Right now the economy is running hot - inflation is too high, unemployment is too low and it is not sustainable. Photo / Alex Burton
Right now the economy is running hot - inflation is too high, unemployment is too low and it is not sustainable. Photo / Alex Burton
The US is winning the war against inflation and the odds look good for a soft landing, says visiting US economist Paul Gruenwald.
But no one is quite prepared to declare victory over inflation yet.
Gruenwald, who is the New York-based chief economist for S&P Global, was in Auckland lastweek to present his take on the world’s post-pandemic recovery.
What do we mean by a soft landing?
Right now the economy is running hot - inflation is too high, unemployment is too low and it is not sustainable, Gruenwald says.
“We want to be on the sustainable path where economies are running at their full potential and inflation is on target.”
“The soft landing means we kind of glide down on to that path and we land, we don’t undershoot on growth and inflation and overshoot on unemployment.
“Unfortunately, since the Second World War, in more instances than not, we don’t get the soft landing, but it looks like we’re in the ballpark this time with strong labour markets providing a cushion.
“We think that the US can make this adjustment without a recession, but growth has to fall below potential.
“So if we think about our potential growth, the speed limit, if you will, at just under 2 per cent, the US is going to have to grow kind of sub 1 per cent for a while in the soft landing scenario and then, you know, take out the excess and then go back to potential [growth] again.
“If it’s a recession, we’re going to go negative for a couple of quarters and then we’ll have the official pronouncement. But right now the recession is not our base case.
“We actually think that the conditions are there for a soft landing, but we can’t rule the recession out. It’s just not the base case right now.”
Has the war on inflation been won?
Despite a sharp drop in US headline inflation, it is too early to declare victory, says Gruenwald.
Headline inflation in the US has come down quickly as food and fuel prices have dropped from last year’s highs.
Paul Gruenwald is the chief economist at S&P Global Ratings in New York.
“But the bit that the central bank is worried about, which is core inflation, that’s still above 4 per cent. So there’s still some work to do.
“The labour market has been quite strong, we continue to get pretty good employment numbers. That’s been quite surprising.
“We’re 500 plus basis points into a tightening cycle and we have still got a lot of juice in the tank.”
What does that mean for US interest rates?
If you look at the market pricing, and if you listen to Federal Reserve chairman Jay Powell and his team, it looks like they’re going to hold in September, Gruenwald says.
“The question is, what’s the labour market and what’s inflation going to do in the coming months? The market’s kind of 50/50 for November.
“But the story is really kind of a long hold. I think the narrative there is we keep the policy rate where it is for the next year or so.
“Next year we’ve got the Fed and other major central banks pretty much where they are now, maybe plus or minus a bit, but the holding higher for longer is the baseline for sure.”
Oil prices have risen sharply in recent weeks. Could they derail the soft landing?
“The oil producers are targeting US$80 to US$90 per barrel and that’s where they’ve lifted the price with their recent production cuts,” Gruenwald says.
“We think that’s digestible on the current trajectory for most economies. We don’t think US$80 to US$90 is a game-breaker.”
Or is China’s economy a bigger risk?
“China is slowing down but for a big economy like the US, that probably doesn’t move the needle. Here in New Zealand it definitely would,” Gruenwald says.
“It looks like the authorities are going to miss their growth target of 5 per cent this year.
“New Zealand as a small, open economy gets blown around a bit in the global trade winds, but the US, being bigger, probably less.”
Federal Reserve chairman Jay Powell. Photo / AP
Inflation aside, is the pandemic economic shock subsiding?
“Well, the shock was huge and the labour market in particular was something where we’ve just been unable to put the labour market back together in a non-inflationary way. It’s the same economy, same industry, same labour force,” Gruenwald says.
“But after the Covid shock, people decided to stay home or they retired early or they didn’t want to go back to work or they changed jobs or whatever, that’s been a bit of a challenge.
“So that one, we’re still working through. The supply chain disruptions and some of the other things that came out of Covid, I think that’s largely out of the data, the fiscal stimulus that was put in place to help cushion balance sheets during the shock, that’s fading away as well.
“We are working through the wages and inflation but, you know, hopefully we come back next year and most of that will be behind us. I think most of that is getting in the rear-view mirror.”
What will drive US growth once we’re through this cycle?
“I think the one big positive structural change that’s come over the last few years is this Inflation Reduction Act, which is not correctly named.
“It’s really the Energy Transition Support Act, but the US Government has put its balance sheet and its might behind companies that are able to make progress on carbon capture or hydrogen technology or battery storage.
“We’re starting to see some good tailwinds on investment. That’s a structural lift to growth.”
The states benefiting from that spending are the more conservative states and those are not the politicians who voted for this, says Gruenwald.
“This was a Democratic initiative and I think all the votes were Democratic, but the beneficiaries are largely Republican, in what we call red states in the US.
“So even if we get a change in the politics, it’s difficult to see them reversing the Inflation Reduction Act because it’s been a big benefit for investment and employment and growth in those parts of the country. This is a structural change that’s giving a boost to the economy around renewables.”
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.
