America seemed headed for an economic fairy tale ending at the end of 2023. The painfully rapid inflation that had started in 2021 appeared to have cooled seriously, and economic growth had begun to gradually moderate following a series of rate hikes by the Federal Reserve.
However, 2024 brought a number of surprises: The economy is growing rapidly, job gains are unexpectedly strong, and progress on inflation shows signs of stalling. This could lead to a very different conclusion.
Instead of the “soft landing” that many economists thought was underway — a situation in which inflation slows as growth eases gently without a painful recession — analysts are increasingly wary that America’s economy isn’t landing at all. Rather than stagnate, the economy appears to be booming as prices continue to rise faster than usual.
A “no-landing” result can be very good for the typical American household. Inflation is not as high as it was at its peak in 2022, wages are rising and jobs are plentiful. But it would spell trouble for the Federal Reserve, which is determined to wrestle price increases back to its 2 percent target, a slow and steady pace the Fed believes is consistent with price stability. Policymakers raised interest rates sharply in 2022 and 2023, pushing them to a two-decade high, in a bid to weigh on growth and inflation.
If inflation remains high for months, it could prompt Fed officials to keep interest rates high for longer in an effort to cool the economy and ensure prices come fully under control.
“The persistent uptick in inflation numbers” is likely “suggesting to Fed officials that maybe the economy is too hot right now for rate cuts,” said Kathy Bostjancic, chief economist at Nationwide. “Right now, we’re not even seeing a ‘soft landing’ – we’re seeing a ‘no-go landing.’
On Wednesday, Fed policymakers got a new sign that the economy may not be landing as smoothly as expected. A key inflation report showed prices rose more than expected in March.
The measure of the consumer price index rose to 3.8% on an annual basis after stripping out food and fuel costs. After months of steady decline, this inflation rate has remained just under 4% since December.
While the Fed officially targets a separate measure of inflation, the Personal Consumption Expenditure index, the new report was a clear sign that price increases remain persistent. Days earlier, the March jobs report showed employers added 303,000 workers, more than expected, as wage growth remained strong.
The combination of strong growth and steady inflation may say something about the state of the U.S. economy, which at any given time can be in one of four states, said Neil Dutta, chief economist at Renaissance Macro, a research firm.
The economy may be in a recession, when growth falls and eventually lowers inflation. It can be stagnant, when growth falls but inflation remains high. It may be in a soft landing, with cooling and inflation. Or it may experience an inflationary boom, when growth is strong and prices rise rapidly.
At the end of 2023, the economy appeared headed for a benign slowdown. But these days, the data is less average—and more full of momentum.
“You’ve put a lot of chips in the soft landing bucket, and steadily that’s been eroded and the possibility of an inflationary boom has come back,” Mr Dutta said. “That kind of reinforced the Fed’s framework, which is that we have time before we decide on a rate cut.”
Fed officials entered 2024 forecasting three rate cuts before the end of the year, which would have lowered borrowing costs to about 4.6 percent from the current 5.3 percent. Officials maintained that call in their March economic forecasts.
But as inflation and the economy in general appear to be holding on, investors are steadily dialing back how many rate cuts they expect. Market pricing suggests traders are now betting heavily on one or two rate cuts this year. Markets also expect fewer cuts in 2025 than previously expected.
Fed policymakers are taking an increasingly cautious tone when talking about when and how much they might cut borrowing costs.
Jerome H. Powell, the Fed chairman, has repeatedly emphasized that strong growth gives central bankers the ability to be patient in cutting interest rates. In an economy this tight, there is less risk that keeping borrowing costs high for a while will push America into recession.
Some of his colleagues were even more cautious. Neel Kashkari, president of the Minneapolis Fed, has suggested he could see a scenario in which the Fed does not cut rates at all in 2024. Mr. Kashkari is not voting on rates this year, but sits at the policy-making table.
Fed policy is raising borrowing costs across the economy, so that would be bad news for households hoping for lower mortgage or credit card rates. And it could create a political problem for President Biden ahead of the 2024 election if high borrowing costs make voters feel worse about the housing market and the economy.
Mr. Biden said on Wednesday that he stood by his prediction that the Fed would cut interest rates this year — an unusual comment from a president who usually avoids talking about Fed policy out of respect for the central bank’s independence from the White House.
“That might delay it a month or so — I’m not sure about that,” Mr. Biden said.
Many Fed watchers believe today’s high interest rates could be sustained for much longer. Many economists and investors had previously expected rate cuts to begin in June or July. After this week’s inflation report, investors increasingly see rate cuts from September or later.
Blerina Uruci, chief U.S. economist at T. Rowe Price, noted that the longer inflation flattens, the longer it could delay rate cuts: Officials are likely to want to see convincing evidence that progress toward cooler inflation has restart before they reduce borrowing costs.
And with the possibility of the economy not actually landing, some economists and officials are suggesting the Fed’s next move might even be a rate hike — not a cut. Michelle Bowman, the Fed’s governor, said she continued to see a risk that “we may need to raise the policy rate further if progress is made on stopping or even reversing inflation.”
Ms. Bostjancic thinks further rate hikes are unlikely at this point: Most Fed officials are still talking about cuts. However, recent data suggest that it may take a long period of stable borrowing costs for the economy to cool down and for progress towards lower inflation to resume.
“More likely they will just keep rates at this level for a longer period of time,” he said.
