The Fed’s Poor Record on Soft Landings

The central bank is trying to hold the economy steady by slowing things down a bit, but history says it will go too far

By Justin Lahart

A man walks by the Marriner S. Eccles Federal Reserve Board Building in Washington, D.C. Photo: Tom Williams/Congressional Quarterly/Newscom/Zuma Press        


There are two things investors should keep in mind about the Federal Reserve: One, it is in a tightening cycle. Two, tightening cycles almost always end badly.

The Fed raised rates for a third time in six months last week, and signaled there are more to come. After all the fits and starts of the past several years, the Fed is finally, unambiguously in a tightening cycle -- a fact underscored by its plans to start reducing the amount of bonds it holds on its balance sheet, a legacy of its efforts to restart the economy after the financial crisis “relatively soon,” according to Chairwoman Janet Yellen.

The Fed’s aim here is to guide the economy to a soft landing. To do that, it foresees continuing to raise rates in order to slow growth, ease the pace of hiring, and nudge the unemployment rate little higher. That way, it reckons it will be able to prevent the job market from overheating while getting the inflation rate to settle at 2%.

But executing a soft landing is notoriously difficult to pull off. The Fed can only guess at what the economy’s just-right levels of growth and employment are, and at what level of interest rates is consistent with hitting those marks. The process of running down its balance sheet introduces new complications, points out J.P. Morgan economist Michael Feroli, as does a likely change in leadership at the Fed.

Moreover, the Fed’s track record with soft landings is incredibly poor. It has had, with the benefit of hindsight, a tendency to overtighten in its efforts to tame inflation and other excesses. Rates suddenly go from looking as if they are too low to too high, and the economy suffers as a result.

By the time it stopped raising rates in 2006, for example, the housing bust that would drag the economy into recession and set off the financial crisis was under way.

The only time the Fed really succeeded in executing a soft landing, according to most economists, was when it raised rates through 1994. In the mid-1960s and mid-1980s it had a couple of qualified successes. Its other tightening cycles over the past 60 years were followed by recessions, though in some cases a recession was necessary to wipe out inflation.

A recession seems far from imminent at the moment. Hiring appears to have slowed, but is still running fast to keep the unemployment rate slipping lower. Inflation has been stubbornly low, allowing the Fed to raise rates slowly, which might prevent the bank from tightening too much.

And while stock valuations are running high, the types of financial market excess that got the economy in trouble during the dot-com and housing bubbles haven’t presented themselves.

Still, with the Fed trying to pull off a maneuver it has had little success with, investors should pay attention. And be a little nervous.

0 comentarios:

Publicar un comentario