AMSCI NEWSLETTER April 2023

The Federal Reserve is predicting an economic downturn this year – but it still might continue to raise interest rates.

A potential recession has been discussed for much of the past year as the Fed has increased the target range for the Federal Funds Rate from 0-0.25 percent in March 2022 to 4.75-5 percent now. While Fed Chairman Jerome Powell has frequently said that he is seeking a “soft landing” for the nation’s economy, the recent banking crisis, seen most prominently in the collapse of Silicon Valley Bank, has led the central bank’s staff to predict that will not happen.

“Given their assessment of the potential economic effects of the recent banking- sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years,” the minutes of the Federal Reserve Federal Open Market Committee (FOMC) March 21-22 meeting stated.

Although the minutes do not indicate whether committee members agreed or disagreed with that forecast, they recorded that members acknowledged “that the developments in the banking sector that had occurred late in the intermeeting period affected their views of the economic and policy outlook and the uncertainty surrounding that outlook” and they “generally expected real GDP [Gross Domestic Product] to grow this year at a pace well below its long-run trend rate.”

“With inflation remaining unacceptably high, participants expected that a period of below-trend growth in real GDP would be needed to bring aggregate demand into better balance with aggregate supply and thereby reduce inflationary pressures,” the minutes stated.

Despite expectations that economic growth will slow – and maybe turn negative – another interest rate hike appears to be not unlikely, with a Reuters article even calling a quarter-point increase “the odds-on bet.”

“Chair Jerome Powell has said he does not want to risk stopping short of the mark on policy tightening, only to have to start raising rates again if inflation heats up again,” the article stated.

The decision will be made by the full FOMC, though, and one of the committee members, Chicago Federal Reserve President Austan Goolsbee, on April 11 called for “prudence and patience – for assessing the potential impact of financial stress on the real economy.”

“The foremost thing on my mind before our next meeting in May is trying to get a handle on this question about credit: Is it actually credit tightening,” Goolsbee said.

The Fed’s adversary for the past year has been inflation, with year-over-year prices reaching 9 percent last June before gradually coming down to 5 percent in March, according to the Bureau of Labor Statistics, the lowest level in almost two years but still well above the central bank’s target of 2 percent. However, while prices overall increased by just 0.1 percent from February to March, core inflation, which excludes the food and energy sectors, increased by 0.4 percent month to month. Compared to a year earlier, core inflation was 5.6 percent.

A CNN article referred to 5 percent inflation as a possible “inflection point” at which, some economists say, price increases are no longer an emergency issue.

The article cited a study by the University of Massachusetts-Amherst Economics Department that stated, “Our findings suggest that it is not typically necessary to force down inflation to such low levels [below 5 percent], especially given that contractionary monetary policies succeed in controlling inflation primarily through the channel of raising mass unemployment and weakening workers’ bargaining power.”

Through it all, the labor market has remained strong, with the nation’s unemployment rate at 3.5 percent after the economy added 236,000 jobs in March, according to the Bureau of Economic Analysis.

“Employment continued to trend up in leisure and hospitality, government, professional and business services, and health care,” the bureau stated.

Although companies are hiring, confidence in the manufacturing sector continues to slide. The Institute for Supply Management’s Purchasing Managers Index in March dropped to its lowest level since the early days of the pandemic in May 2020. The index of 46.3 was below the threshold for growth in the sector (50) for the fifth straight month and below the threshold for growth in the overall economy (48.7) for the fourth consecutive month.

“With Business Survey Committee panelists reporting softening new order rates over the previous 10 months, the March composite index reading reflects companies continuing to slow outputs to better match demand for the first half of 2023 and prepare for growth in the late summer/early fall period,” the chair of the institute’s Manufacturing Business Survey Committee said.

Among consumers, two separate confidence measures – The Conference Board’s Consumer Confidence Index and the Index of Consumer Sentiment from the University of Michigan’s Surveys of Consumers – both showed small increases.

“While consumers feel a bit more confident about what’s ahead, they are slightly less optimistic about the current landscape,” the senior director for economics
at The Conference Board said. “The share of consumers saying jobs are ‘plentiful’ fell, while the share of those saying jobs are ‘not so plentiful’ rose.”

Consumers slowed their spending from February to March, with retail sales declining by 1 percent during that time, according to the Census Bureau. This followed a 0.2 percent decline from January to February.

“Sales fell among most retailers, including at auto dealers, gas stations, electronics stores, and home and garden stores,” the Associated Press

reported. “Gas-station sales plunged 5.5% in March, though the data isn’t adjusted for price changes, and gas prices fell last month. Excluding car dealers and gas stations, retail sales fell a less-dramatic 0.3%. Spending jumped 1.9% at online retailers and ticked up 0.1% at restaurants and bars.”

Housing starts in February were up 9.8 percent from January but were 18.4 percent lower than a year earlier, according to the Department of Housing and Urban Development and the Census Bureau. Existing home sales ended a 12- month streak of declines by spiking 14.5 percent from January to February, the largest increase since July 2020.

“Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines,” the association’s chief economist said. “Moreover, we’re seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs.”

The Dow Jones Industrial Average closed at 33,886.47 on April 14, marking a 2.2 percent year-to-date gain. The S&P 500 Index ended that day at 4,137.64, up 7.8 percent on the year.

The dollar on April 13 was trading at 0.90 euros, 0.80 pounds, 132.39 yen and 6.87 yuan.

The next meeting of the Federal Reserve Federal Open Market Committee is scheduled for May 2-3. A few days before that, the Bureau of Economic Analysis will announce its estimate of economic growth in the first quarter. A strong, or even semi-strong, number could embolden Powell and other inflation hawks on the committee, while a weak showing might mean the country has seen the last rate increase for a while.