A rallying stock market, cooling inflation and better-than-expected economic data are causing more investors to bet that the Federal Reserve can achieve a “soft landing” in which consumer prices normalize without triggering a recession. Vanguard Group’s economists aren’t buying it.
(Bloomberg) — A rallying stock market, cooling inflation and better-than-expected economic data are causing more investors to bet that the Federal Reserve can achieve a “soft landing” in which consumer prices normalize without triggering a recession. Vanguard Group’s economists aren’t buying it.
Joe Davis, the fund manager’s global chief economist and head of its Investment Strategy Group, joined the What Goes Up podcast to explain why that is. He also offered his reaction to the Fed’s latest meeting and gave his outlook for the bond market.
Below are some highlights of the conversation, which have been condensed and edited for clarity. Click here to listen to the full podcast, or subscribe on Apple Podcasts or wherever you listen.
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Q. One of the remarks that caught some people by surprise this week was when Jerome Powell said he doesn’t see the economy getting back to that 2% inflation target until 2025. We’ve seen such an aggressive drop from the peak in headline CPI of 9% to 3% in the last print. Does it make sense that it would take that much longer to get to 2%?
A. Well, I think it will take some time. And I think that was a subtle, but a very important, point actually. It’s one of the most important comments I thought that was made. And there’s our own research and projections, the Federal Reserve’s projections, as well as academic analysis, including from former Fed Chairman Ben Bernanke, which all point to the same outcome — which is inflation remaining elevated, meaning above 2%, for some time. The primary reason for that is the tightness in the labor market. And so we have been of the view — I’ve had strong conviction for some time — that we were going to need to see some material cooling in the labor market to get to 2% in any near-term horizon, because it is in the wage dynamics.
And so I think the bond market has slowly come to grips with that, starting to price out cuts, right? If we recall at the beginning of the year, there was high conviction in the bond market that there would be significant easing, and almost at this point right now. And so I think those comments point to the fact that it’s going to take some labor market weakness to go that last yard, as many call it, from 3% trend inflation down to 2%.
Q. Is there evidence of a wage-price spiral at this point?
A. I think there was clearly that last year. You had wage pressures that were significant, 6-7%. You had labor market turnover that was high. Now, again, we all knew some of that was somewhat temporary. But I think where I come out now, there’s not a wage-price spiral, but the fact is the labor market is imbalanced. And many point to the job vacancy-to-unemployment ratio. That ratio is unbalanced. We’ve looked at that data actually back to as far back as World War I, so 100 years, which gave us early insight during the throes of Covid that we’re going to have some wage-based inflation pressures.
The ratio now has come down, that’s good news. But the ratio right now is 1.5 vacancies to unemployment of one. So 1.5 is above one, it’s imbalanced, demand exceeds supply. We’re starting to enter the territory where any further drop in vacancies starts to be associated with a modest increase in unemployment. And there hasn’t been an exception to that for a hundred years.
Q. Well, let’s talk about that soft landing notion. It seems like it’s getting a bigger and bigger constituency among economists. One of the interesting things Powell said was that the Fed staff is no longer forecasting a recession. How are you thinking about it?
A. Many of the forecasts out there, they seem dramatically bipolar. Either there’s a recession camp or there’s a soft landing camp, right? But the forecasts, including the Fed, including Vanguard’s and many other economists, they’re actually more similar than different. There’s just been this bipolar sort of, oh, we’re in the recession camp, or not. Why I say that is almost everyone has a rise in the unemployment rate of at least 30 or 40 basis points, so going above 4% over the next year. Well, historically, that has been 100% associated with a recession. Now, not necessarily deep in magnitude, but a recession. That, by the way, is the Federal Reserve’s forecast. I mean semantically, they’re on record saying no recession. But by that metric, it actually is a recession because you have very modest job losses. GDP could be, you know, 0.5%, 1% next year. That’s closer to our projections.
The data’s been a little bit stronger than expected, but ultimately our view has been you can’t have your cake and eat it too — which means to get inflation down that last yard to 2%, you have to see a modest weakening in the labor market, which means the unemployment rate’s going to rise, although hopefully not drastically. Let’s say, let’s say four-and-a-half percent over the next year. Well, that’s a 100 basis-point rise. So by definition, that is a recession. Now, anyone who thinks that that’s a soft landing is spitting in the face of 150 years of history. I’m just saying that that’s categorically wrong.
This was just the highlights. Click here to listen to the entire podcast.
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