HERE WE GO AGAIN: The Fed’s inability to predict accurately — even for the upcoming couple of quarters — may be on display again. How can the central bankers hike interest rates by 75 basis points later this month when economic growth and inflation are suddenly slipping?
A U-TURN BY THE FED by fall might be its greatest embarrassment ever — even worse than missing the inflation surge or last year’s insider trading scandal.
THE FED WAS SO ADAMANT about rate hikes, just a few weeks ago, that a 50 or 75 basis point hike still seems likely later this month. Perhaps there will be hints in its statement and Powell’s press conference that additional tightening this fall could be gentler.
BEHIND THE CURVE: Powell and his colleagues infamously missed the inflation surge that was becoming apparent in the spring of 2021; it was “transitory,” said Powell, who urged aggressive fiscal stimulus to cope with the pandemic. Some of that stimulus still hasn’t been spent.
POWELL FINALLY REALIZED, BY WINTER, that inflation was breaking out. The acute labor market tightness had become self-evident, but even then the Fed merely reduced its stimulative purchase of Treasuries and mortgage-backed securities. Only after an explosion of inflation this spring did the Fed shift to aggressive tightening.
BY THEN IT WAS TOO LATE, as 8% inflation forced the Fed to over-react. In recent congressional testimony, Powell spooked the markets by refusing to rule out a recession because of the Fed’s policies. And he glibly asserted that the housing market might have to “recalibrate.”
BY THEN FEARS OF RECESSION were rampant in the battered stock market, and consumer confidence crashed. As an economic slowdown became apparent this summer, interest rates began to fall and inflation fears abated somewhat.
WHAT STRIKES US DURING THIS 15-MONTH ROLLER-COASTER is that the financial markets were always far ahead of the Fed. The markets saw inflation coming, and now they can smell a slowdown. So, fittingly, the Fed may be forced to shift policy by fall, which is what the markets can see more clearly than Powell.
THE FED’S INFLATION HAWKS, led by Loretta Mester, are determined to extinguish inflation, and they’re in no rush to stop tightening. Meister says it will take two more years of rate hikes to accomplish that goal. Within the markets there suddenly is a belief that rate cuts may be necessary in 2023.
THAT’S BASED ON FEARS of recession and demand destruction; inflation is still worrisome. But even on this front, there are tentative signs of softening in prices
of everything from grains to metals. And for the U.S., the mighty dollar will ease
inflation pressures.
MAKING FORECASTS IS A HUMBLING EXERCISE, as key variables change overnight. But the great surprise this summer — certainly at the Fed — is the dramatic deceleration of the economy and signs of plateauing prices, at the least. The Fed has gotten it wrong again and may have to shift course — again.