Fed holds the line, hopes for a soft landing

What was most striking about the latest US Federal Reserve (Fed) meeting, Max?

It was a really clear message of resolute hawkishness, both from the committee via the summary projection dots, which saw expectations for interest rates next year raised by about 50 basis points. And from Powell (Chairman) and the press conference, where he very much reiterated this point that we are going to be in there for the long haul. It is to be higher for longer, which we’ve been predicting for some months, and they're not going to pivot quickly, which is what the market has been expecting all year. That very much aligns with how we've been thinking about the Fed over the last year or so. The Fed is not going to come to the rescue for markets and ultimately it is fighting against growth.

Do you think they are coming round to expecting a soft landing for the economy?

That was another big change. Previously they were implying a recessionary expectation or outcome and a hard landing. And now that's really been removed from their expectations. We heard from the last meeting that the staff had taken out the recession forecast that has stood since the collapse of Silicon Valley Bank earlier this year. We’re now seeing the committee members follow the staff. 

Powell in the press conference said their objective is a soft landing. That's what he is trying to do. And so, it's no surprise that the committee members are also toeing that line. They want policy to be able to weave this very narrow path to a soft landing.

Can recession really be avoided?

In August we raised our soft landing probabilities from around 5 or 10 per cent, to 20 or 25 per cent, and in turn also lowered our recession probabilities from 80 to 60 per cent. So, we do agree with them to a degree. But ultimately, we do think treading that very narrow path is going to be very hard: the odds of recession versus a softer landing as you can see from those percentages are still around 3 to 1. 

There is still a massive labour market imbalance and that is going to force them to stay with this higher for longer stance on rates and to be anti-growth. 

Why is growth holding up so well?

You've seen the policy rate move up massively, but, in reality, loads of people had locked in lower interest rates in the immediate aftermath of the pandemic. And so, what we're seeing is an economy that isn't being affected too much by these high interest rates. What we expect to happen in 2024 is those effective rates are going to start being pulled up.

That pulling effect is going to be how monetary policy bites. That will hit consumers via their mortgages. It will hit businesses who will suddenly pay double or triple the amount they’d locked in previously. 

If we're right about recession, that's how the cycle will kick in. But the key mechanism is higher effective interest rates, which need time to come in.

Is there now a greater distinction between the US and the other big global economies?

Once we see the numbers for Q4, we’ll have a better idea of where we are heading over the next year. We're seeing a Euro area that is basically on the verge of recession now and the European Central Bank may be done on hiking rates. We've got a UK economy that is now teetering, with recession likely over the next six months or so. Again, that will force the Bank of England to also pull back. And then for China, we've got this really interesting balancing act that policy makers there are trying to do. Our Asia economists expect them to succeed and reach their 5 per cent growth target.