[Interview] "Low Possibility of US Recession... Fed Expected to Cut Rates Twice in September and December"

[Insights from US Scholars and Experts] ③
David Wessel Hutchins, Director of the Center for Fiscal and Monetary Policy
US More Likely to Achieve Soft Landing than Recession
Current Interest Rates Restrictive... Freeze Needed Until Inflation Falls
Labor Market Gradually Cooling
Possible Target Increase Discussion After Inflation Hits 2%
Federal Budget Deficit Unsustainable
Anti-Immigration Executive Orders Expected to Cause Labor Shortages in Construction, Restaurants, and Hospitality

Editor's NoteWith the U.S. presidential election just five months away this November, global macroeconomic uncertainties and geopolitical risks continue to persist. The U.S.-China technological hegemony war surrounding advanced industries such as semiconductors and artificial intelligence (AI) is intensifying, and the U.S. has signaled a second trade war by raising tariffs on 'overproduced' Chinese imports. While global financial markets are solely focused on a U.S. interest rate cut, the Federal Reserve's (Fed) pivot timing remains uncertain as the U.S. economy continues to prosper. Countries around the world, including South Korea, are closely monitoring the repercussions of U.S.-China conflicts, U.S. industrial and trade policies, and changes in the macroeconomic environment, seeking ways to respond. Accordingly, Asia Economy has planned an interview series covering four sectors?U.S. macroeconomics, trade, China, and semiconductors?featuring American scholars, experts, and former trade officials to review key issues, future outlooks, and response strategies. The interview articles will be published in the order of Chris Miller, Professor of World History at Tufts University's Fletcher School; Yasheng Huang, Professor of International Management at MIT Sloan School of Management; David Wessel, Senior Fellow at the Brookings Institution and Director of the Hutchins Center on Fiscal and Monetary Policy at Brookings; and Barbara Weisel, former Deputy U.S. Trade Representative (USTR).

David Wessel, Director of the Hutchins Center on Fiscal and Monetary Policy at Brookings Institution

"The likelihood of a soft landing is much higher than a U.S. recession. The Federal Reserve (Fed) is expected to begin cutting interest rates in September and to implement two rate cuts by December within this year."

David Wessel, Senior Fellow at the Brookings Institution and Director of the Hutchins Center on Fiscal and Monetary Policy at Brookings, said in a recent interview with Asia Economy, "Although consumption, manufacturing activity, and employment indicators are slowing, the possibility of a U.S. recession is very low."

On the 11th (local time), the World Bank (WB) raised its U.S. economic growth forecast for this year from 1.6% to 2.5%, and buoyed by the U.S. boom, also raised the global economic growth forecast by 0.2 percentage points to 2.6%.

He said, "The current benchmark interest rate level of 5.25?5.5% is restrictive," but added, "It is advisable for the Fed to maintain the current rate level for the time being until the economy slows further and inflation continues to decline."

He also expects the Fed to keep the benchmark interest rate unchanged at 5.25?5.5% for the seventh consecutive time at the Federal Open Market Committee (FOMC) regular meeting held over two days starting today. While this prolonged high interest rate stance poses risks of burdening the economy, he explained that rates should not be lowered until it is confirmed that inflation is steadily slowing toward the Fed's 2% target.

Regarding the recent mixed signals from the U.S. labor market, Wessel diagnosed, "Employment remains strong but is gradually cooling." According to the U.S. Department of Labor, job openings in April were 8.059 million, the lowest since February 2021. Meanwhile, nonfarm payrolls increased by 272,000 in May, significantly exceeding the forecast (182,000) and the previous month’s figure (175,000), showing a labor market oscillating between extremes.

On the background of the U.S. economy continuing its 'lone boom,' he evaluated, "During the COVID-19 pandemic, aggressive fiscal and monetary policies were implemented, and the labor market that stimulates consumer spending was strong." He also noted that "a positive trade shock, where export prices rose while import prices did not due to a strong dollar, contributed to the robust economy."

Wessel pointed out the chronic fiscal deficit problem of the U.S. federal government, saying, "It is on an unsustainable path," and "The federal government debt growing faster than GDP cannot continue forever."

The following is a Q&A with Director Wessel.

-The Consumer Price Index (CPI) rose 0.3% month-over-month and 3.4% year-over-year in April, down from 0.4% and 3.5% in March, respectively. How do you assess the recent inflation situation?

▲I think there is slow progress in inflation decline. Most supply shortages have been resolved, but demand remains strong. Rising car prices have increased auto insurance premiums, which in turn have raised repair and replacement costs. Housing costs, a component of the CPI, are also a major cause of inflation. The pace of decline in housing costs is surprisingly slow. For inflation to slow further, demand that makes it difficult for companies to raise prices must cool down. Additionally, the labor market, which contributes to persistent inflation, remains tight.

-Recent U.S. employment data have been mixed. Is the U.S. labor market still overheated, or is it cooling down?

▲The U.S. labor market is cooling. Although May nonfarm payrolls (272,000) significantly exceeded market expectations (182,000), the ratio of job openings per unemployed person in April (1.24) has returned to pre-pandemic levels. Employment remains strong, but various indicators, including job openings, suggest a gradual cooling. (April job openings were 8.059 million, well below market expectations (8.37 million) and the previous month (8.355 million).)

-Concerns about economic downturn arise due to slowing consumption and manufacturing activity and some weak employment indicators. Is a soft landing of the U.S. economy possible, or is the risk of recession increasing?

▲The risk of recession always exists, but at present, the likelihood of recession appears very low. The economy is cooling as the Fed intended. A soft landing of the U.S. economy is still possible, and the current probability of a soft landing is higher than I initially expected. I expect inflation to continue a gradual decline and the Fed to gradually lower interest rates.

-Is the current U.S. benchmark interest rate level of 5.25?5.5% restrictive? Should the Fed prioritize lowering inflation or start cutting rates?

▲The current rate level is restrictive. The Fed should maintain the current rate level until the economy slows further and the inflation decline trend continues. One risk is that the Fed is waiting too long to cut rates, but since recession risk is very low, the Fed can afford to be patient.

-The European Central Bank (ECB) has started cutting rates. How many rate cuts do you expect the Fed to make this year?

▲If inflation data support it, I expect the Fed to start cutting rates in September. Then, I anticipate one more rate cut in December, totaling two cuts this year.

-Jamie Dimon, Chairman of JP Morgan, and former Treasury Secretary Larry Summers have mentioned the possibility of the Fed raising rates.

▲I think that possibility is very low.

-There are claims that the Fed should raise its inflation target above the current 2% due to a rise in the neutral interest rate.

▲The Fed should not raise the inflation target now. The inflation target increase should be discussed only after inflation falls to 2% and remains at that level for some time.

-The chronic fiscal deficit problem in the U.S. is very serious.

▲The U.S. federal budget is on an unsustainable path. The debt growing faster than GDP cannot continue forever. While a crisis is not imminent, the current U.S. political system is not in a position to resolve issues such as taxes, social security, and Medicare. On the other hand, household and corporate debt levels in the U.S. are not problematic.

-President Joe Biden signed an executive order restricting illegal immigration. What impact will this have on the U.S. economy?

▲Unexpected surges in immigrants have contributed to steady increases in U.S. labor supply. It is unclear to what extent immigration growth has helped cool the labor market and inflation overheating. It is too early to predict the results of the executive order, but if immigrant inflows decrease, industries heavily reliant on low-skilled workers such as construction, restaurants, hospitality, and agriculture may face employment difficulties. In the long term, immigration, especially of high-skilled workers, benefits the U.S. economy.

About David Wessel

David Wessel is an expert on the U.S. Federal Reserve (Fed), federal government budget, and U.S. politics. After working for 30 years at The Wall Street Journal (WSJ) as an economics editor, Washington bureau deputy chief, and Berlin bureau chief, he joined the Brookings Institution in 2013. He currently serves as a Senior Fellow at Brookings and Director of the Hutchins Center on Fiscal and Monetary Policy at Brookings. He is a member of the U.S. Bureau of Labor Statistics Data Users Advisory Committee and has taught at Dartmouth Tuck School of Business and Princeton University. He studied at Harvard University and Columbia University.

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