Could the Fed push the US economy into recession?

Normally, a central bank will tighten monetary policy when an economy is overheating and halt or slow rate hikes when it begins to cool down. But, for the first time since the 1980s, the US Federal Reserve raised interest rates amid an economic downturn.

The Fed was slow to react to the surge in inflation, insisting that supply chain problems in the wake of the coronavirus pandemic were only “transient”. Although prices began to rise in March 2021, the Fed only began raising rates a year later, first by 25 basis points, then by 50 and, in the last three meetings, of 75 basis points – actually emergency movements.

It has now been 19 months since US inflation has come close to the Fed’s 2% target. The costs of food, gasoline and housing, in particular, rose dramatically, and in June the consumer price index (CPI) reached 9.1%, the highest in more than 40 years.

Inflation falls, Fed still hawkish

Despite signs that inflation may now have peaked – the CPI stabilized at 8.3% in August – the Fed said it would continue to hike rates until the inflationary beast be tamed.

The Fed’s persistent hawkish stance and accusations that it has lagged have raised concerns that measures could push the US economy into recession.

“The truth is, no one can be sure of the clarity and the presence of recession danger in the United States,” HSBC bank Americas head of research DW Daragh Maher told DW. “But the more stubborn inflation proves to be, the greater the risk of recession.”

Maher added that weaker growth was not an “acceptable side effect of this fight against inflation”, but rather “a necessary element”.

Indeed, policymakers fear the prospect of stagflation: the combination of stagnant economic growth and persistently high inflation seen in the 1970s and early 1980s.

US food inflation hit 11% in August

The Fed has few options

Some wonder if the Fed’s current approach is similar to that of 1979, when Federal Reserve Chairman Paul Volcker crushed inflation with a series of historic rate hikes but triggered a two-year recession. years, during which the US unemployment rate reached 10%.

Financial markets have now priced in a fourth straight 75 basis point rate hike in November, with some analysts predicting more hikes to come.

“I believe 75 is the new 25 until something breaks, and nothing has broken yet,” Bill Zox, portfolio manager at Brandywine Global Investment Management, told Bloomberg News, adding that he thinks the Fed is nowhere near a break or a pivot. .

Could further rate hikes cause market instability?

Warnings against further rate hikes intensified this week, first from veteran market analyst Ed Yardeni, who said the tightening was a blunt tool that could destabilize financial markets.

“When you also have QT2 [quantitative tightening] and a booming dollar, there are very restrictive monetary developments,” Yardeni told Bloomberg News. “I think they have another rate hike coming in November and it will be all because the issue of the financial stability will emerge as a major concern.”

Signs of vulnerability have already been seen in European banks such as Credit Suisse and by the run on the pound, which has forced the The British central bank will intervene in the bond market to protect the nation’s pension funds.

Western rate hikes are hurting the developing world

The United Nations has also taken a stance on the issue, warning on Monday that interest rate hikes by the world’s wealthiest countries risk a painful global recession it would hurt developing countries most.

The United Nations Conference on Trade and Development (UNCTAD) has said monetary tightening by the Fed, as well as the Bank of England and the European Central Bank, is a “reckless gamble” that could backfire dangerously against him.

UNCTAD said the reason for the high inflation was less due to excess demand for goods and services than to persistent trade problems, as well as rising food and energy prices.

HSBC’s Maher noted how the Fed’s hawkish stance has prompted global investors to seek a safe haven in the dollar.

The US currency has strengthened against most other currencies over the past year, which has exacerbated inflation in the rest of the world, as many goods, including oil, are denominated in dollars.

“Excessive currency weakness can, in turn, create other pressures, for example on imports,” Maher said. “A number of countries, including in Europe, have seen their trade balances deteriorate” as inflation remains stubbornly high, which could mean “more rate hikes to come, even if inflation slows” , he added.

Edited by: Ashutosh Pandey

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