USA: Soft landing, painful landing?

This week the FOMC announced the first of what is promised to be a long series of key rate increases. Although less aggressive than 1994, the Fed’s current plans show a noticeable tightening in just a few months in response to much stronger inflationary pressures. Will this relapse the economy? All gurus on earth give the possibility of a recession and give a better display to hear. History shows that there is no ironclad link between monetary tightening and the risk of a recession. The Fed expects a soft landing. There is nothing unlikely or impossible about it.

US focus Chief Economist Bruno Cavalier and Economist Fabian Bossy

2022.03.21.fed key rate
US: Fed Key Rate and Neutral Zone

There was little doubt about the FOMC’s decision at the March 16 meeting. The key rate has been increased by 25bp (see p.2). New information can be found in the revision of the key rate forecast. According to the FOMC’s median scenario, the tightening end will reach as early as 2023 instead of 2024 in December last year’s forecast. It rises to 2.8% compared to 2.1%, even beyond the 2.4% long-term level. This is the first time that the Federal Reserve has estimated that it was possible to return the key rate to an equilibrium or neutral zone about 10 years after announcing this type of forecast (Graph). Of course, this kind of calculation needs to be considered carefully, but the message is clear. To weigh inflationary pressures, monetary policy needs to be significantly tightened in the next 12-18 months. This raises the question of business cycle reaction. The Fed is often referred to as an expanding serial killer. The treatise is simple. At the top of the cycle, excesses (inflation, credit) have forced the Fed to tighten its policies significantly, driving the economy into recession. A prime example is the Fed under the Paul Volcker administration in the early 1980s.

2022.03.21.Yield curve
US: Yield curve and probability of recession

In short, the Fed can’t turn the economy into a soft landing. There are many counterexamples in this treatise. In 1994, a sudden and unexpected tightening caused a bond crash, but by 1995 the Fed was able to ease policy again and the economy continued to expand for several years. The 1999-2000 tightening is remembered as the dot-com bubble continued to collapse, but the US economy stagnated in the worst of 2001 (despite the 9/11 shock). In 2019, the Fed retreated again as expansion broke record-breaking periods and key rates approached the critical zone. Without a pandemic, there was no predisposition for the US economy to fall into recession the following year. The yield curve has a reputation for predicting a recession (slightly misused). Assuming the Fed’s expected rate hike spills over to a quarter of long-term interest rates, this raises the implicit probability of a recession from less than 10% today to 33% a year later (3%).Graph).


After a strong recovery in January (+ 3.8%, revised to + 4.9% m / m), retail sales in February were virtually stable (+ 0.3% m / m). Sales of service stations surged (+ 5.3% m / m) due to the further intensified rise in fuel prices in early March. With the decline in the Omicron wave, restaurant spending has recovered 1.1 points above November levels after a two-month decline. Disposable income cannot grow indefinitely, so there are amendments elsewhere. The underlying sales index (excluding volatile components such as gasoline, automobiles and building materials) decreased by 1.2% m / m from + 6.7%. Overall, from January to February, this total consumption proxy is expected to grow at an annual rate of over 10% q / q in the first quarter of 2022. In essence, when corrected for strong price effects, this increase is only 5%, indicating that real consumption is well tolerated by the inflation shock at this stage. This is not a future guarantee as price pressure has a cumulative impact on purchasing power.

On the activity side, manufacturing production is dynamic (+ 1.2% m / m in February) and should show a sharp acceleration in the first quarter of 2022. The same is true for home construction. Housing starts are more than 4% above the level in the fourth quarter of 2021. Building permits have almost returned to their peak in early 2021. The NAHB index for home builders in March is the third straight month. His level remains much higher than usual.

In February, inflation in producer prices showed signs of gradual easing before the war in Ukraine began and commodity market tensions rose again. The same applies to import prices.

Monetary policy and fiscal policy

West Virginia Democratic Senator Joe Manchin opposed various elements of the “Joe Biden Administration” plan that would force Joe Biden to reduce his budget ambitions. On March 14, he announced that Sarah Bloom Raskin was opposed to being appointed Fed Governor for banking oversight because of leveled criticism of the oil and gas sector. In return, Ruskin gave up running for the post. This is a decision to lift Jerome Powell’s second term official confirmation and move forward with other vacant post candidates.

In line with Jerome Powell’s support, the FOMC announced on March 16 that the federal funds rate range will rise 25bp from 0-0.25% to 0.25-0.50%. The decision was made with eight votes against one of James Bullard (Fed) in support of the 50bp increase.

The Federal Reserve Chair said the debate on asset portfolio reduction (“quantitative tightening”) went smoothly. Some details will be provided in the minutes, which will be published within three weeks. Its implementation may be announced at the May 4th meeting in the short term anyway. Similar to the previous episode of QT, from 2017 to 2019, the asset portfolio will be reduced by limiting reinvestment rather than selling securities, at least at the beginning of the process. The difference is that this time the balance sheet shrinks twice as fast, tightening monetary policy. Ultimately, the Fed only holds Treasury securities and RMBS wants to hold no more (current balance: $ 2.73 billion). The war in Ukraine made the environment more opaque, but Jerome Powell had no doubt about the Fed’s intentions. This increase is only the first in a long series. The 50bp option will not be excluded in the future.

Continues this week

Markit Purchasing Manager Morale Surveys will be released as a preliminary version on March 24th. These are the first full investigations conducted after the start of the war in Ukraine. Local manufacturing data gave a mixed signal. A survey by the Federal Reserve Bank of New York shows that sentiment is declining sharply amid concerns about rising commodity prices and further disruption to the supply chain. Philadelphia Federation surveys show strong power in purchase orders, production and employment.