U.S. economy sending mixed signals: Here’s what it means
WASHINGTON — Maybe it was just too good to be true.
For a few weeks in late January and early February, the U.S. economy seemed to have reached a rare sweet spot. Inflation was steadily slowing from painful heights. And growth and hiring remained surprisingly sturdy despite ever-higher interest rates imposed by the Federal Reserve.
Perhaps, the thinking went, the Fed’s inflation fighters were managing to nail a notoriously difficult “soft landing’’: A scenario in which borrowing and spending slow just enough to tame inflation without tipping the world’s biggest economy into a recession.
“We were looking at landings that were pillow-soft,’’ recalled Diane Swonk, chief economist at the accounting giant KPMG. “There was a bit of glee about that.’’
The financial markets roared their approval in the first six weeks of 2023, with stock prices surging on expectations that the Fed might soon pause and eventually reverse the series of aggressive rate hikes it began nearly a year ago.
Then something went wrong.
It began on Valentine’s Day. The government said its closely watched consumer price index had surged 0.5% from December to January — five times the increase from November to December.
Over the next week and a half, two more government releases told essentially the same story: The Fed’s drive to curb inflation wasn’t even close to being won.
That realization brought a related worry: If high inflation was even stickier than we thought, then the Fed would likely keep raising rates — and keep them high — longer than was assumed. Those everhigher borrowing rates would make it more probable that a recession, with layoffs and business failures, might occur.
“It’s heartbreaking,’’ Swonk said. “This has put the Fed back in defensive mode, and they’re going to have to harden their resolve on rate hikes.’’
Unsurprisingly, the stock market has recoiled at the prospect.
Here’s a closer look at the economy’s vital signs at a perplexing time of high interest rates, still-punishing inflation and surprisingly strong economic gains.
Inflation
Consumer inflation, not much of a problem, on average, since the early 1980s, started picking up in the spring of 2021 as the economy roared out of recession and Americans spent freely again. At first, Fed Chair Jerome Powell and some economists dismissed the resurgent price spikes as likely a temporary problem that would resolve itself once clogged supply chains had returned to normal.
But the supply bottlenecks lasted longer than expected, and so did high inflation. Worse, Russia’s invasion of Ukraine a year ago sent energy and food prices rocketing. By June 2022, consumer prices were 9.1% higher than they’d been a year earlier — the hottest year-over-year inflation in more than four decades.
By then, the Fed had begun, belatedly, to respond. It has raised its benchmark rate eight times since March 2022 in its most aggressive credit tightening since the early 1980s.
In response, consumer inflation edged down from its mid-2022 peak. It posted milder year-over-year increases for seven straight months as supply chains unclogged and higher borrowing costs worked their way through the economy, putting a brake on overspending.
Financial markets appeared ready to declare the inflation dragon all but slain.
Then came January’s unexpectedly hot consumer inflation data. Two days later, the government reported that wholesale prices had jumped 0.7% from December to January, nearly twice what forecasters had expected.
Next came bad news from the inflation gauge the Fed watches most closely: The government’s personal consumption expenditures price index. It accelerated 0.6% from December to January, far above the 0.2% November-to-December uptick. On a yearover-year basis, prices rose 5.4%, up slightly from the annual increase in December and well above the Fed’s 2% inflation target.
The PCE report “adds to the difficult if not impossible task facing the Fed in terms of getting inflation back to its 2% target without driving the economy into a ditch,’’ said Joshua Shapiro, chief U.S. economist at the Maria Fiorini Ramirez Inc. consultancy.
One concern is that this time, inflation may prove harder to slow than it was initially. Households have increasingly shifted their spending away from physical goods like patio furniture and appliances to experiences like traveling, restaurant meals and entertainment events. Inflationary pressures, too, have shifted from goods toward services, where price acceleration can be harder to tame.
In part, that’s because chronic labor shortages at stores, restaurants, hotels and other service-sector industries have led many employers in those industries to keep raising pay to attract or retain workers. Those employers, in turn, have generally raised their prices to make up for their higher labor costs, thereby fueling inflation.
Some economists expect the Fed to raise its benchmark rate by a substantial half-percentage point when it next meets March 21-22, after having announced only a quarter-point hike when it met Jan. 31-Feb. 1.
The overall economy
The flipside of the disquieting inflation news is good news on the state of the economy — or what would be considered good news in normal times. Even burdened by rising borrowing rates, the economy has proved stronger and sturdier than most forecasters had imagined.
“This economy today looks very different from where we thought it was in mid-January,’’ said Peter Hooper, an economist at Deutsche Bank. “Before, we thought that things were slowing down, the labor market was softening, wage and price inflation was coming down.”
With inflation pressures still persistent, Hooper said, “there’s this growing expectation that the Fed has clearly more work to do.’’
The economy regained its footing last summer after enduring an anemic first half of 2022. The nation’s gross domestic product — its total output of goods and services — contracted from January through March last year and again from April through June.
Though one informal definition of a recession is two straight quarters of negative growth, most economists set aside such concerns this time. They noted that the economy had shrunk in early 2022 because of factors unrelated to its underlying health: Leaner business inventories and a surge in imports, which widened the U.S. trade deficit.
GDP quickly regained momentum: It grew at a solid 3.2% annual rate from July through September and a 2.7% rate from October through December. Steady consumer spending contributed heavily to the growth.