The U.S. economy hasn’t slowed all that much. High inflation has proven to be quite sticky. And the rip-roaring labor market is still producing lots of new jobs.
No matter. The Federal Reserve is poised to make no change in a key U.S. interest rate next week after raising it in 10 straight meetings since the spring of 2022.
If the Fed pauses or skips a rate hike, as Wall Street widely expects, the central bank needs to craft a new message to explain its decision to go easy in light of prevailing trends on growth and inflation, economists say.
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One way to do that to fine-tune the Fed’s latest quarterly forecast for the economy.
The Fed could push out its prediction of an economic slowdown and rising unemployment into 2024. And concede — yet again — that inflation might take a bit longer than expected to subdue.
“They have to acknowledge the economy is stronger than they thought,” said Chris Zaccarelli, chief investment officer of the Independent Advisor Alliance in Charlotte, N.C. “And clearly the labor market has held on longer than expected.”
In its March forecast, the Fed predicted growth in the U.S. economy would slow to a meager 0.4% in 2023 from 2.1% last year. Basically that would put the U.S. on the cusp of recession.
Yet like so many of the Fed’s pandemic-era predictions, its forecast for gross domestic product doesn’t look so good right now. GDP expanded at a 1.3% annual pace in the first quarter and new information suggests it could be revised closer to 2%.
Early data also suggests GDP in the second quarter could increase at a similar clip, largely because of surprising resilience in consumer spending.
“It would take a really disappointing second quarter or a much faster slowdown in the second half of the year” to meet the Fed’s GDP forecast, said Jim Baird, chief investment at Plante Moran Financial Advisors.
What’s kept consumer spending — the main engine of the economy — from sputtering are rising incomes and still-strong labor market.
The U.S. produced a prodigious 339,000 new jobs in May, more than three times what the Fed thinks the economy needs.
The Fed had predicted unemployment would climb to 4.5% by year end as the economy slowed, reducing the upward pressure on wages and helping the Fed to get inflation under control.
Yet that forecast also looks in doubt. The jobless rate jumped to 3.7% in May from 3.4%, but it’s been stuck near a half-century low for months.
“They are running out of time to push the unemployment rate higher,” Baird said.
What would be a telltale sign of a pronounced decline? The U.S. economy shedding most of the 1.57 million new jobs created this year.
“You’d have to pull out another million-ish jobs from the economy,” said Brian Mulberry, client portfolio manager at Zacks Investment Research.
What the Fed could do is flip the script.
It might raise its GDP forecast for 2023 and lower its 1.2% estimate for 2024, indicating it now believes the long-expected slowdown in the economy will take place either late this year or early next year.
The Fed could also lower its unemployment forecast for this year by a notches, but stick to its view that the jobless rate will rise above 4.5% by next year.
What about inflation?
Most forecasters don’t think the Fed will tinker much with its predictions even though progress has been slow lately.
The Fed has predicted that price increases would slow to 3.1% this year, based its preferred PCE index. Inflation as measured by the PCE stood at a yearly rate of 4.4% in April.
The Fed also thinks the core rate of inflation, which excludes volatile food and energy costs, will taper off to 3.6% by year end. The yearly rate stood at 4.7% in March.
Even the Fed’s more optimistic forecasts still leaves it far from its 2% inflation goal.
Wall Street is split on whether the central bank will pencil in another rate hike this year by raising its fed funds target to 5.3% from the current 5.1%.
“The only things that will change their mind again is if inflation moves higher,” contended Zaccarelli .
He said the Fed will talk tough on inflation, but it would prefer to carry a smaller stick. “They don’t want to crash the economy.”
Mulberry is not so sure. If getting prices back down is their primary goal, he argued, “they should be inclined to continue to hike” given the strength of the economy and the labor market.