indicators
In an environment where wage growth is easing, pandemic-era savings are depleting, and businesses that retained workers are realizing that labor shortages are easing, the question arises: Will consumer spending slow down? It remains uncertain. The Federal Reserve is expected to keep its benchmark overnight interest rate steady in the range of 5.25%-5.50% for the fourth time since July. The focus will be on any signals in the Fed’s policy statement or from Fed Chair Jerome Powell during the post-meeting press conference regarding the timing and pace of future rate cuts.
The resilience of the economy despite “restrictive” monetary policy has caught attention. The S&P 500 index reached a record high, consumer sentiment is rebounding, and President Joe Biden’s administration has praised the progress. However, the numbers have presented more challenges than clarity, and some of the Fed’s underlying assumptions have been questioned. The inflation rate has fallen, despite the unemployment rate remaining relatively steady for two years, and the economy continuing to grow faster than the estimated inflationary rate. Powell’s initial outlook for rising joblessness and slower wage growth to curb high inflation has been revised. The Fed has emphasized the need for “disinflation” with a growth rate below the economy’s potential.
The Impact of Federal Reserve’s Policy
The durability of the current economic expansion, marked by the recovery of jobs lost due to the pandemic and more, depends partially on the outcome of the Fed’s policy. Various scenarios are possible, ranging from a delayed tightening of monetary policy that impacts the job market negatively, to a situation where improvements in productivity and supply dynamics prompt the Fed to lower interest rates despite strong economic growth.
Monetary policy has already had an impact on financial conditions, potentially slowing the projected growth rate of 1.4% this year by about half a percentage point annually according to the Fed’s measure. The issue now is whether the Fed can adjust interest rate cuts to maintain the projected growth pace while addressing developing weaknesses in the economy, such as rising credit usage and defaults among households, and assessing the health of banks that have lent against devalued commercial properties. Fed officials are determined not to keep interest rates high for too long but also believe that easing prematurely and risking a resurgence of inflation would be a greater error. The Fed has shown resilience with the possibility of achieving a “soft landing” from high inflation in 2022, driven by the pandemic’s influence on global supply chains, consumer spending patterns, and hiring practices. Powell, like his predecessors, will need to make a judgment call to gauge if inflation pressures are contained despite ongoing growth.
The Challenge of Rate Cuts
Until rates are lowered, it remains uncertain how the economy will fare. Luke Tilley, the chief economist at Wilmington Trust Investment Advisors, predicts that the U.S. economy will avoid a recession but does not rule out the possibility of Powell making a mistake similar to the Fed in the 1970s, leaving policy tighter than necessary. Tilley believes that the lagged impact of rate hikes will be more significant than expected, and inflation is likely to slow faster than the Fed’s projections. Therefore, if rate cuts do not begin until June, rates may still be too high by the end of the year.