'We’re at the critical time'—Fed chair confesses what is keeping him up at night (it's not inflation)

The Fed has made progress on inflation, but it may have come at a cost, admits Fed chair Jerome Powell
By Sam Bourgi
•
12 July 2024
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Fed Chair Jerome Powell is confident the central bank can achieve a “soft landing” that cools inflation without triggering a recession but admits it’s keeping him up at night.

In his second day of testimony before the Senate, Powell said, “Trying to make decisions that give that the best chance [of a soft landing]—that is the thing that I think about in the wee hours.”

“We’re at the critical time—inflation’s coming down, the labor market is cooling, and we want to get it right,” he said.

Powell has been walking a tightrope in recent months, trying to balance the resurgence of inflation at the beginning of the year with new evidence that cost pressures are cooling again.

The latest reading of the core Personal Consumption Expenditures (PCE) index—the Fed’s preferred measure of inflation—showed the smallest increase in three and a half years. On an annual basis, core PCE slowed to 2.6% in May, the smallest increase since March 2021 and not that far from the Fed’s 2% target.

As Powell noted at the time, the data suggested that “we’re getting back on a disinflationary path.”

Although the Fed is making progress on inflation, several economists say the central bank is letting the economy slip into a recession. If they’re right, talks of a “soft landing” can be thrown out the window.

Recession risks are growing

In June, Queens’ College president Mohamed El-Erian placed the odds of a U.S. recession at 35% due to the Fed’s lack of action on interest rates. That was before the latest U.S. Services PMI—which affects three-quarters of the economy—posted its biggest monthly drop in four years.

Claudia Sahm—the economist and creator of the Sahm Rule—said recession isn’t her base case, but that “it’s a real risk.”

“I do not understand why the Fed is pushing that risk. I’m not sure what they’re waiting for,” she said, referring to rate cuts.

“The worst possible outcome at this point is for the Fed to cause an unnecessary recession,” she explained.

The Sahm Rule, which identifies the start of a recession when the unemployment rate’s three-month moving average rises half a percentage point or more from its recent 12-month low, ticked higher in June as joblessness rose to 4.1%.

By keeping rates higher for longer, the central bank risks “breaking” something in the economy, said Moody’s chief economist Mark Zandi.

“Those rates are corrosive [to] the economy. They wear the economy down, and at some point, something could break,” Zandi said. “If I were king for the day, I would really be cutting rates at this point, because I do think the economy could use that relief.”

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