Now it has entered a precarious balancing act, trying to contain high inflation while avoiding a severe economic slowdown, perhaps even a recession.
The Fed announced on Wednesday that it would begin raising interest rates for the first time since 2018, and the initial response from financial markets has been welcoming. The stock market rose, bond yields faltered and commodity prices moderated.
But whether the economy can withstand rising rates in a period of geopolitical turmoil and an ongoing pandemic is a question with no immediate answer.
“Certainly, inflation is very high, and recession risk is a lot higher today than it was 12 months ago — there’s no question about that,” said James Paulsen, chief investment strategist for the Leuthold Group, an independent stock market research firm in Minneapolis. “But I think there’s a pretty good chance we’ll make a soft landing.”
However, that is not a unanimous position among market strategists.
“I think the recession risk is very high,” said David Rosenberg, chief economist at his own company Rosenberg Research in Toronto. prices. Now it must be seen to move aggressively.,
The Fed’s language was remarkably strong. “Inflation remains high, reflecting supply-demand imbalances related to the pandemic, higher energy prices and broader price pressures,” it said. “The invasion of Ukraine by Russia is causing enormous human and economic hardship.,
But his actions so far have been lenient. It began its mission cautiously, raising its benchmark rate, the federal fund rate, by just 0.25 percentage point.
That’s just the beginning.
The central bank indicated that this increase will likely be the first of seven this year, a significant shift in direction. Fed fund rates have been close to zero since March 2020 — a level intended to pull the economy out of the recession caused by the coronavirus pandemic that month.
In addition, Jerome Powell, the chairman of the Fed, said in a news conference on Wednesday that the Fed could begin rolling back the grand experiment known as quantitative easing in May, which swelled its balance sheet to a massive $8.9 trillion and the recovery from the pandemic.
In unusually candid language in response to a reporter’s questions, Powell said the Fed “should have started tightening interest rates sooner, before inflation got that high. In addition, the Federal Open Market Committee, the Fed’s body that determines policy, which financial markets and federal statistics have been saying for months: Inflation is uncomfortably high and likely to remain so for some time to come.
The commission said in a statement on Wednesday that it expected inflation to remain well above the 2% target until at least 2023.
“It will likely take longer for inflation to return to our price stability target than previously expected,” Powell said.
On the other hand, he said, Russia’s war in Ukraine is not only contributing to inflation by raising the prices of crucial commodities such as oil and wheat, but also increasing uncertainty in the economic outlook. Still, Powell insisted that the economy remained strong and that now was a good time to avoid the “anchoring of runaway inflation.”
Russia, supply chains and an oil shock
That may well be the case. The unemployment rate, just 3.8% in February, is extremely low, and inflation, at 7.9% for the 12 months to February, as measured by the consumer price index, is as high as it has been since the 1980s.
Under these circumstances, it would be difficult to argue that the Fed should do nothing about current inflation rates.
Yet the geopolitical situation is fraught with danger.
Oil prices have fallen from the peaks they reached last week, but war-induced oil supply shortages and rising prices – including Western sanctions against Russia – remain a serious threat to the economy.
In an interview, James D. Hamilton, a professor of economics at the University of California, San Diego, and a leading expert on the economic effects of oil shocks, said they “have been a major contributor to recessions over many decades. and supply levels, the effects of the Russian war are “reasonably manageable for the U.S. economy.,
But Hamilton pointed out that Russia’s oil, which accounts for about 10% of world production, cannot be easily replaced if completely cut off – an outcome he considers unlikely. Nevertheless, even the loss of a substantial part of it could constitute an oil price shock to rival that of the 1970s, he said.
In addition, the reduced availability of Russian raw materials such as palladium, which is important for catalytic converters in petrol-powered cars, and nickel, which is used in car batteries and for many other purposes, are also causing shocks.
How serious is the danger that these war-related problems will cause major economic problems in the United States? “We will have to look closely at this,” said Hamilton.
Omicron in China
Another variable the Fed should consider: The global supply chain problems that have contributed to inflation in the United States could be made much worse by China’s worst outbreak of COVID-19 since early 2020. Lockdowns and restrictions in China, deliveries of products such as Toyota and Volkswagen cars and Apple iPhones, as well as components such as printed circuit boards and computer cables, are slowing, Keith Bradsher reported for The New York Times from Beijing.
“The situation in China is certainly complicating things for the Fed,” said Yung-Yu Ma, chief investment strategist for BMO Wealth Management in the United States. †
“Before that it was already a challenging environment,” he added. “Remember, we started in the good old markets in January with our concerns about what the Fed would do to interest rates.
The Experimental Fed
All things being equal, at a time like this it may make sense for the Federal Reserve and other central banks to prepare a full suite of monetary instruments and issue reassuring statements that they are ready to bolster the economy. where and when needed. Powell did say that the rate tightening would be “data-driven” and that the central bank was fully committed to supporting a strong economy. But he unequivocally emphasized that the Fed immediately focused on cutting inflation.
With luck, it will be able to gradually reduce the pace of price increases to more comfortable levels without having to raise interest rates high enough to trigger a recession.
But as Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research, noted, many people in the markets aren’t quite convinced. “What a bundle of contradictions,” she said on Twitter. “Raise rates a lot, lower inflation, but GDP growth and unemployment are stable. Hmmm.,
The Fed’s long and innovative experiments on monetary policy are far from over.
The latest announcements put the central bank on a narrow path that may prove less straightforward toward its goals of price stability and maximum employment than a tightrope walk. Meanwhile, the coronavirus, the Russian war, supply chain disruptions and rising prices threaten to upset the delicate balance.
This post Inflation versus recession: the Fed is on a tightrope was original published at “https://economictimes.indiatimes.com/markets/stocks/news/inflation-vs-recession-the-fed-is-walking-a-tightrope/articleshow/90305209.cms”