Is the U.S. economy cooling and helping to tame inflation?

“A cooler economy is usually not a welcome prospect, but the Federal Reserve’s fight to restore low inflation might be dependent upon it.

That’s why the latest report on consumer spending and inflation is sure to please worried Fed officials. Spending fell to a three-month low in April and a recent surge in inflation appeared to show signs of cresting.

“This was a Fed-friendly personal income and spending report that shows a clear shift in consumers’ willingness and ability to spend in the second quarter,” said chief U.S. economist Scott Anderson of BMO Capital Markets.

“Moreover, moderating demand appears to be starting to temper the surge in inflation we saw in the first three months of the year.”

The Fed could get some more good news next week if the May employment report due on Friday shows another modest increase in new jobs. A shortage of labor has pushed up wages and made it harder to get inflation under control.

Wall Street forecasters predict the U.S. added 178,000 jobs in May, similar to the preliminary 175,000 increase in April that was the second smallest in two years.
To be sure, inflation is still too high.

The PCE price index, the Fed’s preferred inflation barometer, is running close to 3% and other measures such as the consumer price index are even higher.

Yet the April price report also offered hints that the early 2024 surge in inflation may be over.

“Things didn’t get any worse — that is the good news,” said Eugenio Aleman, chief economist at Raymond James.

The next step would be for inflation to begin to subside again — and that means economic growth likely has to cool further.

When consumers spend less, businesses hire less and or cut prices to attract buyers. Both of those approaches tend to lower inflation.

The danger, of course, is that a weaker economy could morph into a recession.

While a downturn would almost certainly quash inflation, it would also do grave damage to millions of Americans who would likely lose their jobs.

Fed officials most emphatically want to avoid such a scenario and cutting interest rates would help stave off a recession. But before the Fed can cut rates, the central bank needs further proof that inflation is resuming a downward trend.

Even some Fed economists, however, question whether the bank’s long-term goal of 2% inflation will be achieve anytime soon.

A new research paper by the Cleveland Federal Reserve, for instance, suggests a 2% annual rate of inflation might not be achievable until 2027. That’s a lot longer than top Fed officials in Washington are forecasting.

Fed officials have already made it clear, though, they would be willing to cut interest rates as long as inflation begins to slow again. They won’t wait until the inflation rate drops to 2% again.

And the Fed would almost certainly act quickly if the economy sputtered.”