If the Federal Reserve pulls off a soft landing, it’s a party
Party like it’s 1994? Rather than 1999, the year made famous by Prince’s purple reign, 1994 is remembered as the time when the Federal Reserve actually performed the rarest of economic feats: a soft landing, reducing inflation without collapse into a recession.
The Fed did so by resolutely tightening policy, starting with an unexpected 25 basis point increase in the fed funds rate. It then imposed a series of stronger-than-expected 50 basis point hikes, culminating in a 75 basis point move, doubling the policy rate in just over a year. (A basis point is equal to 1/100th of a percentage point.) This brought inflation down to below 3% without a recession, setting the stage for the dot-com boom that capped the end of the century.
The economy’s soft landing has not been smooth sailing, however, including turmoil in the mortgage-backed securities market; the bankruptcy of Orange County, California, which bet upside down on interest rate derivatives; and the Mexican peso crisis, which prompted a US bailout. During this century, however, the Fed has tightened cautiously, raising the funds rate in “measured” steps 17 times in 2004-06; maintain zero rates until the end of 2015, well after the end of the 2008-09 financial crisis; and now by lifting rates from zero and ending massive securities purchases, well after the economy has recovered from the 2020 Covid crisis and with inflation at its highest level in four decades.
It appeared that the Fed would continue this pattern, based on actions and projections at its policy meeting on March 15-16. Its median estimate of the summary of economic projections at the end of 2022 for the policy rate was 1.9%, with a ceiling at 2.8% at the end of 2023 and 2024, slightly above the Fed estimate of a neutral rate of 2.4%. This slight tightening was supposed to reduce inflation sharply to 2% by the end of 2023, without an increase in unemployment and economic growth to almost 2%.
The implausibility of this benign result was denounced here last week. Afterwards, a parade of Fed speakers suggested that deeper rate hikes of 50 basis points are possible if the data supports them. Wall Street Fed watchers then outdid themselves to raise their rate forecasts, with Citigroup chief economist Andrew Hollenhorst predicting moves of 50 basis points in May, June and July on Friday.
Markets reacted accordingly, with fed funds futures on Friday in a target range of 2.50% to 2.75% by the end of the year and a mid-2023 peak of 3 .00% to 3.25%. Treasury yields jumped 34 basis points for two- and 10-year bonds, with the latter briefly above 2.50%. Still, major stock indexes posted their second straight weekly gain, led by the Nasdaq Composite. It rose 1.98% in the past week, for a 10.32% two-week advance, while the
added 1.79%, leaving the benchmark just 5.29% below its January 3 high.
Indeed, the stock market has had “everything but the kitchen sink” over the past month, Evercore ISI’s Friday daily missive said, with the war in Ukraine and soaring oil prices looming. adding to rising interest rates. Instead of 1999, maybe we’re celebrating like 2007, when the former Citi CEO said he still danced while the music was playing.
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Write to Randall W. Forsyth at [email protected]