In our previous blog post we pointed out how the Federal Reserve would probably need to see some clear signs of inflation decelerating during the next few months or it may have to get more aggressive in terms of its policy tightening efforts.
Well, it seems officials could not even wait that long because during last week’s Federal Open Market Committee (FOMC) meeting monetary policymakers voted to raise the fed funds rate by 75 basis points, lifting the target range to 1.50-1.75 percent. That was the largest single-meeting rate increase in over a quarter of a century and essentially a message from the committee that historic levels of inflation require a historic response. Moreover, in the official statement released by the FOMC the committee stressed that it is “strongly committed to returning inflation to its 2 percent objective.” Considering that the core PCE price index, the Fed’s preferred measure of consumer inflation, is currently signaling an annual rate of inflation of roughly 5 percent and that the FOMC’s updated projections do not have this dipping back under 2 percent until 2025 at the earliest, last week’s policy move should not be too surprising.
To this end it is also worth noting that the Fed getting more aggressive now is actually good news because it will help them avoid having to take much more significant actions down the road should they find themselves even further behind the curve, another thing we argued earlier in the year. To put this another way, a little economic pain now is deemed by monetary policymakers to be preferred over a lot more pain later on. The “pain” here will result from tightening financial conditions enough so that borrowing money becomes more expensive, in turn slowing down economic activity enough so that the demand side overcorrects and allows the supply side to recover more easily, i.e. these tighter financial conditions will cause both consumers and businesses to spend less, fix the current supply-demand imbalance, and ultimately reduce the upward pressure on prices.
Exactly how long this takes is not yet known, and while the Fed would like to tighten policy as gradually as possible, the latest actions and messaging from the committee suggest they are starting to acknowledge that the so-called “soft landing” may not be achievable. The harder landing would involve a hit not just to consumption but also the labor, real estate, and stock markets as well as the blowback from more restrictive monetary policy filters through the economy. The stock market is probably the best real-time, forward-looking discounting mechanism of future economic changes and the recent price action is perhaps a sign that investors were well ahead of the Fed in this sense. Again, though, inducing a mild recession now is preferred by the Fed over having to get much more aggressive down the road to stave off an outright depression. As for when a recession may occur our base case all year has been likely sometime in 2023.
This still appears the most likely scenario as the labor market remains strong and excess savings and credit availability are still ample enough to support consumer spending throughout the remainder of 2022. Moreover, although the Fed got more aggressive this month overall policy is still relatively very unrestrictive, whereas by yearend FOMC projections suggest another 175 basis points in hikes, again supporting the argument for a greater economic headwind, at least from monetary policy, showing up in 2023. However, since a recession is technically just an academic axiom, saying a recession can be avoided until 2023 does not at all mean that there are not many Americans who are going to be struggling in the meantime and if political history repeats itself this is likely bad news for incumbents in the upcoming midterm elections.
What To Watch This Week
- Durable Goods Orders 8:30 AM ET
- Pending Home Sales Index 10:00 AM ET
- Dallas Fed Manufacturing Survey 10:30 AM ET
- 2-Yr Note Auction1:00 PM ET
- 5-Yr Note Auction 1:00 PM ET
- International Trade in Goods (Advance) 8:30 AM ET
- Retail Inventories (Advance) 8:30 AM ET
- Wholesale Inventories (Advance) 8:30 AM ET
- Case-Shiller Home Price Index 9:00 AM ET
- FHFA House Price Index 9:00 AM ET
- Consumer Confidence 10:00 AM ET
- Richmond Fed Manufacturing Index 10:00 AM ET
- Mary Daly Speaks 12:30 PM ET
- 7-Yr Note Auction 1:00 PM ET
- Money Supply 1:00 PM ET
- Loretta Mester Speaks 6:30 AM ET
- MBA Mortgage Applications 7:00 AM ET
- GDP 8:30 AM ET
- EIA Petroleum Status Report 10:30 AM ET
- Survey of Business Uncertainty 11:00 AM ET
- 2-Yr Note Settlement
- 5-Yr Note Settlement
- 5-Yr TIPS Settlement
- 7-Yr Note Settlement
- 20-Yr Bond Settlement
- Jobless Claims 8:30 AM ET
- Personal Income and Outlays 8:30 AM ET
- Chicago PMI 9:45 AM ET
- EIA Natural Gas Report 10:30 AM ET
- Fed Balance Sheet 4:30 PM ET
- PMI Manufacturing Final 9:45 AM ET
- ISM Manufacturing Index 10:00 AM ET
- Construction Spending 10:00 AM ET
- Baker Hughes Rig Count 1:00 PM ET
- SIFMA Early Close