Jerome Powell shoots for soft landing that’s eluded seasoned Federal Reserve chiefs

Jerome Powell-led Federal Reserve could end up crashing the US into a recession as it jacks up interest rates to prevent the labour market and the economy from overheating

Rich Miller
First Published1 Mar 2018
In his appearance this week before the House Financial Services Committee, Jerome 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. Photo: AP
In his appearance this week before the House Financial Services Committee, Jerome 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. Photo: AP

Washington: 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 US 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 US 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 US into a recession as it jacks up interest rates to prevent the labour 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 27 February.

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. His comments sent equity prices skidding and bond yields higher.

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 11 January 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 labour 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.

At 4.1% in January, unemployment is already below Fed officials’ 4.6% 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%.

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.

The ‘Maestro’

Greenspan, dubbed ‘the Maestro’ for his skillful stewardship of the economy, told Bloomberg Television on 31 January 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 27 February 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 27 February. Bloomberg

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