Fed bets on 'soft landing', but recession risk looms

Jerome H. Powell, the chairman of the Federal Reserve, pointed out this week that the central bank he leads could succeed in its quest t...

Jerome H. Powell, the chairman of the Federal Reserve, pointed out this week that the central bank he leads could succeed in its quest to rein in rapid inflation without driving up unemployment or triggering a recession. But he also acknowledged that such a mild outcome was not certain.

“The historical record gives reason for optimism,” Powell said.

This “certain” is worth noting: While there may be hope, there is also cause for concern, given the Fed’s track record when it is in anti-corruption mode. ‘inflation.

The Fed has sometimes succeeded in raising interest rates to cool demand and weaken inflation without significantly harming the economy – Mr. Powell cited examples in 1965, 1984 and 1994. But these instances did occur amid much lower inflation and without the continued shocks of a global pandemic and war in Ukraine.

What Fed officials avoid saying out loud is that central bank tools work by slowing the economy and that weakening growth always carries the risk of overdoing it. And while the Fed ushered in its first rate hike this month, some economists — and at least one Fed official — believe it was too slow to begin to ease off. Some warn that delay increases the chances of overcorrection.

The Fed has triggered recessions with past rate hikes: this happened in the early 1980s, when Paul Volcker raised rates in a campaign to bring inflation down very quickly and caused unemployment to soar painfully in the process.

“There is no guarantee there will be a recession, but you have high inflation, and if you really want to bring it down quickly, you have to increase a lot,” said Roberto Perli, head of global policy at Piper Sandler. , an investment bank and a former Fed economist. “The economy doesn’t like it. I think the risk is significant.

Not surprisingly, it can be difficult to rein in inflation while sustaining economic expansion. Higher borrowing costs ripple through the economy by slowing the housing market, discouraging large purchases and prompting businesses to scale back expansion plans and hire fewer workers. This large decline is weakening the labor market and slowing wage growth, helping inflation to moderate. But the chain reaction unfolds gradually and its results can only be seen with a delay, so it’s easy to brake too hard.

“No one expects a soft landing to be simple in today’s environment – ​​very little is simple in today’s environment,” Mr. Powell acknowledged during his remarks this week, adding: “My colleagues and I will do our best to succeed in this difficult task.

Six of the Fed’s eight rate-hike cycles since the early 1980s have ended in recession, though some of them were caused by external shocks – like the pandemic – and others by outbursts. asset bubbles, including the 2007 housing crisis and the internet crash. stocks in the early 2000s.

Fed officials are hoping that the strength of the current economy will help them avoid a hard landing. They point to the fact that labor markets are booming and consumer demand is strong, so rising rates and moderating voracious buying could help supply catch up and cool the economy. without burning it. Mr. Powell argued that with so many open jobs per jobless worker, the Fed might be able to slow the labor market a bit without driving up the jobless rate.

Loretta J. Mester, president of the Federal Reserve Bank of Cleveland, said the Fed was not at a point where it had to choose between fighting inflation or curbing growth.

“Given the current state of the economy and the risks, in my view, the main economic challenge is inflation,” Mester told reporters on a call Wednesday. “I don’t see that as a compromise at this point.”

James Bullard, the president of the Federal Reserve Bank of St. Louis, said in an interview that he thinks the fact that the central bank has credibility as an inflation fighter – and raises rates to defend this credibility – could enable it to adjust its policy. in a way that allowed demand to moderate without causing major economic disruption.

In the 1980s, when Mr. Volcker was chairman of the Fed, the central bank had to convince the world that it was ready to fight inflation after more than a decade of rapid price increases.

“Do whatever it takes – I guess that’s the mantra du jour. I think inflation is our biggest concern,” Mr Bullard said. “I don’t think, though, that it’s a Volcker-like situation.”

Short-term consumer and market inflation expectations have risen over the past year, with inflation hitting a 40 years tall and continued to accelerate, but longer-term price growth expectations rose only slightly.

If consumers and businesses were anticipating rapid price increases year after year, that would be a worrying sign. Such expectations could become self-fulfilling if companies felt comfortable raising prices and consumers accepted these higher costs but demanded larger paychecks to cover their growing expenses.

But after a year of rapid inflation, there is no guarantee that longer-term inflation expectations will remain in check. Keeping them in check is a big part of why the Fed is acting now even as a war in Ukraine stokes uncertainty. The central bank raised rates a quarter point this month and predicted a series of interest rate hikes to come.

While officials would typically look past a temporary spike in oil prices, like the one the conflict has caused, worries about expectations mean they don’t have that luxury this time around.

“The risk is growing that a prolonged period of high inflation could push long-term expectations to an uncomfortable rise,” Powell said this week.

Mr Powell has signaled that the Fed could raise interest rates by half a percentage point in May and begin imminently to shrink its bond balance sheet, policies that would remove aid from the US economy much more. faster than during the last economic expansion.

Some officials, including Mr. Bullard, have urged action quickly, arguing that monetary policy is still in a state of emergency and out of step with a very strong economy.

But investors think the Fed will have to backtrack after a series of rapid rate hikes. Market prices suggest — and some researchers believe — that the Fed will hike rates notably this year and early next, to reverse some of those moves as the economy slows dramatically.

“Our base case is for the Fed to reverse quickly enough to avoid a full-blown recession,” wrote Krishna Guha, head of global policy at Evercore ISI, in a recent analysis. “But the probability of succeeding is not particularly high.”

So why would the Fed put the economy at risk? Neil Shearing, the group’s chief economist at Capital Economics, wrote that the central bank was following the “point in time saves nine” approach to monetary policy.

Raising interest rates now to reduce inflation gives the central bank a chance to stabilize the economy without having to adopt even more painful policy later. If the Fed lagging and higher inflation becomes a more enduring feature of the economy, eradicating it will be even more difficult.

“Delaying rate hikes due to fears over the economic fallout from the war in Ukraine would risk making inflation more entrenched,” Shearing wrote in a note to clients. “That means further policy tightening is eventually needed to knock it out of the system and make a recession even more likely at some point in the future.”

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Newsrust - US Top News: Fed bets on 'soft landing', but recession risk looms
Fed bets on 'soft landing', but recession risk looms
Newsrust - US Top News
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