MainStreet Macro: Bumpy rides and soft landings

I spent last week at a lovely hotel in France with a beautiful view of the ocean. Naturally, because I’m an economist through and through, the ocean view had me thinking of inflation news on both sides of the Atlantic.

Two of the world’s largest economies – the United States and the European Union – have suffered with big bouts of high inflation since the pandemic. Now, they’re adjusting to higher, for possibly longer, interest rates in three important ways. 

Inflation is slowing

The Federal Reserve and the European Central Bank, or ECB, have been raising rates aggressively for the better part of a year to rein in inflation.

It’s working. Eurozone inflation peaked at 10.6 percent in October 2022. But data released last week showed November inflation at 2.4 percent, so very close to the ECB’s 2 percent target.

Not to be outdone, the Federal Reserve also is closing in on its target. U.S. inflation peaked at 9 percent last year. Recent data released showed the Consumer Price Index had fallen to 3.2 percent in October.

For a wider view, a report last month from the 38-member OECD released showed global inflation reaching 7 percent in 2023, down from 9.5 percent a year earlier. The OECD predicts that inflation will fall to 5.2 percent next year. 

Economic growth is slowing

The OECD also said that it expects that economic growth to slow in 2024, then accelerate in 2025. Emerging markets are expected to lead the way, with significant slowdowns predicted in the U.S. and Europe.

If that prediction proves true, it will be a sharp turnaround from the 5.2 percent U.S. GDP growth reported in the third quarter by the Bureau of Economic Analysis. Higher-for-longer interest rates will likely contribute to an economic slowdown in the U.S. and Europe next year. 

Corporate profits are slowing

Higher interest rates have laid a bumpy road for U.S. companies over the last three years.

Growth in corporate profits surged to 15 percent in 2021 from the previous year. In 2022, they fell back to a more consistent pre-pandemic level of around 4 percent.

Last week, BEA data showed that corporate profits slid down to about 0.5 percent in the third quarter as companies felt the pinch of higher borrowing costs.

My Take

This year, the most-asked question of economists has been whether the Fed will be able to achieve a soft landing of the U.S. economy.

I really dislike this line of inquiry for two reasons. One, it presumes that inflation is a one-and-done journey. Two, it assumes the destination is immaterial as long as the plane lands gently.

Maybe I’m alone in this, but I prefer a bumpy ride if it gets me where I want to go safely. If I’m heading for the French Riviera, don’t land me anywhere else just because it’s more convenient or easier to land sooner.

European and U.S. central bankers have an economic upgrade now that is rarely afforded in high inflation cycles – low unemployment. The solid labor market over the last 10 months is giving monetary authorities on both sides of the Atlantic unusually great latitude to ensure target inflation is reached without triggering widespread job loss.

This week’s job data – ADP’s U.S. private-sector employment for November comes on Wednesday and the Bureau of Labor Statistics shares its employment report Friday – will help the Fed decide just how much longer the ride back to 2 percent will be.

For the economy, a turbulent flight that reaches its destination is better than a soft landing that’s short of its goal – and risks an even bumpier round trip back toward where we started.