The Fed may have to blow up the economy to get inflation under control


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The Federal Reserve will most likely raise interest rates again by three-quarters of a percentage point on Wednesday, its fourth consecutive oversized hike. And it is still possible that another rate hike of this magnitude will occur in December.

But the big question for many investors — and American consumers — is whether the Fed will send the economy into a recession with these massive rate hikes.

Hopefully any slowdown will be mild, but this is uncharted territory for the Fed. Former central bank chairs Alan Greenspan, Ben Bernanke and current Treasury Secretary Janet Yellen have never had to raise rates so often in a row by such large amounts.

It’s unclear what all this tightening will do to the economy. The housing market is already beginning to show signs of strain. Bond yields climbed because of the Fed. And mortgage rates, which tend to move in tandem with the benchmark 10-year Treasury, have soared this year as a result.

There is also a growing chorus of Democratic lawmakers on Capitol Hill warning Fed Chairman Jerome Powell and other Fed members to slow rate hikes because they fear even tighter monetary policy will lead to a recession.

But as long as the labor market remains healthy, the Fed will likely continue to focus solely on its price stability mandate and ignore anything related to maximum employment.

“The Fed still has work to do,” said Steve Wyett, chief investment strategist at BOK Financial. “Inflationary pressures take longer to come out of the system.”

The strong rebound in gross domestic product, or GDP, in the third quarter after two straight quarters of economic contraction could also appease some (but not all) recession-worries. It could also encourage the Fed to continue its aggressive policy of raising rates… even if such a policy risks causing a recession in the long run.

The worry is that the Fed may choose to scrutinize current economic data more and not think enough about the lag effect of its existing rate hikes. Inflation in the US economy may not have peaked yet, but there’s a growing sense that we’re pretty damn close.

“It is critical that policymakers…prepare for a slowdown in demand as the lagged impact of rising interest rates and inflation begins to exert powerful downward pressure on economic activity. “said Joseph Brusuelas, chief economist at RSM US, in a report. He added that the economy “is clearly at risk of falling into recession in the short term”.

Another factor at play could cause the Fed to raise rates sharply in its next two meetings and then slow its pace.

Each year there is a rotation of regional Fed chairs who get votes at central bank policy meetings. The next change will take place before the first Fed meeting of 2023, which ends on February 1. Experts point out that some of the new voting members may not be as inclined to support such large rate increases as the current slate of regional chairs of the Federal Open Market Committee.

So there could be a shift from a more hawkish stance (likely to support higher rates) to a more dovish one (prone to warn against future hikes).

“The committee’s political temperament becomes less hawkish in 2023. Sensing a window of opportunity closing, this year’s more hawkish voters may seek to do more while they still can, that is, more frontloading,” said BNP Paribas Securities US. economists Carl Riccadonna and Andy Schneider in a report.

The Fed meeting comes just two days before the country receives its next labor market bulletin. Economists predict a slowdown in job growth, but not substantial.

According to Reuters estimates, experts predict 200,000 jobs were added in October, down from job gains of 263,000 in September. (That September figure will likely be revised, though.)

The jobless rate, which fell to 3.5% in September, is expected to rise to 3.6% this month. But that’s still close to a minimum of half a century.

Figures from the Bureau of Labor Statistics count both private sector and government jobs. Another jobs report, from payroll processor ADP, is also due out next week, and this one is for Corporate America only.

According to forecasts, economists expect ADP figures to show a further slowdown in business hiring, with 190,000 jobs added in September from 208,000 a month earlier.

Even if the pace of hiring is starting to slow down, it is clear that the labor market remains tight. Wages rose at an above-average rate, but not as fast as inflation.

The government said in the September jobs report that the average hourly wage had risen by 5% over the past 12 months. The Fed generally prefers to see wage growth in the 2-3% annual range as a sign that inflation is under control.

According to figures released on Friday, the Fed’s preferred measure of inflation, the so-called personal consumption expenditure (PCE) index, showed prices had risen 6.2% in the past 12 months to in September.

A sharper slowdown in wage growth therefore seems unlikely as long as the labor market remains robust and consumer prices continue to rise.

“The pace of hiring is very high, unsustainable and driving up wages and inflation,” economists from The Hamilton Project, a policy research group at the Brookings Institution, said in a recent report.

Monday: EU GDP; Eurozone inflation; revenues from Goodyear (GT), Aflac (AFL) and Avis Budget (CAR)

Tuesday: US ISM manufacturing index; revenues from BP (BP), Pfizer (PFE), Uber (UBER), Eli Lilly (LLY), Fox (FOXA), Prudential (PRU), Mondelez (MDLZ), AIG (AIG), AMD (AMD), Caesars ( CZR), Clorox (CLX) and Electronic Arts (EA)

Wednesday: Fed Rate Decision; ADP jobs report; PMI Germany; revenues from CVS (CVS), Humana (HUM), Paramount, Yum (YUM), Ferrari (RACE), MetLife (MET), Allstate (GER), Qualcomm (QCOM), Booking (BKNG), eBay (EBAY), MGM (MGM), Roku (ROKU) and Etsy (ETSY)

Thursday: Bank of England rate decision; weekly jobless claims in the United States; US ISM services index; revenues from Cigna (CI), ConocoPhillips (COP), Marriott (MAR), Kellogg (K), Moderna (MRNA), Royal Caribbean (RCL), Wayfair (W), owner of CNN Warner Bros. Discovery, Starbucks (SBUX), PayPal (PYPL), Amgen (AMGN) and Block (SQ)

Friday: US jobs report; revenues from Cardinal Health (CAH), Duke Energy (DUK) and Hershey (HSY)


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