There may be trouble ahead as inflation reappears

There will be no soft landing for the economy. Neither will there be a hard landing. Fasten your seat belts and have the flight attendant bring a few more peanuts. This metaphorical aircraft will continue cruising along at an acceptable speed, manned by the same number of crew as before, bothered only by inaccurate, continually revised, weather reports.
Pilot Powell, also known as the chairman of the Federal Reserve Board, peered through his windscreen and saw turbulence ahead — a labour market that was showing signs of heading towards higher unemployment. Buoyed by signs that he and his colleagues had successfully ridden out the inflation storms, and seeing no signs that the inflation calm was transitory, on September 18 he ordered a large cut in the Bank’s benchmark interest rate.
In came that enemy of forecasts, reality. Instead of turning down, the jobs market turned up, adding more jobs in September than in the previous six months. Instead of rising, the unemployment rate ticked down to 4.1 per cent. Consumers continue to spend. Inflation reappeared.
On November 5, the tallying of votes will begin, officially ending we know not when, but probably not soon. Losing Republicans will cry foul and pursue the lawsuits already filed to have the election declared fraudulent. Losing Democrats will begin preparations to impeach the incoming president. Jerome Powell, having met with his monetary policy committee to discuss the latest jobs and price data, will announce the Fed’s decision on interest rates on November 6.
Important voices on the Fed committee are already proposing to call a halt to rate cuts, and stand pat until the political and economic fog clears. Christopher Waller, an influential member of the monetary policy committee, sees “little indication of a major slowdown in economic activity … [a] quite healthy labour market … [and] disappointing” inflation data. He is not the only committee member calling rate cuts into question.
Other members disagree and have taken to the financial news channels to call for more rate reductions in November and December, and on into the new year. They seem to be pushing at an open door, as Powell will have a problem of his own making. When the September cut was announced, he labelled it a “recalibration” of monetary policy, the likely beginning of an era of falls in the cost of borrowing. The announcement of a re-recalibration of policy, a few weeks after its recalibration, might prove embarrassing. To avoid red faces, a further cut is likely — a result to which the markets are assigning an 88 per cent probability.
Much of this discussion about interest rates signifies at most very little, or, more likely, nothing. Whatever the Fed decides to do this year won’t much matter. The economy will chug ahead, perhaps at, or close to, the 3 per cent annual rate at which it is now growing. The labour market will be fine. But by 2025 it is more rather than less likely that we will be entering an era of higher, not lower, rates.
Fiscal policy will increase inflationary pressures. Neither of the candidates for the White House is fussed by a deficit for the 2024 financial year that exceeded last year’s by 13 per cent, and is running at about 7 per cent of GDP. Or by a national debt closing in on $36 trillion (£27 trillion) and projected to reach 122 per cent of GDP by 2034. Both Kamala Harris and Donald Trump have plans that would spill still more red ink over the nation’s ledger, even before they deal with a defence budget inadequate to fund a military capable of matching the co-ordinated firepower of our adversaries.
Higher tariffs, favoured by both parties, especially by Trump, who plans to use them to finance his several tax cuts, will feed into the prices of most goods. Trade unions will continue to top one another in a race for higher pay, especially as the goods carrying tariffs, from vehicles to trainers to apparel, become more expensive.
In that circumstance, the Fed will need to react to the incontinence of America’s political masters — perhaps by raising the target rate of inflation from 2 to 2ish per cent without it looking 2ish, or by abandoning rate-cutting in favour of rate raising. Higher interest rates will be the new normal. Interest paid on the national debt, already in excess of military spending, will rise. Debt will be paid in depreciated dollars. Growth will slow.
Fortunately, there are a couple of “unlesses”. Unless the nation’s politicians can come together on deficit-reducing tax increases. Unless what appears to be a significant increase in America’s world-leading productivity is maintained, and greater efficiency offsets some of the cost increases imposed by higher wages, tariffs, green energy, deficit spending and whatever broken links in our supply chains the world might have in store for us.
There is, of course, the possibility that Jamie Dimon, chief executive of JP Morgan, says he “wouldn’t take off the table … recession and higher inflation”. The upward pressures on prices hit straitened consumers hard, defaults on credit card and mortgage debt rise, overly indebted companies follow layoffs with bankruptcy filings, the unemployment rate rises. Stock markets stagger.
Call it stagflation.
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Irwin Stelzer is a business adviser