Fed will get inflation under control next year: Moody’s economist

That transitory inflation that the White House and Federal Reserve has been talking about for more than a year might finally start to show some transient characteristics at some point next year, according to Sohini Chowdhury, senior economist for Moody’s Analytics.

Speaking Monday at the InvestmentNews RIA Summit in Boston, Chowdhury laid out a relatively rosy outlook for an economy that might face some new challenges down the road, depending on the outcome of Tuesday’s midterm elections.

Against the backdrop of inflation hovering near a 40-year high, Chowdury said she expects the delayed economic reactions to the Fed’s string of interest-rate hikes could see inflation start to recede after an anticipated 50-basis point rate hike in February, followed by a 25-basis point hike in July.

“Our forecast for inflation stays high for the first half of next year but is eventually tamed,” she said. “Inflation will start coming down next year, but not to the low levels we’re used to seeing. It will be a while before we get to the Fed’s 2% target.”

While Chowdhury said she's less concerned about the chances of the U.S. economy entering a period of stagflation, which is a combination of high inflation and sluggish economic growth, she does believe the aggressive Fed policy could drive the U.S. into recession.

But even that, she said, will likely be a mild period of negative economic growth.

When asked to explain how peak-level inflation that's being combatted by a suddenly aggressive monetary policy wouldn't trigger a severe economic recession, Chowdhury referenced the root cause of the current situation, namely, a global pandemic.

“Usually, the size and shape of a recession depends on what caused it,” she said.

Thus, while the government was able to justify its sweeping programs to send money to consumers and businesses from the early days of the pandemic and even as it subsided, Chowdhury said there are some silver linings to the economy left in its wake.

“The best news is, U.S. banks are exceptionally well capitalized; they are sitting on a ton of capital,” she said. “The real economy seems to be doing good so far. If this inflation had happened separate from the pandemic, it would have been different.”

Chowdhury is optimistic about things like improvements to the global supply chain and a housing market that is starting to cool off after spiking during the pandemic.

Then, of course, there's the wrinkle of the outcome of the midterm elections.

Following the popular belief the election will produce a balance of political power in Washington, with the Republicans likely winning back the majority in the House of Representatives and potentially gaining a majority in the Senate, Chowdhury sees three economic impacts.

The first is a fresh battle over government spending in the lead-up to a new spending bill a year from now. The second issue is the next debate over the debt ceiling.

“If we run out of our ability to borrow and if the two parties can’t agree to increase the debt ceiling, the government defaults on its debt,” she said. “Nobody believes that will happen, but we came very close last time.”

The third impact of a divided government goes to the government’s response in terms of stimulus spending to address a potential recession next year.

“If it’s a mild recession, which is more likely, the two parties will have a hard time agreeing on a package,” Chowdhury said.