Balanced Mandate Risks

Estimated reading time: 4 minutes

Navigating the Fed’s Dual Mandate

Inflation has come down faster than expected, unemployment has remained low, the stock market has hit new all-time highs, and consumer sentiment has improved. It’s hard to imagine a better past few months for the Federal Reserve’s attempt at achieving a soft landing.

However, this doesn’t mean that the coast is clear. At least not yet.

The Fed has come around to the view that risks to their dual mandate of stable prices and maximum employment are in better balance. This means that the labor market has cooled some, and inflation has come off its highs. As a result, the Fed has to be more careful now and evenly weigh both sides of its mandate.

A deeper look into labor data shows us that despite persistently low unemployment, the quits and hires rates have steadily declined over the past two years, and are now down to 2017-18 levels. Workers are less likely to quit their job as their feelings about the labor market worsen, while employers generally hire fewer workers when their businesses aren’t expanding.

The challenge for the Fed is knowing just how much more, if at all, needs to be done to rein in inflation. Do too much and they jeopardize the employment mandate, don’t do enough and they risk reigniting inflation.

Supply Bogeyman Lurks

There are some things, however, that the Fed has little control over. The supply shocks of the past few years, for example, are an obvious example, as they were unpredictable and had cascading effects. It’s early, but current geopolitical tensions and conflict in the Middle East could have similar, if not as extreme, effects.

The greater frequency of attacks on ships using the Red Sea route has disrupted the flow of trade. As a result, shipping costs have spiked and are up roughly 90% y/y (after being down 70-80% y/y in 2023). If these higher costs are sustained for longer, they could affect the price of goods, energy and food. As it stands now, estimates suggest that the increase in shipping costs may push global core inflation up by ~0.1 percentage point, or in other words not very much.

Implications for Energy Prices 

However, given the region’s importance to global energy supply, a much greater supply shock could occur if the current conflicts were to broaden. It could push energy prices meaningfully higher, and as we saw in 2022, a sharp rise in energy prices can have major spillover effects. Supply-side healing helped the Fed get inflation down without much labor market pain, but further shocks could dash its hopes for a soft landing.

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