Trapped Fed Goes Big Again With Recession Looming

The Fed hiked rates by the most since 1994 for the second consecutive meeting on Wednesday.

Put differently, the Fed hiked rates by the most since last month. There were no dissents.

By the time the new statement made it official, another 75bps increment was a foregone conclusion. Following the June gathering, officials left the door open for a downshift to 50bps, but another red-hot read on inflation ruled out any near-term deescalation. In fact, the combination of June’s CPI scorcher and a 100bps move from the Bank of Canada less than two hours later, raised the specter of a full-percentage move from the FOMC this month.

Markets briefly priced an “all-in” outcome as a coin toss, but officials were careful to avoid preemptively endorsing anything bigger than last month’s already aggressive hike. Subsequently, a cooler-than-expected read on University of Michigan inflation expectations and escalating recession fears removed the 100bps tail risk.

The statement language on inflation was largely unchanged, although the word “food” made a cameo, a polite nod to the stark reality facing American families in the grocery aisles. “Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures,” the Committee said. Officials reiterated a “strong commitment” to returning inflation to 2%. The Fed has now delivered 225bps of hikes over four meetings (figure below).

The next 75- to 100bps should be a done deal, with emphasis on “should.” You know what they say about the best laid plans.

Real growth is anemic, at best. The Atlanta Fed’s GDPNow tracker improved on the eve of Q2 GDP data, due Thursday. The nowcast tipped a 1.2% contraction. Even if growth doesn’t turn negative, the economy is plainly decelerating. The odds of Jerome Powell pulling off the fabled “soft landing” are now infinitesimal.

By September, Europe could be well on the way to a deep downturn and it’s likely that consumer spending in the US will remain hamstrung by inflation, which is precipitating a cost of living crisis in two ways: The price of necessities is elevated and real wage growth is deeply negative. The tragic irony is always the same. Addressing the proximate cause of consumer angst means adopting measures that are virtually guaranteed to make consumers even more miserable. The Fed’s conviction will be tested on all fronts. If headline inflation softens materially, at least some officials will likely be tempted to dial back the tightening impulse.

“Recent indicators of spending and production have softened,” the Fed said Wednesday, describing the economy in far less sanguine terms compared to the June statement. “Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low.”

Biden administration officials including Janet Yellen have been keen to emphasize that two consecutive quarters of negative real GDP growth is not, in fact, the “technical definition” of a recession. The NBER makes recession determinations, and it doesn’t subscribe to the two-quarter rule of thumb. Fed officials will likewise downplay the recession story irrespective of what the advance read on second quarter growth shows.

No one speaking in an official capacity for the Fed or the White House will say the world’s largest economy is in a recession. Some lawmakers will though, even if Q2 GDP manages to print in positive territory. Any such political lamentations will be a bipartisan affair. Democrats will bemoan “insult to injury” for the middle class, as rate hikes exacerbate the burgeoning slowdown at the risk of lost jobs, for example. The GOP, meanwhile, will claim (implicitly or otherwise) that the Fed was behind the curve in part because it strayed too far from its mandate in a misguided effort to engineer social outcomes favored by Progressives. (Because nothing shouts “Progressive!” like a Republican lawyer-turned investment banker.)

In the near-term, at least, policymakers will hew closely to talking points about the primacy of price stability and the absolute necessity of ensuring longer run inflation expectations don’t become unanchored. As Powell is fond of putting it, an economy without price stability doesn’t work for anyone.

But as much as Powell doesn’t want to be remembered as the Fed Chair who lost control of inflation, there’s a sense in which that ship has already sailed. And crashed into the rocks. Inflation is out of control in the context of developed markets and advanced economies.

The question, then, isn’t whether Powell let inflation get away from the Fed. He did. Maybe it wasn’t his fault, but it is his mandate. The question, rather, is whether price growth spirals further — whether expectations de-anchor such that social stability is threatened.

That outcome remains far-fetched, and as such, Fed officials need to bind themselves to the mast in order to avoid falling victim to the siren song of easing prematurely on the notion that 4% or 5% inflation is tolerable if it means averting a deep recession.

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15 thoughts on “Trapped Fed Goes Big Again With Recession Looming

  1. Sorry don’t buy it. The housing market is rolling over, the big boxes are full of inventory and commodity prices are also weak. The last man standing is employment- that is a coincident or lagging indicator. I am listening to the talking heads on Bloomberg and I must say I find their commentary full of bullsh**. A lot of them are saying that rates have to go much higher- is a strong dollar, an inverted yield curve, weaker commodities suggest higher rates and higher inflation??

    1. “Sorry don’t buy it.”

      To quote a great film, “That’s handy, cause I ain’t sellin’ it. It’s a fact.”

      Inflation is 9.1%. In America. That already happened. It’s nice that you and me and the majority of people who frequent this site don’t notice a 12% rise in grocery bills. That leaves us free to muse idly about what may happen later, confident in the notion that whatever happens, we’ll be fine unless inflation accelerates to 30%.

      The Fed absolutely can’t afford to adopt that mentality. They tried it. It made fools of them. And to the extent that policy bent prevented them from taking steps that might have at least moderated inflation, if not kept it at bay given the exogenous, supply-driven nature of the shock, then that’s a policy failure.

      I mean, you’re a regular reader, so I say this respectfully, but my goodness, the transitory narrative was false. Let it go, friend. Even if inflation collapses tomorrow it still wasn’t transitory. The battle is lost. It’s over. You can’t wait three years on inflation to moderate and then say, “Look! It was transitory after all!” Everything’s “transitory” eventually.

      1. I’d like to see you do an article on the effects of 64% inflation in Turkey so far in 2022. We’re freaking out at 9 percent, what are the Turks doing at 64%?

        1. Actually H did do an article about that a few months ago. If I remember correctly Erdogan believes he can reduce inflation by cutting interest rates

        2. A friend of mine, and former innovative finance prof, is a Turkish citizen and they ain’t doin’ too well. At the current inflation rate anything your past life represented is essentially gone and your future is not bright.

    2. You’re being way too sanguine. The inventory issue is a cyclical over-correction, but nothing crazy. This is not 2009 housing inventory level cluster-f.

      Energy prices rolled over on demand destruction, but the demand is right there lurking while energy prices remain extremely elevated. Everything is one shock away from another leg up. It could be Russian action, another fire at an LNG port, terrorist attacks on infrastructure in Saudi Arabia or Libya, or domestic unrest in Nigeria, or… you get the point. Food prices are off their parabolic tops, but they’re creeping back up into a system that’s incredibly strained. Remember what swine flu in China did to pork prices? We have a raging bird flu epidemic in America. Over 10 million birds have already had to be “culled.” I’ve seen the smoke columns, it’s disturbing. Imagine a pile of a half million dead birds drenched in diesel and lit on fire. Actually, don’t, that’s pretty messed up. It’s also a pretty good metaphor for worldwide commodity markets.

  2. It is pretty clear that the economy is downshifting. Not sure when the inflation stats capture the weakness- but all kinds of items are starting to go on sale and that will clearly lead to lower inflation in fairly short order. Real time prices are suggesting this- the inflation you cite reflect the past. So be it. The Fed got behind the curve and is forced to react to current inflation stats- I cannot blame them. Inflation is one of their primary mandates and right now it is too high. They are not that far behind now though and I expect a pivot a lot faster than the talking heads- that is my main point.

    1. When car factories in Germany are shut,
      (likewise for potash, aluminum, etc), lockdowns continue in China, and SPR releases have run their course we may quickly find ourselves locking back on the sale prices of today and next week with lament.

      There’s already talk of mortgages having ‘topped out’ which, if true, doesn’t bode well for OE rent stabilization. The housing market may have hit a speed bump but if easing commences it very well may not result in price drops.

  3. I partially agree with Ria in regard to housing, retail inventories, etc. Coincidentally, the dollar is the standard currency, and many Americans still seem to have a lot of dollars to spend, especially with the cheap prices at the big box stores. That said, it will not last forever. Bottom line, the Fed is splashing chilly water on the economy. The read next month will not be so hot. Same for August.

    We do muse here. I think we can all be thankful for being able to muse about the Fed and the economy.

    I believe we have to imagine that growth will indeed tilt negative. But to what extent will it be prolonged by ongoing, high global oil prices? That’s my question. We’re not the only country impacted. Supply shortages and a Fukata oil market affect most everyone on the planet.

  4. CPI at 9% – fighting it with 3% interest levels >>> It will NOT work.
    At least 5%+ is needed to corral it but to get down to the 2% level more is needed.

    1. HeyJoe, I would have to agree.

      The game is still being played – that is the difference between what they say and what they know.

      They are trying to support the story that that an addtional 75 – 100 should be the top of the interest rate cycle. Probably the reason they did not raise rates 100 points this time round – this narrative would seem untenable.

      Sounds a little (or a lot) like the tune the Fed was singing about inflation being transitory…. until it was not. And it become downright foolish to say otherwise.

  5. H-Man, while hope springs eternal, at some point we have to deal with reality. Today the Fed hikes by the most (combined with June) in the last 40 years and the stock market rejoices and many of your readers believe the war is over. Yes inflation will end at some point but I suggest that journey has quite a ways to go. Remember the Fed today said there is no recession and the current hike takes us to zero. That thinking also gave us transitory inflation and a 75 point hike was not being considered while abandoning forward guidance which was a fool’s errand to begin with. So how much faith do you have in these leaders based upon their record over the past six months?

    1. What they know and what they say are different. They all (the Fed, the Whitehouse, etc) know we’re in a Recession (even if they’d like someone 6 months from now to look back and then declare it retroactively).
      It’s normal to consider that the economy charged forward after being forcibly held back (for society’s own health and safety), then it hit the rough pointy patches of Inflation (and labor shortages) so it’s slowed down. Masses of people and their psychology are going to be messy; of course we’re not more productive if our inputs (fuel and food) take a whole lot more dollars.

      So the fiction of “it’s not a Recession” makes it easier for the Fed to concentrate on Inflation which is definitely not a solved problem. I hope they have the discipline to raise again by 75 bps because the unrest that’s building could elect a populist mob that tear everything down to “fix it” (like “default on the debt”)!

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