History shows that the Fed cannot meet its inflation target without a recession

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Friday December 16, 2022

Today’s newsletter is over Jared Blikre, a reporter focused on the markets at Yahoo Finance. Follow him on Twitter @SPYJared. Read this and more market news along the way Yahoo Finance app.

Forget a soft landing in 2023.

Should the Fed achieve its target of reducing inflation, it is anything but a guarantee for a deep recession next year, caused by a rapidly deteriorating labor market.

As Yahoo Finance’s Myles Udland explained in Thursday’s Morning Brief, Fed Chairman Powell was exercising credulity at his latest press conference as he tried to argue for a possible soft landing next year, in which inflation falls without the economy contracting.

Powell struggled to fit the FOMC’s own forecasts for next year’s economy into a narrative that avoids a hard landing — or a recession.

Powell hammered on the strong labor market and didn’t mince words when he said, “There is an imbalance in the labor market between supply and demand,” noting that it will take “a considerable period of time” to bring the labor market back into balance. to get.

Federal Reserve Board Chairman Jerome Powell looks on at a press conference following the announcement that the Federal Reserve has raised interest rates by half a percentage point, at the Federal Reserve Building in Washington, US, December 14, 2022. REUTERS/Evelyn Hockstein

The problem for the Fed has been inflation, which is currently well above the 2% target.

In November, headline inflation, as measured by the consumer price index (CPI), was 7.1% year-on-year. In June of this year, inflation peaked above 9%.

The Fed’s forecasts released on Wednesday show that inflation will slow next year as unemployment rises. But with inflation reaching 3.5% by the end of 2023, the Fed’s own projections show that prices are still rising at an unacceptable rate.

And if Alfonso “Alf” Peccatiello according to the notes of The Macro Compass, a recession is a foolproof way to reduce inflation.

Since 1960, every recession, except the pandemic-induced downturn of 2020, started with inflation at or above 3.7%. And it wasn’t until 1974 that the recession ended with inflation exceeding 2.7%.

Modern economic history shows that recessions drive inflation down.  And the current Fed is more focused on achieving the latter than avoiding the former.  (Source: The Macro Compass)

Modern economic history shows that recessions drive inflation down. And the current Fed is more focused on achieving the latter than avoiding the former. (Source: The Macro Compass)

Also a problem for Powell and the Fed is that while the 0.5% GDP growth in 2023 provides evidence to rebut the recession suggestions inferred from their forecasts, the outlook for the labor market is less ambiguous.

The Sahm rule is a relatively new Fed model that correctly predicted the last nine recessions and did so much faster than they were officially announced in real time. The recession alert is triggered when the three-month moving average of the unemployment rate rises more than 0.50% above the lowest low of the last 12 months.

The current lowest unemployment rate in 12 months is 3.5%. So if and when the 3-month average rises above 4.0%, that could indicate that the economy is already in recession.

Even if we mark this local low from the November unemployment rate of 3.7% and move the Sahm Rule trigger to 4.2%, the Fed’s outlook still looks hairy. The Fed is forecasting an unemployment rate of 4.6% by the end of next year, so it’s easy to see where the central bank’s argument is flawed.

But if we take Powell’s comments and the Fed’s forecasts together, we see that all anti-recession arguments are ultimately mostly academic.

The goal of this Fed is to bring inflation down, and in a big way.

“Without price stability, the economy doesn’t work for anyone,” Powell said Wednesday.

And the road to that stability – read: 2% inflation – is the labor market.

“The labor market situation will ease somewhat,” Powell said. “And I wish there was a completely painless way to restore price stability. There isn’t. And this is the best we can do.”

What to watch today


  • 9:45 a.m. ET: S&P Global US Manufacturing PMIPreliminary December (46.9 expected, 46.4 during last month)

  • 9:45 a.m. ET: S&P Global US Services PMIDecember Preliminary (47.8 expected, 47.7 during previous month)

  • 9:45 a.m. ET: S&P Global US Composite PMIDecember Preliminary (46.5 expected, 46.2 during last month)


  • accent (ACN), Darden Restaurants (D.R.I.), Winnebago Industries (WHO)

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