Insuring Against Recession?

Fed Vice Chair Richard Clarida spoke on Friday and briefly summarized the outlook for the economy and monetary policy. “The U.S. economy is in a good place, and the baseline outlook is favorable,” Clarida said. However, “despite this favorable baseline outlook, the U.S. economy confronts some evident risks in this the 11th year of economic expansion.” Monetary policy “is not on a preset course, and the Federal Open Market Committee will proceed on a meeting-by-meeting basis to assess the economic outlook as well as the risks to the outlook, and it will act as appropriate to sustain growth, a strong labor market, and a return of inflation to our symmetric 2 percent objective.” While Clarida failed to provide a clear clue on whether the Fed will cut short-term interest rates again on October 30, he indirectly illustrated the Fed’s internal debate.

As we saw in the Summary of Economic Projections released in September, the Fed’s economic outlook is similar to most outside economists. The baseline scenario is for moderate growth in 2020, with growth in real GDP near 2%, and inflation moving gradually toward the Fed’s 2% goal. The unemployment rate, currently at 3.5%, is at a 50-year low. The most recent Beige Book noted that “labor market tightness across skill levels and occupations was widely cited as a factor restraining hiring.” Wages are rising broadly in line with productivity growth and underlying inflation, and despite ongoing tightness in labor market conditions, there is no evidence that wage pressures have fueled a substantial increase in consumer price inflation. Laissez les bon temps rouler!

Clarida noted that “business fixed investment has slowed notably since last year, exports are contracting on a year-over-year basis, and indicators of manufacturing activity are weakening.” In its latest World Economic Outlook, the IMF marked down its forecasts of global growth and cautioned that “with the slowdown in industrial production, trade growth has come to a near standstill.” Despite wage pressures and the impact of tariffs, firms have had a mixed ability to pass higher costs along. “Global disinflationary pressures cloud the outlook for U.S. inflation,” according to Clarida.

Recall that Chair Powell cited three reasons for cutting rates in late July and mid-September: “It is intended to insure against downside risks from weak global growth and trade policy uncertainty, to help offset the effects these factors are currently having on the economy, and to promote a faster return of inflation to our symmetric 2% objective.” The global outlook has weakened further, trade policy remains uncertain, and while the Fed remains optimistic about inflation moving toward the 2% goal, it’s been consistently wrong about that. Hence, while the outlook remains favorable, the risks are weighted to the downside.