Will the Fed Start Believing in a Soft Landing?

Can the Federal Reserve engineer a soft landing, in which it defeats excessive inflation without tipping the US economy into recession? This week, Fed officials will offer important clues as to whether that’s achievable.

The Sept. 19-20 meeting of the policy-making Federal Open Markets Committee isn’t likely to deliver any interest-rate surprises: Officials have amply signaled that there won’t be any further increase this time around. That said, they will update the Summary of Economic Projections, which lays out how they expect growth, inflation and unemployment to develop given appropriate monetary policy. Those projections haven’t been consistent with the soft landing that many in markets are already predicting, so any changes will be significant.

Here are five things I’ll be watching.

1. Will there be another rate hike this year? In June, 12 out of the 18 committee participants indicated two or more 25-basis-point increases in 2023. One happened in July. Do they still see one more coming, despite data suggesting a somewhat softer labor market and less underlying inflation (excluding the spike in gasoline prices)? I expect that a majority will. The economy still has considerable forward momentum, the labor market is too tight and services inflation hasn’t fallen enough to be consistent with the Fed’s 2% objective. Also, keeping a rate hike in the forecast has the tactical benefit of restraining markets, which might otherwise decide that “we’re done” and generate an unwanted easing in financial conditions.

2. What’s the forecast for unemployment? According to the Sahm Rule, every time the unemployment rate has risen by 0.5 percentage point or more since World War II, the outcome has been recession. As of June, Fed officials’ median forecast was for an increase of almost a full percentage point, to 4.5% in 2024. If that number comes down, it will indicate growing confidence in the likelihood of a soft landing.

3. How low can unemployment be without stoking inflation? Since March 2021, the median Fed forecaster has put this long-term unemployment rate at 4.0%. That’s down from 5.0% to 5.2% in 2009. A renewed decline is possible, given that the pace of payroll gains has moderated and wage inflation has fallen along with the ratio of unfilled jobs to unemployed workers. If some officials conclude that unemployment around the current level of 3.8% is sustainable, this would also signal growing support for a soft-landing scenario.