If you think some of the aerial tricks snowboarders did during the Winter Olympics were spectacular, check out what Federal Reserve Chairman Jerome Powell is trying to do: pull off an unparalleled soft landing of a U.S. economy with a rock-bottom unemployment rate.
Powell, who delivers his second round of semi-annual testimony to Congress on Thursday, told lawmakers on Tuesday the next two years will be “good” ones for the economy. If he’s right, he’ll be at the controls when the current U.S. expansion becomes the longest on record.
It’s what comes afterward that has investors like Bridgewater Associates Inc. President Ray Dalio and economists like Moody’s Analytics Inc.’s Mark Zandi worried. The concern: The Fed could end up crashing the U.S. into a recession as it jacks up interest rates to prevent the labor market and the economy from overheating.
“If we were to roll the camera forward to two years from now, and we are having a lot more — let’s say, stimulation — particularly in the United States,” the Fed “will have a problem getting it right,” Dalio, whose firm manages about $160 billion in assets, told Bloomberg Television on Feb. 27.
Three or Four
In his appearance this week before the House Financial Services Committee, Powell opened the door to the Fed raising rates four times this year as he acknowledged stronger economic growth may prompt policy makers to rethink their plan for three hikes. Stocks have fallen in the two days since his testimony and futures early Thursday pointed to further declines. The yield on the 10-year Treasury note was 2.83 percent at 8:19 a.m. in New York, four basis points lower than it was before Powell’s testimony was released on Tuesday.
Zandi said he can’t remember a time when the Fed achieved what Powell is trying to do now.
“It’s very hard to soft land an economy once you’re below full employment,” the chief economist of Moody’s Analytics said. “It’s like landing in the fog on an aircraft carrier that’s in the middle of choppy seas.”
It’s tough because the central bank is trying to slow economic growth enough to edge up unemployment but not so much as to trigger a contraction in gross domestic product. “It’s going to take some real good policy making and some luck to avoid a recession in 2020,” coinciding with the next presidential election, Zandi said.
New York Fed President William Dudley has noted that the economy historically “has always ended up in a full-blown recession” whenever joblessness has risen by more than 0.3 to 0.4 percentage point.
In a Jan. 11 speech in New York, Dudley saw a “real risk” of economic overheating over the next few years.
“Not only do we have an economy that is growing at an above-trend pace — at a time when the labor market is already quite tight — but the economy will be getting an extra boost in 2018 and 2019 from the recently enacted tax legislation,” he said.
What Our Economists Say
The chances of the Fed acting aggressively and inverting the yield curve, which could lead to a recession this year or next, are extremely lean because policy makers do not have to combat rapidly rising inflation and raise rates faster than the gradual pace they have recently adopted. If the latest fiscal reforms help boost investment and improve productivity growth, the capacity limits of the economy will rise as well. This would keep the risks of overheating thereafter in check.
— Yelena Shulyatyeva and Carl Riccadonna, Bloomberg Economics
At 4.1 percent in January, unemployment is already below Fed officials’ 4.6 percent estimate of its long-run sustainable rate, according to the median projection of policy makers in December. Powell said he thinks that rate is “somewhere in the low fours,” though he added it could be anywhere from 5 to 3.5 percent.
The January jobless reading is the lowest since 2000. Back then, the Fed under Alan Greenspan was raising interest rates to try to bring a red-hot economy off the boil. The tighter credit ended up contributing to a recession the following year as the Nasdaq stock market bubble burst.
Greenspan, dubbed ‘the Maestro’ for his skillful stewardship of the economy, told Bloomberg Television on Jan. 31 that both the stock and bond markets are in bubble territory now.
“At the end of the day, the bond market bubble will eventually be the critical issue, but for the short term it’s not too bad,” he said. “But we’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact, as you know, on the whole structure of the economy.”
Fed officials have acknowledged that asset prices are “elevated” but they argue that the overall threat to financial stability is moderate, in part because leverage is fairly low.
Former Fed Chair Janet Yellen saw similarities between today’s economy and that of the late 1990’s in a Feb. 27 event at the Brookings Institution in Washington. Unemployment is low, yet inflation is contained.
“We have an economy operating below estimates of its longer-run unemployment rate,” said Yellen, now a fellow at Brookings. “It’s important to stay on the path where the economy doesn’t overheat.”
Powell is aware of the risks.
While he doesn’t see the economy boiling over now, “if that does happen, then we’ll have to raise rates faster, and that raises the chances of a recession,” he told lawmakers on Feb. 27.