Daily Management Review

A Strike, A Government Shutdown, And Student Loans Might Add Ice To The US Fed's Efforts To Curb Spending


A Strike, A Government Shutdown, And Student Loans Might Add Ice To The US Fed's Efforts To Curb Spending
Officials from the US Federal Reserve, who have hesitantly accepted the idea that they might be able to stop inflation without a recession, will meet this week with new dangers to that best-case scenario in the form of an autoworkers strike, a potential government shutdown, and consumer debt pressure.
With an initial walkout of over 13,000 workers at three plants, the United Auto Workers began a strike against all three major automakers on Friday. However, those numbers may rise. The existing spending authorizations expire on September 30, giving federal elected officials only that date to reach an agreement; however, congressional Republicans have stalled negotiations. After a three-year hiatus due to the COVID-19 pandemic, student loan repayments resume in October.
None would probably influence the short-term threats that policymakers perceive or their attention away from bringing down still-high inflation if taken individually.
However, given that the economy is already forecast to slow down over the course of the year, protracted disruptions in the auto industry and at federal agencies could have unexpected consequences. These include a reduction in consumer spending, a potential increase in car prices that would undermine the Fed's efforts to fight inflation, and the kind of blow to consumer and business confidence that could mean the difference between a "soft landing" and a downturn.
Goldman Sachs economists have moderated their generally bullish outlook with warnings of a fourth-quarter "pothole" that could knock more than a percentage point from gross domestic product growth. Millions of consumers also face the renewal of student loan payments in October, which will divert from other spending.
According to Goldman's projection, the economy would still be expanding at a rate of 1.3% per year at that time. However, the sums they observe being subtracted from GDP are more than the 1% growth rate that Fed policymakers had anticipated the economy to achieve as of June, as well as exceeding many private projections.
According to Vincent Reinhart, chief economist at Dreyfus and Mellon and a former head of the Fed's monetary policy division, it may not take much to throw the economy off course given that the aggressive Fed interest rate hikes are still working their way through the economy, banks are tightening credit, and consumers are using up their savings from the pandemic.
Reinhart noted that the Fed's balance sheet shrinkage has now reached levels that could unpredictably tighten financial conditions as an additional danger.
"Recession comes from shocks relative to the vulnerability of the economy. If you are late in a tightening cycle, the funds rate is restrictive, the buffers have been worked down, then you are more vulnerable," he said. "These types of events would have been waved off a year ago."
Any new risks may have little impact on the Fed's policy rate, which is already anticipated to remain between 5.25% and 5.5% at its meeting on September 19–20. Instead, they may change the mood and rhetoric around the meeting.
At this time, central bankers haven't been providing much direction regarding impending decisions. They are probably nearing the end of the rate rises they started in March 2022 to combat high inflation, but they are not yet prepared to claim with absolute certainty that rates have peaked or to suggest when they might be dropped. This is partly due to their disagreement over the best course of action.
Inflation has been declining in recent months even while the economy has continued to grow above trend and add a significant number of jobs each month, which has typically benefited the Fed.
However, the two major sectors' shutdowns, which might result in up to 146,000 auto workers going on strike and up to 800,000 government workers missing out on pay, will undermine growth and confidence week after week.
The potential for protracted confrontations on both fronts worries analysts.
"The unique circumstances this time around mean any strike impact could be particularly damaging," with auto supply chains still tangled from the pandemic and bargaining expected to be intense as workers try to regain ground lost to inflation amid record industry profits, said Michael Pearce, lead U.S. economist for Oxford Economics.
Widening strikes have the potential to reduce car production by 30% and, when taking into account their ripple effects across the economy, could reduce growth by as much as 0.7 percentage points for as long as they last. This would be a significant reduction for an economy with trend growth estimated to be 1.8% annually.
While previous government shutdowns have been brief, the most recent one, which occurred in late 2018 to early 2019, lasted five weeks and reduced annualised output by 1%, according to Goldman estimates of 0.2 percentage points of GDP lost per week.
These kinds of occurrences frequently result in lowering GDP in one period before it recovers later when workers receive back pay and greater wages. The dynamics are difficult to anticipate; some economists contend that the hit to consumer spending may even benefit the fight against inflation.
There were little long-term effects of the previous government shutdown, according to a Congressional Budget Office assessment.
However, it can be difficult to predict inflection moments, which occur when enterprises and people start to cut back at once. According to some economists, the behaviour of tens of millions of borrowers may already be changing once student loan repayments resume.
This week, Ian Shepherdson and Kieran Clancy of Pantheon Macroeconomics noted that while payments to the U.S. Department of Education increased, online searches for "plane tickets," "restaurant reservations," and "new cars" decreased, with other hard data "offering no hint of any near-term improvement."
Even if retail sales increased more than anticipated in August, the increase was largely brought on by increasing petrol costs. Only 0.2% more was spent on other items.
Reinhart argued that if the economy does falter, the Fed won't intervene until the battle against inflation is won, putting more pressure on businesses and households with high interest rates.
"They've been living with recession risk," he said. "They've been prepared for it for a year and a half."