It’s starting to look like Jay Powell and his colleagues at the US Federal Reserve have accomplished something few thought possible even a few months ago – engineering a “soft landing” for the world’s largest economy without tipping it over in recession.
In the middle of last year, it looked like a very tall order.
The overall rate of inflation – the consumer price index (CPI) – had peaked at one 40 years tall of 9.1% in June last year, but fell only very slowly in light of a series of joint rate hikes by the Fed.
Worse still, “core” inflation — the measure that strips out volatile items such as energy, food, alcohol and tobacco — was still rising, suggesting that domestically generated inflation (as opposed to externally generated inflation triggered by Russia’s invasion of Ukraine) was by being anchored.
Therefore, the Fed continued to raise fed funds, its key policy rate, aggressively.
From a range of 0.25% to 0.5% in March 2022, when the Fed began raising interest rates, Fed funds charged all the way up to the current range of 5.25% to 5.5% reached in July this year.
Some good news
The harsh medicine seems to have worked.
Tuesday brought news that US CPI fell from 3.7% in September to 3.2% in October, while crucially the “core” gauge fell from 4.1% in September to 4% in October – a level last seen in September 2021.
Although the numbers suggest that US inflation is not quite back to the Fed’s 2% target rate, the readings have intensified hopes that the central bank will not need to raise rates again from here, even pushing forward the date when it could begin to easing monetary policy.
The markets are now pricing in US interest rate cuts as early as May next year.
US stocks therefore gave a party on the news.
The S&P 500 – the main US stock index – and the Nasdaq both posted their best one-day gains on Tuesday since April, with the S&P’s 1.9% gain taking its gains so far in November to 7.2%.
The Nasdaq, meanwhile, is up nearly 10% so far this month.
Perhaps the most striking rise was seen in the Russell 2000, the index of US small-cap stocks, which rose nearly 5.5% on the day.
A potential once-in-80-year achievement
If the Fed has managed to achieve a soft landing, it will be a huge achievement.
The central bank has not been able to achieve a reduction in inflation of this magnitude without sending the US economy into recession for 80 years.
The big question is whether President Biden will benefit from it at all.
The mood among the American public remains rather sour, with surveys suggesting that more Americans still expect to be worse off a year from now than those who expect their economy to improve.
The President’s rejection ratings has been over 50% since inflation took hold early last year and remains high despite the fact that for some months now wages have grown faster than prices and unemployment remains at an extraordinarily low level of 3.9% – at US employers create 204,000 jobs per month in the three months to the end of October.
This is something that has confused commentators.
As the Wall Street Journal put it in a headline earlier this month: “The Economy Is Great. Why Are Americans in such a Rotten Mood?”
A worse British picture
That’s something that will worry too Rishi Sunak and Jeremy Hunt as they celebrate today’s news that UK headline CPI inflation fell from 6.7% in September to 4.6% in October – the lowest level since October 2021 – while core inflation fell from 6.1% in September to 5.7% in October.
Because the British economy is in a markedly worse state than the American one.
Yes, there are some similarities.
Like the US, UK wages have been rises faster than prices for the last three months, while UK unemployment – again in line with the US – at just 4.2% in the three months to the end of October – remains remarkably low by historical standards.
But the comparisons end there.
In the three months to the end of October, the US economy expanded by a remarkable 4.9% year-on-year, with government spending, household spending and business investment all contributing to the growth.
On the contrary UK economy flat during the three months to the end of September, the most recent quarter for which figures are available.
Why Britain is worse off
The US government is also injecting an extraordinary amount of stimulus into the economy.
President Biden’s improbably named Inflation Reduction Act is injecting $369 billion into the economy to support the energy transition and infrastructure upgrades.
The Biden administration has also continued the Trump administration’s work in trying to bring jobs that were previously offshored back to America.
The UK government has no such options despite running a bit lower budget deficit than the United States.
The United States, which benefits from the world’s reserve currency, the dollar, can continue to borrow without inflaming bond markets in a way Britain cannot – as highlighted in the wake of Kwasi Kwarteng’s September 2022 mini-budget.
Moreover, where the British government has used it, it appears to be to no avail.
This can be seen most markedly in the NHS where, despite a significant increase in resources and staffing, the number of patients being treated is no higher than it was before the 2019 pandemic.
And the UK government’s flagship infrastructure project, HS2, has been just that severely restricted.
The UK is also not attracting the foreign investment that the US is.
It has even been overtaken by France as Europe’s primary destination for foreign direct investment.
Investors’ indifferent attitude towards the UK can be clearly seen in the UK stock market.
The FTSE-100 trades on a price-to-earnings multiple (the standard investor gauge) of just 9.87 times.
By contrast, the S&P 500 stands at a multiple of 24 and the CAC 40 in Paris stands at one of 13 times. Even the DAX 40 in recession-hit Germany stands at 11.6 times earnings.
Things are even worse in the case of the FTSE Mid 250, a better indicator of the health of UK companies than the FTSE-100, whose constituents derive three-quarters of their earnings from abroad.
The FTSE-Mid 250 sits on a price-earnings multiple of a ridiculously low 6.43 times.
Today’s data suggests that Bank of Englandlike the Fed, is winning the fight against inflation.
It has also brought down inflation without so far triggering a recession in the UK – something which even the Bank did not think possible this time last year.
However, if a soft landing is achieved, the American experience suggests that Mr. Sunak will not get more credit than Mr. Biden.