The authors are economists of Shinhan Securities. They can be reached at firstname.lastname@example.org. — Ed.
Tightening fears resurface on strong jobs data and growing inflationary pressure
At the beginning of 2023, expectations for slower tightening and upbeat economic outlook with normalization of the Chinese economy triggered a rally in financial markets. But the positive sentiment soured after the release of solid US economic data in January. Many even predicted the US economy could be headed for a “no landing” scenario. The expected timing of rate cuts has been pushed back to the end of the year.
US Fed’s moderate tightening pace grounded in lessons drawn from history
The US Fed had sought to stabilize prices even at the expense of employment up until last year. Now, its focus is placed on finding a balance between economic growth and inflation. The shift in the Fed’s tightening pace can be explained by its past experience. The current high inflation, driven by the strong jobs market, pent-up demand, and public policies, shares similarities with economic conditions of the periods after the two world wars. During those times, inflation uncertainties quickly faded away upon the dissipation of pent-up demand. The central bank’s aggressive tightening to quell inflation concerns after World War I led to a hard landing of the US economy, while moderate tightening after World War II resulted in a soft landing. Lessons from the past caution against excessive tightening.
Turning point expected in mid-2023: Renewed inflation fears or slowing growth
Despite solid economic conditions seen earlier this year, there is a possibility that the US economy may cool down rapidly around mid-2023 as jobs fall on waning pent-up demand and excess savings are exhausted. The pent-up demand is already starting to fade in some service sectors. The lowest and highest income quartiles are expected to be the first ones using up their excess savings, although collectively, the total amount should remain in positive territory this year. Amid high expectations for the reopening of the Chinese economy, we see possibilities of two scenarios: 1) if the US jobs market remains solid, rising inflation fears could lead to faster tightening; and 2) if the US jobs market slows down, economic trajectory toward slower growth should remain unchanged.