Fed Seems Confident in Soft Landing, But We See Risks

The Federal Reserve forecasts only a modest uptick in U.S. unemployment next year as inflation cools, but history and current labor market trends make us less certain.

The U.S. Federal Reserve’s latest economic projections suggest policymakers are increasingly confident the U.S. economy could achieve a soft landing in 2024. However, we see several macroeconomic risks that could challenge that outlook.

With growing economic and political headwinds this fall, as well as still-sticky inflation trends, we believe the outlook the Fed presented may be optimistic. The U.S. unemployment rate will likely need to rise further than the Fed forecasts as the central bank seeks to achieve its price stability goal.

Updated projections paint a brighter picture

Although Fed Chair Jerome Powell at his press conference said he would not characterize the baseline outlook as a soft landing, the Fed now expects core inflation to cool from an estimated 3.7% at year-end 2023 to 2.6% at year-end 2024 with the unemployment rate rising to just 4.1% and growth only slightly below trend at 1.5% in 2024. Observers are welcome to call this “soft” or “soft-ish” or something else, but what’s important is how policy eventually manifests in the real economy.

We believe the Fed’s new projections – unveiled after its September meeting – imply an acceleration in productivity, along with a higher neutral rate (r*) in the short run, which would be enough to bring inflation back down toward target without a meaningful rise in unemployment or much damage to economic activity and growth. While the supply-side improvements (which Chair Powell highlighted) alongside the moderation in inflation and ongoing labor market resilience have been welcome developments for the U.S. economy this year, history suggests these trends may not continue.

The Fed remains focused on taming inflation: Officials signaled their intent to keep rates restrictive for longer than previously forecast, leaving intact the additional rate hike implied in their projection for 2023 and lifting their outlook for the federal funds rate at year-end 2024 by 50 basis points (bps) relative to the prior projections in June (the latest projections imply two 25-bp cuts following the peak). However, given the economic headwinds, we believe policymakers may be challenged to enact the additional rate hike this year and anticipate rates easing faster than the Fed is forecasting in 2024.