With a Gallic shrug, Fed bids adieu to the recession that wasn't

 

With a Gallic shrug, the Fed bid farewell to the recession that wasn't

WASHINGTON (Reuters) - Blame it on economic theory that doesn't match reality, the groupthink of forecasters or the political partisanship of opponents of the Biden administration, but a year ago, much of the U.S. was convinced the country was in, or soon would be, a recession.

In the first two quarters of 2022, US economic output shrank at a 1.6% annual rate from January to March and a 0.6% annual rate from April to June, and by one common, though not technically precise, definition the country has already entered. decrease.

Why not? The Federal Reserve was rapidly raising interest rates, housing investment appeared to be falling, and the conventional wisdom was that other industries, consumer spending, and the labor market would collapse as well.

"A number of forces are converging to slow economic momentum faster than we previously expected," Michael Gapen, chief U.S. economist at Bank of America, said in a July 2022 analysis. “We now forecast a mild recession in the US economy this year... In addition to the fading of previous fiscal support... inflationary shocks have eroded real household purchasing power more than we previously predicted and financial conditions have tightened noticeably. The Fed has changed its tone toward faster rate hikes."

Fast forward a year and the unemployment rate at 3.5% in July is actually below the point where many analysts expected it to start rising, consumers are continuing to spend and many professional economic forecasts have followed Gapen in a course correction.

Reuters polls of economists over the past year showed the risk of a recession a year from now rising from 25% in April 2022, a month after the first rate hike in the current Fed tightening cycle, to 65% in October. Last read: 55%.

"Incoming data has made us reconsider our previous view" of the coming recession, which had already been pushed to 2024, Gapen wrote earlier this month. "We are revising our outlook in favor of a 'soft landing' where growth will fall below trend in 2024 but remain positive throughout."

Recession revisionists include the Fed's own staff, who followed their models and gradually lowered the outlook for the U.S., moving from heightened concerns about "downside risk" since last fall to citing a recession as a "credible" outcome since last December, and then assuming since the Fed's meeting in March 2023 that the recession will start this year.

With the failure of the California-based Silicon Valley bank expected to further tighten bank lending, "staff projections included a mild recession beginning later this year with a recovery over the next two years," the Fed's March note said. 21-22 meeting showed.

In May and June, the Fed's projections "continued to assume" that the US economy would be in recession by the end of the year. Fed Chairman Jerome Powell recently confirmed that the more dovish outlook was gone for the July 25-26 meeting, with perhaps more details on the staff outlook coming from the minutes of that meeting, which will be released at 2:00 p.m. EDT (1800 GMT) on Wednesday.

"The staff now sees a noticeable slowdown in growth beginning later this year in the forecast, but given the economy's recent resilience, they no longer anticipate a recession," Powell told a news conference after the end of last month's policy meeting. .

The Fed's policymakers' projections, which are released quarterly, have never shown GDP shrinking every year. What was the difference between the immediate recession that many thought was underway last year and the growth that surprised the upside?

The forecast wasn't even close: By the third quarter of last year, growth had returned to a brisk 3.2% annual pace, and since then it has remained at 2% or more, higher than the 1.8% the Fed considers the economy's underlying potential. The Atlantic Fed's GDP "nowcast" puts output growth for the current July-September period at 5.0%, showing continued strong momentum.

A big part of the story is the continued strength of US consumers, who continued to "stretch" and spend more than expected, according to Omair Sharif, president of Inflation Insights. Spending has shifted from the commodity shopping seen at the start of the coronavirus pandemic to a hot service economy that exploded this summer in billion-dollar movies and music concerts.

But dollar amounts keep rising regardless of what's in the basket, leaving economists constantly pushing back the date when pandemic-era "excess savings" will dry up, or wondering whether low unemployment, continued strong hiring and "hoarding" workforce. companies, along with rising profits, overcame any concern about the outlook.

But it's not just like that.

High interest rates may not be working in the same way in an economy that spends more on services that are less sensitive to rates, and where businesses continue to borrow and invest more than many economists had anticipated—perhaps to cash in on regulatory shifts aimed at to support projects in the field of technology and green energy.

A surge in local government spending also unexpectedly boosted growth as localities put pandemic-era funds to work with delays. One risk is if inflation rebounds along with a tighter-than-expected economy and the Fed has to tighten further, triggering the inflation-killing downturn that officials still hope to avoid.

But the chances of that may be decreasing.

"We've been hesitant to move into the 'soft landing' camp for a while, but not anymore," noted Sal Guatieri, chief economist at BMO Capital Markets, referring to the Fed's hopes of reducing inflation without provocation. recession "Broad strength" in the U.S. economy, he said, "convinced us that the U.S. economy is more durable than expected. . . . Not only is it not slowing down any further, but it may be accelerating." Reporting by Howard Schneider; Editing by Paul Simao