Fed: inflation expectations versus recession expectations

The risks of recession worry everyone, but they have not yet outweighed the risks of inflation in the US monetary debate. For the Fed, reducing inflation is an absolute priority at this stage. This requires weighing on demand. To choose between the two evils, the Fed prefers, not to mention, an economy in recession, rather than inflation, which continues to deviate from its goal. Medium-term inflation expectations, which are discussed in detail here, have risen and are now slightly above normal. Not enough to conclude that they are not fixed, but enough to seriously worry the Fed.

Focus US Bruno Cavalier, Chief Economist, and Fabien Bossi, Economist

During this week’s congressional hearing, Jerome Powell was asked whether raising the Fed’s key rate would affect gas or food prices. He had to agree that this was not the case. From Senator Elizabeth Warren, these insidious questions were intended to emphasize that the war that the Fed intends to wage with inflation will not work without changing the rise in prices, but at the risk of provoking a recession (see page 2). Of course, the Fed has never argued that tightening monetary policy will have an immediate impact on current inflation, particularly on prices that depend in part on world commodity markets. Its purpose is to influence price formation in the future. If the Fed decided at the last minute to raise the rate by 75 bp. instead of 50 bp, this was partly a response to rising certain inflation expectations. This was explained by the chairman of the Fed, referring, in particular, to the expectations obtained from the University of Michigan survey, as well as the synthetic index calculated by the Fed (Common Inflation Expectations). In the first case, five-year inflation is expected at 3.3%, or +0.3 points in a few months. This is a significant increase for the variable, which has varied from 2.5% to 3.0% since the mid-1990s. As for the CIE index, which has been almost stable at 2% for two decades, it is 2.2%. The analysis can be extended to other indicators (table). In addition to differences in levels that reflect certain biases, the results are similar. All indicators of expected inflation exceed the historical norm, but in a rather insignificant part. We cannot conclude that inflation expectations are not fixed. If the economy unfolds under a hard landing scenario, the Fed will not necessarily have to tighten monetary policy.

06/28/2022  Inflation
USA: various indicators of inflation expectations


“A recession is not inevitable,” Janet Ellen, the finance minister, told the Associated Press on June 19. Joe Biden said the same the next day. They cannot be completely wrong, because, according to Benjamin Franklin, the only two definite things in life are death and taxes, but not recession. Predicting a recession is a complex exercise that can lead to a variety of approaches (See Focus-US from June 17 : “What do our recession models say? However, when officials of this rank make such statements, it is because they are defending themselves against an opinion (households, markets, managers, forecasters) that is increasingly committed to a recession scenario, even if everyone remains cautious about its exact beginning and More importantly, its duration and severity, when you want to show off without getting wet, you write, as Bill Dudley, the former president of the New York Fed, “A recession is imminent in the next 12-18 months” (Bloomberg, June 22). It remains to be seen what will happen. points per month.

06/28/2022  Recession in the United States

The Conference Board has an indicator that identifies ten variables that have in the past demonstrated the property of an advanced reversal relative to the economic cycle. In May, the figure fell for the fourth time in five months, but in too modest a proportion (-0.8% since the beginning of the year) to give a reliable signal. And the rollback of the leading indicator is not very scattered. In other words, it is not the result of a large number of its components, but primarily reflects the decline in household morale and the correction in stock markets.

Although weekly unemployment claims are still low, they continue to grow slowly. As of June 18, the average for four weeks is 224,000, the lowest point – 171,000 in early April.

In June, the PMI fell 4.6 points to 52.4, the lowest level since the summer of 2020.

Monetary and fiscal policy

Following the publication of the semi-annual report on monetary policy, Jerome Powell answered questions from senators on June 22 and questions from representatives the next day. One week after FOMC, the discourse did not change. The Fed seeks to reduce inflation to 2% and will continue to raise key rates. The economy is considered strong enough to withstand it, but the Fed chairman acknowledged that a recurrence of the recession is possible. Michelle Bowman (board) favored growth of 75 basis points in July, as did Charles Evans (Chicago). Faced with the risk of recession, markets are less aggressive. Yields on 2-year bonds for the week fell by 20 basis points.

Continuation of this week

A large amount of data in the coming days will help to refine the estimate of real GDP growth in the 2nd quarter of 2022. The latest forecast of the Atlanta Fed from June 16 indicates the stagnation of real GDP. It will be recalled that such a mediocre result is due to the negative contribution of inventories and foreign trade, which reduced growth by 1.8 points. The same phenomenon occurred in the first quarter, but in even greater proportions, as real GDP fell by even 1.5% qoq year on year. General expense report (June 30) will be a desirable addition to retail data: we will see if the cost of services will remain, while the cost of goods shows signs of weakness. The offer will send durable goods (27 numbers), a proxy for business and construction equipment costs (July 1). Also follow the Conference Board survey on consumer sentiment (28 numbers) and a survey of ISM procurement managers in the manufacturing sector (July 1).