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Making Sense of US Economy’s Mixed Signals

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Maybe it was too good to be true.

For a few weeks in late January and early February, the US economy seemed to hit a rare sweet spot. Inflation was steadily decelerating from painful highs. And despite the Federal Reserve charging ever higher interest rates, growth and employment have held up surprisingly well.

Perhaps the Fed’s inflation fighters have made the notoriously difficult “soft landing”. That is, a scenario in which borrowing and spending slow enough to keep inflation in check without sending the world’s largest economy into recession.

“We were watching the pillow-soft landing,” said Diane Swonk, chief economist at accounting giant KPMG. “There was a little bit of jubilation about it.”

Financial markets have voiced approval in the first six weeks of 2023, driving stocks on hopes that the Fed may soon come to a halt and finally reverse a string of aggressive rate hikes that began almost a year ago. soared.

Then something went wrong.

It started with Valentine’s Day. The government announced that the consumer price index rose by 0.5% from December to January.

In the space of a week and a half since then, two more government announcements have essentially said the same thing: the Fed’s fight to contain inflation has come even closer to victory.

This realization has raised related concerns. If high inflation is even stronger than we thought, the Fed will likely continue to raise rates longer than expected and keep them high. With borrowing rates higher than ever, a recession with layoffs and business failures is more likely.

Federal Reserve Chairman Jerome Powell was scheduled to warn Congress on Tuesday that the central bank will need to raise interest rates even higher than previously suggested if inflation continues.

“It’s heartbreaking,” Swonk said. “This will force the Fed to get back on the defensive and be determined to raise rates,” he said.

Not surprisingly, the stock market rebounded on the outlook.

Here, we take a closer look at the economy’s vital signs during a complicated time of high interest rates, still-tough inflation, and surprisingly strong economic gains.


Consumer inflation, which has averaged less trouble since the early 1980s, began to pick up in the spring of 2021, as the economy emerged from recession and Americans were free to spend again. Initially, Fed Chairman Jerome Powell and some economists believed the renewed price spike was a temporary problem that was not likely to resolve itself once the clogged supply chain returned to normal. bottom.

However, supply bottlenecks persisted longer than expected, as did high inflation. To make matters worse, Russia’s invasion of Ukraine a year ago sent energy and food prices skyrocketing. By June 2022, consumer prices were up 9.1% year-on-year. This is the highest year-on-year inflation rate in over 40 years.

By then, the Fed had belatedly started responding. Since March 2022, he has raised the benchmark interest rate eight times in the most aggressive credit tightening since the early 1980s.

In response, consumer prices have eased slightly from their peak in mid-2022. Year-on-year growth moderated for the seventh straight month, as supply chains were unblocked and higher borrowing costs pushed the economy to put the brakes on overspending.

Financial markets appeared ready to declare the inflation dragon all but killed.

Then came unexpectedly hot consumer inflation data for January. Two days later, the government announced that wholesale prices had risen by 0.7% from his December to January.

Then there was the bad news from the Fed’s most closely watched inflation gauge. It is a price index of government personal consumption expenditure. From December he was up 0.6% through January, well above the 0.2% gain in November-December. Year-on-year, prices rose his 5.4%, up slightly from December’s annual gains and well above the Fed’s 2% inflation target.

Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez, said the PCE’s report “struggles with the Fed’s challenges in terms of returning inflation to its 2% target without driving the economy into a ditch.” It adds a difficult, if not possible, challenge,” said Consulting.

One concern this time around is that inflation may be harder to decelerate than it was originally. Households are shifting their spending away from physical goods such as patio furniture and appliances to experiences such as travel, restaurant dining, and entertainment events. Inflationary pressures are also shifting from goods to services, and it can be difficult to contain price increases.

One reason is that chronic labor shortages in shops, restaurants, hotels and other service sector industries have led many employers in these industries to raise wages to attract and retain workers. because it continues. These employers generally raise prices to compensate for higher labor costs, thereby accelerating inflation.

Some economists say the Fed will raise the benchmark rate by a significant 0.5% at its next meeting on March 21-22, after announcing only a half-point rate hike at its January 31-February meeting. I expect. 1.

stubbornly strong economy

The flip side of the disturbing inflation news is good news, or what would normally be considered good news, about the state of the economy. Even plagued by rising borrowing rates, the economy has proven to be stronger and stronger than most forecasters had imagined.

“Today’s economy looks a lot different than we thought it would in mid-January,” said Deutsche Bank economist Peter Hooper. I thought price inflation was going down.”

With inflationary pressures still lingering, Hooper said, “there’s a growing expectation that the Fed has clearly more work to do.”

The economy regained its footing last summer after enduring a downturn in the first half of 2022. The country’s gross domestic product (total production of goods and services) shrank last year from January to March, and from April to June.

One of the informal definitions of a recession is two straight quarters of negative growth, but this time most economists have put such concerns aside. They attributed the economy’s contraction in early 2022 to factors unrelated to its underlying health: declining business inventories and a surge in imports, which widened the U.S. trade deficit. pointed out.

GDP quickly regained momentum. It grew at an annual rate of 3.2% from July to September and 2.7% from October to December. Robust consumer spending contributed significantly to growth.

Economists are still predicting a recession sometime this year – they were always skeptical of a soft landing – but now see it coming later than they expected. A survey of 48 forecasters released last week by the Keizai Association found that only a quarter of respondents believed a recession would start by the end of March, compared with half of those who expected it in December. decreased from

resilient labor market

The surprising strength of the US job market has disappointed hopes through the economic turmoil of the COVID era. 2021 and 2022 were his two best years for recruitment according to US government records dating back to 1940.

Job creation was expected to slow down this year. Not far. In January, employers added a staggering 517,000 jobs to him, well above his 260,000 increase in December. Nearly 208,000 more were likely added in February, according to a survey of forecasters by data firm FactSet.

Moreover, American workers as a whole enjoy almost unprecedented job security despite high-profile job cuts in technology and several other sectors. The number of government monthly layoffs and layoffs will drop below 1.5 million for the first time in 2021 and has stayed there ever since.

The unemployment rate hit 3.4% in January, the lowest level since 1969. There are now an average of about 2 job openings for every unemployed American.

However, a strong labor market will put upward pressure on wages and, by extension, prices. In other words, more inflation.

“The wage increases and tight labor market that we are seeing are consistent with inflation of 3.5% to 4%, not 2% or 3%,” said KPMG’s Swonk. “That’s our harsh reality.”

consumers will continue to spend

Their jobs are stable, their bank accounts are fueled by pandemic-era savings, and Americans are fending off rising interest rates and prices to keep spending.

January retail sales bounced back from a weak holiday shopping season, rising at the fastest pace in nearly two years. Even after accounting for inflation, consumers spent the after-tax dollar at the fastest pace since his March 2021. Consumer spending on services ranging from healthcare to dining out to airline tickets accounted for 95% of his economic growth last year.

Moody’s Analytics chief economist Mark Zandy estimates that consumers still have $1.5 trillion in “excess savings” due to government support and shelter-in-place savings. during the peak of the pandemic.

Yet inflation continues to pose challenges for millions of households. Inflation-adjusted average hourly wages have fallen for the 22nd straight month, according to government data. Many low- and middle-income households are turning to credit cards to keep up with their spending.

housing hit

While the Federal Reserve’s interest rate hikes have had limited impact on the economy as a whole so far, they have hit one industry: housing.

Residential real estate usually depends on people’s willingness to take out the most expensive purchase of their lives: a mortgage. The Fed continued to raise interest rates last year, so the average interest rate on a 30-year fixed mortgage was over 7% last fall and more than doubled when he started in 2022. decreased slightly.

The damage is serious. Existing home sales have fallen for a record 12 straight months, according to the National Association of Realtors. Also, according to the government’s GDP report, investment in housing fell nearly 26% annually from October to December, after declining 18% from April to June and 27% from July to September. Did.

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