As Fed staffers sigh into the weekend this week there may be a hint of relief this time around as Fed Chair Jerome Powell announces that his staff has stopped forecasting a recession for the US and that a soft landing for US’ inflation woes seems more likely. Soft landing meaning that there is a chance for inflation to go back down without the involvement of high levels of job losses.. just some. A sacrifice we are all willing to make, I am sure – as Jerome Powell ended his press release with the phrase “a lot left to go” before wall street starts revving its engines.
Typically, the Fed is not in the business of forecasting recessions directly, they leave that to sterling institutions like the World Bank and privately owned Financial Institutions and think tanks. No, one should understand that the Fed is only responsible for publishing their outlook as measured by the usual economic suspects – inflation, FX, money supply, etc. – and forecasting is only a small part of their toolkit to maintain the US economy. For instance, prior to the Global Financial Crisis (GFC) in 2008, the Federal Reserve and other economic institutions did acknowledge and warn about the housing market bubble, unsustainable lending practices, and potential risks to the financial system that can lead to the sub-prime mortgage that crippled “small” banks like Bear Stearns. Similarly, during the dot-com bubble and subsequent recession in the early 2000s, the Fed has been there to voice their concerns about overvaluation in technology stocks and the potential impacts on the broader economy before cutting rates in response to a hedge fund collapse that started a chain reaction into the dot-com crash, oops.
In terms of the GFC, Fed hit smash on the money printer button as banks banking on the sub-prime mortgages watched the world burn around them, the Fed reacted strongly and started their quantitative easing (QE) program which worked into one of the longest bull runs in history in the 2010s. So, historically speaking the Fed has been historically good at its job but this time around its hard to believe that majority of what drove Fed staffers to say “probably no recession” is mainly attributable to how Fed has handled inflation since the start of the Pandemic.
As this time there were quite a few obstacles to the Fed’s plan, first event to consider this time, is the US government’s reaction to the Covid-19 pandemic. In terms of processes and protocols the Fed did what it knows best and broke out their crisis toolkit which includes the tried and tested QE as their best weapon. However, the US government had its own bureaucratic problems to deal with making disbursement of their QE a bottleneck that needed to be dealt with and this of course would cause a delay in the already laggy macroeconomic measure for inflation – CPI. Another more glaring obstacle (which only had a somewhat muted presence during the GFC), was the halting of the manufacturing mecca that is China. This international aspect of Covid-19 introduced a very dreadful source of inflation, supply-side inflation. And this, is where the Fed’s skills need tweaking. The US has little reason to devolve into the recession mania it went into during the first two years after Covid-19 officially hit shores around the world, it had a strong Fed and the US government had no shortage of tricks up its sleeves too (like to power to mandate PPE manufacturing) and enforcing necessary protocols to curb the pandemic. However, some bureaucratic hoopla there and bipartisan stuff there caused some delays in the US road to recovery and have caused an already sticky enemy (supply-side inflation) to become even stickier.
Thus, despite the Fed’s use of its tools and influence on the US economy to curb the inflation crisis, I would have to attribute the “external/error term” in the Fed Staffer’s models for the no recession output. As the Fed’s battle with inflation changes momentum to the Fed’s side, I would have to say that Jerome Powell is as lucky as Ray Croc’s neighbor if his neighbor was Volcker and the lawnmower he borrowed was QE.