Stocks fall after inflation report shows unexpected price rise in August
The Fed is still dashing catch up inflation. The pandemic has tossed nearly every playbook, and it continues to cloud policymakers’ understanding of what’s going on in real time. After misjudging inflation for much of last year, the Fed is now scrambling to raise rates to all-time lows and get its benchmark rate high enough to slow growth and consumer demand. . So far, outsized interest hikes have not been enough to show the progress that central bankers want.
But this accelerated response also means increased risk that the economy will soon be dragged down in a recession. Rate hikes of any size operate with a lag, and already the Fed’s actions are driving up mortgage rates and forcing economists to revise growth forecasts downward. But the full weight of the Fed’s massive hikes will still not be felt until later this year or 2023.
Stock markets were up slightly on Monday.
Krishna Guha, vice chairman of Evercore ISI, said the Fed had “put itself in a bit of a box” by making three-quarter point hikes a new normal. The central bank has given little guidance on when or how it will decide to slow down – or how it will react if the economy cools too much too quickly.
“You take very big steps on rates, you increase rates very quickly, before you have time to learn from the data and know if the level of rates is about right, a little too much or a little too much little,” Guha said. “In effect, your decisions exceed your ability to learn from the data.”
The Fed is ready to move forward with higher interest rates
Fed officials are beginning to recognize the dangers of moving at such a torrid pace. In a speech this month, Fed Vice Chairman Lael Brainard said that “at some point in the tightening cycle, the risks will become more two-sided,” noting the uncertainty around the time that it will take for tighter monetary policy to trickle down to the global economy. Richmond Fed Chairman Tom Barkin told the Financial Times this month that he’d rather “move faster than slower” to raise rates, “as long as you don’t inadvertently break something in the works. of road”.
So far, however, bank officials show no signs of backing down. They reiterate the message that they will reduce inflation, even if it hurts families and businesses or hurts the labor market.
For weeks, the markets have price in a third three-quarter point rise at the Fed’s September meeting, which is due to take place on Tuesday and Wednesday. It seems almost guaranteed now that the August inflation data has come in unexpectedly, especially for basics like housing and food.
Markets crash after Powell says tackling inflation will cause ‘some pain’
Wall Street fell on the inflation report last Tuesday, with the Dow Jones industrial average plunging more than 1,200 points on fears the Fed may have to follow its oversized hikes. Markets also fell for the remainder of last week. The report also spurred speculation among some economists and market analysts that the Fed is expected to hike a full percentage point this week.
Diane Swonk, chief economist at KPMG, said a one-point hike should be considered as the Fed’s credibility is at stake. But she acknowledged it would not be without consequences.
“While I’m arguing here for an even bigger increase, the real problem is that rapid increases themselves are destabilizing,” Swonk said.
Historically, the Fed has slowly and deliberately, raising or lowering rates by a quarter of a percentage point. Exceptions include major emergencies such as September 11 attacks or the financial crisis that triggered the Great Recession. And in fact, at the start of the coronavirus pandemic, the Fed cut rates to near zero as part of its wide-ranging bailout.
Last year the Fed refrained from raising rates, officials say it bubbling inflation would be a temporary feature of the covid recovery. It was wrong, and the Fed finally rushed to start raising rates this March. It is now on track to push rates past the “neutral” zone of around 2.5%, where rates are neither slowing nor stimulating the economy, and into “restrictive territory” which is dampening growth. consumer demand and lower inflation. The rise expected this week would drive rates between 3% and 3.25%, and rates are expected to climb to at least 4% by the end of the year.
Poorer countries could suffer from US efforts to slow inflation
“There’s an element of panic is one word, a realization that you’re behind is another,” said Julia Coronado, president of MacroPolicy Perspectives and a former Fed economist. “But it’s a dangerous time because everyone in the world, all the central bankers, seem to be jumping on the same bandwagon.”
Indeed, the Fed’s oversized hikes could be all the more effective as the world’s major economies step up their fight against inflation at the same time. On Thursday, the World Bank said the global economy could be heading into recession as central banks from Australia to Europe tighten policy. Already, economic growth is slowing in the United States, Britain, Europe and China. And as Fed policies strengthen the dollar, poorer countries could quickly suffer the consequences, as higher rates drive up the cost of financing debt or importing goods for countries that borrow. in dollars.
The sad reality, however, is that pain at home and abroad may be needed to rid the economy of its biggest problem. Kaleb Nygaard, a Fed history expert and host of the Reserve podcast, compared the economy to a forest and the Fed to forest rangers who sometimes have to start small fires to clear unwanted underbrush.
“This time around the rangers are trying to do more controlled fires, trying a lot harder not to burn so many trees,” Nygaard said. “But they’re worried that the interest rate hikes they’ve made so far haven’t slowed inflation enough. These big interest rate hikes are like the rangers loosening the reins of the fire and letting it burn a little hotter and a little wider.
“The underbrush is proving harder to clear than they had hoped,” he added, “meaning they may have to sacrifice more trees than they need.” ‘originally hoped to clear the forest’.