Confidence grows that Federal Reserve can deliver a soft landing for US economy

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Economists and analysts are increasingly hopeful that the Federal Reserve can avoid pushing the US into a recession, as inflation slows and strong growth persists despite 11 interest rate increases.

The Fed this week raised rates by another quarter percentage point to the highest level in 22 years. But a flurry of upbeat data has increased the likelihood that the central bank can deliver a soft landing — lowering inflation through tighter monetary policy without crushing economic activity.

Jan Hatzius, chief economist at Goldman Sachs, said the data added to his confidence that the US could avoid a recession. Goldman last week reduced the probability of a recession to 20 per cent, down 5 percentage points.

“We believe the Fed is on track for a soft landing,” Hatzius said. “The data this week has been consistently good. It adds to my conviction.”

The US Bureau of Economic Analysis on Friday reported that the Fed’s preferred gauge of inflation — the core measure of the personal consumption expenditures index — cooled in June to 4.1 per cent, the lowest level since October 2021, from 4.6 per cent in May.

Separately, the employment cost index, which tracks wages and benefits and is closely watched by policymakers as an indicator of wage growth, rose by 1 per cent in the second quarter, down from 1.2 per cent in the first three months of the year.

While wage growth has concerned economists because of its contribution to inflation, it also has helped keep the US consumer strong. Hatzius noted this week’s ECI data was good because it showed a slowdown in wages, which nevertheless have been cooling less quickly than prices.

Both the ECI and the core PCE figures were lower than economists had forecast.

“I am optimistic that we are getting a soft landing — that we are already seeing inflation moderate dramatically and we will continue to see inflation moderate and not see a big rise in unemployment,” said Heidi Shierholz, a former chief economist at the Department of Labor who is now director of policy at the Economic Policy Institute.

“If we do have a recession, it will have been a policy failure. It will have been because the Fed raised rates too much,” she added.

The evidence of slowing inflation comes alongside signs that growth remains resilient. The commerce department on Thursday reported the US economy grew 2.4 per cent on an annualised basis in the second quarter, well above the 1.8 per cent economists had forecast, and above the 2 per cent rate in the first quarter.

Optimism about the US was shared by officials. Fed chair Jay Powell said on Wednesday that central bank staff had withdrawn their forecast for a US recession, while also acknowledging there was still work to be done to bring inflation down to target.

While the Fed’s stated aim is to return to its 2 per cent inflation target, some analysts suggested a “softish” landing of close to 2 per cent may be sufficient.

“We might not have a precise soft landing, but it will be softish,” said Ajay Rajadhyaksha, global chair of research at Barclays. “We may not get down to 2 per cent inflation, but it might not be the end of the world if US inflation lands closer to 2.6 or 2.7 per cent, without huge job losses.”

The economic news boosted US markets, which had already become more optimistic about the economic outlook with riskier asset classes performing well in recent weeks.

The S&P 500 stock index is almost 20 per cent up in the year to date, bolstered by excitement about artificial intelligence and the implications for big tech stocks. The Nasdaq Composite, a home for many of the largest technology names, is up 37 per cent and rose 2 per cent in the past week — helped by strong quarterly earnings for Meta.

Riskier companies are paying the smallest premium in 15 months to borrow in the bond market.

The strength of the US economy, and market ebullience, could still force the Fed to keep interest rates higher for longer, some economists warned — which could ultimately crush the labour market and send the US into recession.

Powell this week said that achieving disinflation without “any meaningful negative impact on the labour market” was a “good thing”. But he warned stronger growth could again spur inflation, potentially necessitating further tightening.

Michael Gapen, chief US economist at Bank of America, said: “History tells you when we’ve gotten in this position before — high inflation, the need to disinflate, raising interest rates fast — far more often than not, you’ve had a recession.”

However, he added, “I think we need to be careful in applying that history to the current context — because if nothing else, we know the Covid business cycle is different.”