Can the Federal Reserve engineer a soft landing, in which it defeats excessive inflation without tipping the U.S. economy into recession? This week, Fed officials will offer important clues as to whether that’s achievable.
The Sept. 19-20 meeting of the policy-making Federal Open Markets Committee isn’t likely to deliver any interest-rate surprises: Officials have amply signaled that there won’t be any further increase this time around. That said, they will update the Summary of Economic Projections, which lays out how they expect growth, inflation and unemployment to develop given appropriate monetary policy. Those projections haven’t been consistent with the soft landing that many in markets are already predicting, so any changes will be significant.
Here are five things I’ll be watching.
1. Will there be another rate hike this year? In June, 12 out of the 18 committee participants indicated two or more 25-basis-point increases in 2023. One happened in July. Do they still see one more coming, despite data suggesting a somewhat softer labor market and less underlying inflation (excluding the spike in gasoline prices)? I expect that a majority will. The economy still has considerable forward momentum, the labor market is too tight and services inflation hasn’t fallen enough to be consistent with the Fed’s 2% objective. Also, keeping a rate hike in the forecast has the tactical benefit of restraining markets, which might otherwise decide that “we’re done” and generate an unwanted easing in financial conditions.
2. What’s the forecast for unemployment? According to the Sahm Rule, every time the unemployment rate has risen by 0.5 percentage point or more since World War II, the outcome has been recession. As of June, Fed officials’ median forecast was for an increase of almost a full percentage point, to 4.5% in 2024. If that number comes down, it will indicate growing confidence in the likelihood of a soft landing.
3. How low can unemployment be without stoking inflation? Since March 2021, the median Fed forecaster has put this long-term unemployment rate at 4.0%. That’s down from 5.0% to 5.2% in 2009. A renewed decline is possible, given that the pace of payroll gains has moderated and wage inflation has fallen along with the ratio of unfilled jobs to unemployed workers. If some officials conclude that unemployment around the current level of 3.8% is sustainable, this would also signal growing support for a soft-landing scenario.
4. What’s the neutral federal funds rate, which neither stokes nor damps growth? In June, the median estimate was unchanged at an inflation-adjusted 0.5%, but the central tendency projection moved higher, to 0.5%-0.8% from 0.4%-0.6%. Given the strength of the economy in the third quarter, further upward adjustments certainly seem possible. This would imply that Fed officials think they have more work to do—that they’ll have to keep rates higher for longer to meet their 2% inflation target.
5. When will rates start coming down? In June, the median forecast anticipated 100 basis points of cuts in 2024 and another 120 basis points in 2025. The message was that as inflation fell, the federal funds rate would follow it down. If officials are leaning toward “higher for longer,” the projected rate cuts should become smaller.
To be sure, one shouldn’t read too much into such forecasts. They’ve been very wrong in the past. Two years ago, the median projection was for the federal funds rate to end 2023 at 1%. Economic uncertainty is unusually high, given doubts about how quickly monetary policy takes effect and near-term issues such as the auto union strike, a possible government shutdown and the resumption of payments on student loans. Whatever Fed officials project, it’s highly likely to be revised.
Bill Dudley, a Bloomberg Opinion columnist and senior advisor to Bloomberg Economics, is a senior research scholar at Princeton University’s Center for Economic Policy Studies. He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee. He was previously chief U.S. economist at Goldman Sachs. He has been a nonexecutive director at Swiss bank UBS since 2019.