The Fed may need to blow up the economy to control inflation

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The US Federal Reserve is likely to raise interest rates by three-quarters of a percentage point again on Wednesday, its fourth consecutive outsized hike. And another rate hike of this size is still likely in December.

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

There are hopes that any recession would be mild, but this is uncharted territory for the Fed. Former central bank chairmen Alan Greenspan, Ben Bernanke and current Treasury Secretary Janet Yellen have never had to raise interest rates so many times in a row by such large amounts.

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

There is also a growing chorus of Democratic lawmakers on Capitol Hill who are warning Fed Chairman Jerome Powell and other Fed members to slow rate hikes because they fear that 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 mandate of price stability and ignore all this stuff about maximum employment.

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

The solid rebound in gross domestic product, or GDP, in the third quarter after two consecutive quarters of economic contraction may also quell some (but not all) recession worries. This could also prompt the Fed to continue its aggressive rate hike stance…even if such a policy risks triggering a recession down the road.

The concern is that the Fed may be choosing to look more closely at current economic data and not thinking enough about the impact of lagging its existing rate hikes. Inflation in the US economy may not have peaked yet, but there is a growing sense that we are very close to it.

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

There is another factor that could lead the Fed to raise interest rates sharply in its next two meetings and then slow its pace.

Each year, there is a rotation of regional Fed chairmen who receive votes at the central bank’s policy meetings. The next change will take place before the Fed’s first meeting in 2023, which ends on February 1. Experts point out that some of the new voting members may not be as willing to support rate hikes as big as the current roster of regional chairs on the policy-setting Federal Open Market Committee.

So there could be a shift from a more hawkish stance, (someone likely to support higher rates) to one that is more hawkish, (tends to be cautious about future increases).

“The committee’s policy temper turns less aggressive in 2023. Sensing a window of opportunity closing, this year’s more hawkish voters may seek to do more while they still can, meaning more upfront,” said BNP Paribas Securities US. economists Carl Riccadonna and Andy Schneider in a report.

The Fed meeting comes just two days before the nation gets its next labor market report card. Economists predict job growth will slow, but not materially.

Experts forecast 200,000 jobs were added in October, up from 263,000 jobs in September, according to Reuters estimates. (That September amount will likely be revised, however.)

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

The numbers from the Bureau of Labor Statistics count jobs in both the private and public sectors. Another jobs report, from payroll processor ADP, is also due out next week, and this one covers just Corporate America.

In line with forecasts, economists expect ADP numbers to show a further slowdown in hiring among businesses, with 190,000 jobs added in September compared with 208,000 a month earlier.

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

The government said in the September jobs report that average hourly earnings rose by 5% over the past 12 months. The Fed typically prefers to view wage growth at 2% to 3% annually as a sign that inflation is under control.

The Fed’s preferred measure of inflation, the so-called personal consumption expenditures (PCE) index, showed prices rose 6.2 percent in the 12 months to September, according to data released Friday.

So a more dramatic slowdown in wage growth looks unlikely as long as the labor market remains strong and consumer prices continue to soar higher.

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

Monday: EU GDP? eurozone inflation? gains from Goodyear (GT), Aflac (AFL) and Avis Budget (CAR)

Tuesday: US ISM manufacturing index. earnings 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. Germany PMI? earnings from CVS (CVS), Humana (HUM), Paramount, Yum (YUM), Ferrari (RACE), MetLife (MET), Allstate (ALL), Qualcomm (QCOM), Booking (BKNG), eBay (EBAY), MGM (MGM), Roku (ROKU) and Etsy (ETSY)

Thursday: Bank of England rate decision. Weekly US jobless claims. US ISM Service Index. gains from Cigna (CI), ConocoPhillips (COP), Marriott (MAR), Kellogg (K), Moderna (MRNA), Royal Caribbean (RCL), Wayfair (W), CNN owner Warner Bros. Discovery, Starbucks (SBUX), PayPal (PYPL), Amgen (AMGN) and Block (SQ)

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

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