The unpredictable course of inflation in recent years has humbled economists regarding their forecasting, yet there's hope for a soft landing in the U.S. and potentially lower Federal Reserve interest rates.
During the three-day annual economics meeting in San Antonio last weekend, several attendees acknowledged the challenges in forecasting the economy and inflation post-pandemic. Many were surprised by the surge in inflation to multi-decade highs and initially assumed a recession would be necessary to alleviate it.
“We didn’t really understand why inflation spiked in the first place,” said University of Michigan professor James Hines. “We maybe shouldn’t be surprised it came down faster than we thought.”
The decline in inflation, with the Fed's preferred measure dropping from 7.1 percent in June 2022 to 2.6 percent in November, has encouraged optimism among economists at the Texas gathering. They anticipate a return to the Fed's two percent target without an economic downturn and foresee potential room for the Fed to cut interest rates, although not as swiftly as expected by investors.
According to Stanford University professor John Taylor, a sustained decline in inflation could lead to a scenario of reduced interest rates. He hinted at the possibility of rates eventually decreasing to a range between three and four percent from the current 5.25 to 5.5 percent range.
Meanwhile, federal funds futures market traders are anticipating the initial Fed cut in March. Their predictions suggest that the central bank might decrease rates to approximately four percent by year-end.
Despite the current outlook, uncertainties remain, with significant risks including a potential geopolitical shock, such as an escalation of the conflict in the Middle East that could trigger a surge in oil prices. Ricardo Reis of the London School of Economics suggested that although there's a small probability of such an event, he expresses confidence that inflation would return to two percent even by the year's end.
Is a "soft landing" on the horizon?
U.S. Treasury Secretary Janet Yellen said last Friday that the country was experiencing a "soft landing" in its economy. A prolonged phase marked by low inflation and increasing wages for Americans is necessary to gain confidence in their prospects.
"What we’re seeing now I think we can describe as a soft landing, and my hope is that it will continue," Yellen said in an interview with CNN.
Over the past two years, the Treasury chief has consistently opposed pessimistic forecasts for the U.S. economy despite the central bank's vigorous rate hikes throughout 2022 and 2023. While not dismissing the potential for a recession, she often emphasized a potential "path" toward achieving a "soft landing."
This Time, Yellen was confident as the recent wage data showed a 4.1 percent increase in average hourly earnings over the year ending in December. With economists projecting a 3.2 percent consumer inflation rate for the year, it is believed that wages outpaced the growth in prices throughout 2023.
"Wage increases are running over price increases now," she said. "American workers are getting ahead and the progress for the middle-income families is very noticeable."
Thursday will bring the latest report on U.S. inflation, as Friday's data revealed that American employers had surpassed expectations, hiring more workers in December while simultaneously increasing wages significantly. This outcome could indicate a labor market that remains robust and resilient.
Another survey released on the same day indicated a significant slowdown in the U.S. services sector last month. The survey revealed a measure of employment reaching its lowest point in nearly 3.5 years, presenting a varied perspective on the performance of the world's largest economy.
Yellen refrained from commenting on how she believed the Fed should proceed, including the possibilities of rate cuts. She acknowledged that the central bank had effectively managed monetary policy.