Why the Fed Should Go Slow
Author: Greg Valliere
May 2, 2022
THE CENTRAL BANKERS are determined to crush inflation, and therefore will hike rates by 50 basis points for the next few meetings. And the Fed will reduce its balance sheet, perhaps by around $3 trillion over the next three years, according to a piece by Nick Timiraos in this morning’s Wall Street Journal.
THE CRUSADE AGAINST INFLATION has wide support in the political, economic and financial worlds. But just as the Fed, in retrospect, over-did its accommodation last year, there’s a chance that Powell could slam on the brakes too aggressively this year. Here are some reasons why:
1. China’s economy may be headed toward a growth recession as a result of its Draconian lockdowns — and new cases have been reported this morning outside of Shanghai. Until China declares a Covid all-clear, its export sector will suffer.
2. Europe’s export sector may improve because of the weak Euro, but energy shortages are an increasing threat to growth.
3. Despite a roaring jobs market, U.S. consumers think the economy and the stock market are in mediocre or poor condition, largely because of inflation. As we wrote last Friday, psychology is a major wild card; could fears of a weakening economy become a self-fulfilling prophecy?
4. Not only is monetary policy becoming less accommodative, but the growth of fiscal spending in the U.S. is dropping significantly. Congress is disinclined to spend much more money — and even if President Biden declares modest student loan relief via executive decree, it may face legal challenges.
5. Supply chain gridlock has improved at U.S. ports, but a potentially disruptive Longshoreman labor dispute looms on the West Coast. And the semiconductor chip shortage is not over.
6. Most importantly, the war in Ukraine may last for many more months. Each side claimed victories in battles over this past weekend, with mounting casualties and no signs of meaningful negotiations. A war lasting through the summer could have a devastating impact on food and fuel supplies.
WITH THESE WILD CARDS, Powell may have to consider a slowdown in the tightening pace by autumn. He probably will talk tough about inflation this week — and he should — but we think there are ample reasons to worry about over-doing the medicine.
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