New Federal Reserve Communication: Can the United States achieve a soft landing, success or failure lies in the next few months

"New York Fed News" and well-known Wall Street Journal reporter Nick Timiraos believe that the next few months will be a decisive moment for the fate of the U.S. economy.

The key to success lies in whether the Federal Reserve led by Powell can achieve precise control of interest rates, as well as keen insights into economic data, in order to bring inflation back to target levels without causing an economic recession.

In his article on Wednesday, Timiraos pointed out that if Powell can achieve this goal, it will be a historic achievement worthy of being recorded in the "Central Bank Hall of Fame." However, if he fails, the U.S. economy will inevitably fall into a recession under the pressure of high interest rates, which would confirm an old adage about the Federal Reserve - "Economies often do not naturally decline, but are killed by the Federal Reserve."

The decisive moment has arrived, can Powell become the next Volcker?

In recent weeks, Powell and other Fed officials have frequently signaled that a rate cut cycle will begin in September, citing easing inflation pressures and a significant cooling job market as signals unfavorable for an economic soft landing.

Timiraos wrote in the article:

For Powell, the decisive moment for the Fed to fight inflation has arrived, which will determine the success or failure of the U.S. economy. The strategies he adopts will be closely watched at the global central bank annual meeting to be held this week in Grand Teton National Park, Wyoming, especially in the highly anticipated speech on Friday.

Looking back at the global central bank annual meeting two years ago, Powell clearly stated the Fed's determination to fight inflation, stating that even at the cost of a recession, they would combat high inflation.

This statement completely dispelled doubts about the Fed's attitude from the outside world and was referred to as Powell's "Volcker moment." Volcker served as Fed Chairman from 1979 to 1987, during which he successfully "tamed" double-digit inflation rates, laying the foundation for a long period of economic prosperity in the United States thereafter.

Subsequently, the Fed embarked on a bold interest rate hiking cycle.

Since March 2022, the Fed has raised interest rates 11 times, with a cumulative increase of 525 basis points. The current federal funds rate target range is 5.25%-5.5%, the highest level in twenty-three years. Since July 2023, the Fed has not adjusted interest rates.

Despite the high interest rates, Powell still believes that the U.S. can avoid an economic recession this time, citing differences in inflation between 2021-2023 and the situation in the 1970s.

Timiraos stated:

For Fed officials, a soft landing will be the ultimate redemption. Three years ago, they mistakenly predicted that inflation would be temporary. If successful, this will prove that the cost of the prolonged aggressive stimulus policies in 2021 was not as catastrophic as many critics warned.

Renowned economist Dario Perkins stated that if the Fed can successfully achieve a soft landing, it will be the most brilliant moment in its history. They can say, 'We not only prevented a repeat of the inflation crisis of the 1970s, but we did so without causing substantial harm to the economy - this time a perfect soft landing.'Timiraos believes that in this process, Powell has the opportunity to become a "hero" like Volcker and Greenspan and leave a mark in history.

From overheating to cooling down, the script of the US economy has begun to reverse

Data released in early August showed that the July non-farm unemployment rate unexpectedly rose to a nearly three-year high, triggering the recession indicator with an accuracy rate of 100% - the Sam rule.

The US inflation rate has dropped from over 7% two years ago to around 2.5%, getting closer to the Federal Reserve's 2% target. Combined with recession warnings from the labor market, the market believes that a rate cut in September is already a "done deal".

Furthermore, the "cushion" of the US economy so far, including savings accumulated during the pandemic and the immigrant wave boosting consumption, is gradually fading. Low- and middle-income families are facing difficulties, the outlook for the US housing market is dim, companies are slowing down hiring, job vacancies are significantly decreasing...

A series of evidence indicates that if the Federal Reserve does not cut rates in time, the US economy is likely to follow the script of a hard landing.

Regarding the issue of a soft landing, Wall Street remains optimistic because the Federal Reserve still has ample room for rate cuts, providing enough support to the economy. Timiraos also pointed out that a soft landing still seems within reach, as the economy is currently "closer to the optimistic scenario proposed by Federal Reserve officials two years ago".

Firstly, last year, the supply chain issues were alleviated, reducing the inflation pressure caused by supply chain disruptions. Secondly, the US economy has avoided major events such as a sharp rise in oil prices or a financial market collapse that could have had a significant impact on the economy. In addition, the increase in immigrants has boosted output in the labor market, helping to alleviate labor shortages, which has a positive impact on economic growth and inflation control.

Although Federal Reserve officials believe that the economy can achieve a soft landing, they are still very cautious in their wording, trying to avoid using the term "soft landing" to prevent an awkward situation of prematurely celebrating success.

Timiraos also warned:

Many recessions initially appear to be soft landings, but since World War II, the US has only successfully achieved it once (a soft landing), in 1995. At that time, Greenspan attempted to stop inflation by quickly raising rates, raising rates from 3% to 6%. Then he changed course, lowering rates to 5.25% within six months.

He believes that whether Powell can achieve this feat depends not only on the actual weakness of the economy but also on whether rate cuts can stimulate enough new loans and consumption to fill the demand gap caused by economic weakness.

Two speculations about the rate cut path

There is a certain divergence within the Federal Reserve on the future interest rate path, but to sum it up, Timiraos believes that in the next few months, the Federal Reserve basically has two options:

The first option is to prevent a rebound in inflation after a rate cut. The Federal Reserve will cut rates by 25 basis points at each of the upcoming meetings this year, and then adjust the size and pace of rate cuts based on the economic performance early next year.

The second option is that if the economy experiences a more severe slowdown, the Federal Reserve may cut rates significantly by 50 basis points and bring rates close to 3% by next spring.

Powell may leave some room in his speech this week. The August non-farm payroll data will be released early next month, and if it falls short of Wall Street expectations like the July data, there may be a tendency to support a larger rate cut.

Chicago Fed President Evans stated:

As a central bank member, I believe that the reason for gradual action is that it provides the central bank with options. The downside is that once the situation starts to change rapidly, this flexibility may no longer be feasible.

Analysts from Wall Street investment banks such as JP Morgan and Wells Fargo believe that given the evidence of excessive weakness in the labor market, the Federal Reserve should immediately implement larger rate cuts, abandoning their long-standing preference for gradual action