The Fed is poised to raise rates again with the economy on a knife edge

WASHINGTON: US central bankers are facing increasing difficulty in balancing as they struggle to quell hyperinflation while keeping the economy growing, although they have made clear they are willing to risk a recession.

But with the war in Ukraine continuing, and Covid-19 causing continuing problems in Asia, avoiding an economic downturn will require luck and depends on many factors beyond the Fed’s control.

As families struggle to make ends meet amid rising gas, food and housing prices, and a growing number of Americans taking second jobs to pay the bills, Federal Reserve officials have made clear that fighting inflation is their top priority even if it means hurting it. Pain.

The Federal Reserve holds its two-day policy meeting next week, where it is expected to raise Wednesday’s benchmark borrowing rate by another three-quarters of a percentage point in its aggressive campaign to cool demand and ease price pressures.

Despite a healthy labor market with a near-record low unemployment rate, workers are seeing their wage gains being overshadowed by high consumer prices, which rose to a 40-year high of 9.1% in June.

A slowing economy is likely to cause more job losses, but policymakers want at all costs to avoid the greater pain of a price vortex becoming entrenched or out of control.

Treasury Secretary Janet Yellen, herself a former Federal Reserve chair, warned last week that achieving a “soft landing… requires skill and good luck.”

Strictly high prices

Former Federal Reserve Vice Chairman Donald Kohn agreed.

“It’s a very complex and multidimensional issue,” Cohen told AFP, particularly because of the ongoing uncertainty in the supply chain.

After flooding the world’s largest economy with subsidies during the pandemic — zero interest rates and a steady flow of liquidity into the financial system — Fed policymakers were congratulating themselves on how quickly the economy recovered, restoring millions of jobs in a matter of months.

But they were surprised by the rapid rise in prices, as Americans were pouring money on massive government aid who went on a spending spree, buying cars, homes and other goods at a time when the global supply chain was still up. A quagmire due to the ongoing epidemic lockdowns in China.

The Fed finally started to raise – raising the interest rate from zero – in March, starting with a 25 basis point increase, followed by 50 basis points in May and 75 in June.

Higher lending costs make it more expensive to borrow money to buy cars and homes or expand a business, which should lower demand, while making it more attractive to save rather than spend.

Other major central banks followed suit, including the European Central Bank which took its first move last week.

Fed Chairman Jerome Powell said last month that the FOMC policy-setting committee would consider either a 50 or 75 basis point hike at its July meeting, and most economists expect a repeat of the three-quarter point increase in June.

Federal Reserve Governor Christopher Waller recently floated the idea of ​​a massive 100 basis point increase, which would be the first since the US central bank began using the federal funds rate for policy in the early 1990s.

We haven’t seen the equivalent amount of tightening in a single move since the early 1980s, when then-Fed Chairman Paul Volcker was on a crusade to crush an inflationary spiral in wage prices.

mixed data

But even Waller pointed out that it’s important not to move too quickly, and a full point hike will only be called for if the data continues to show accelerating price increases.

“I think they will probably only discuss 100 basis points because the inflation picture is still very bad,” said Julie Smith, professor of economics at Lafayette College.

She said in an interview that some recent data “suggests that previous price increases are likely to be paying off”.

Home prices have risen dramatically, setting new records again and again, even as interest rates have risen, and consumer spending continues to increase, leading some economists to warn of a contraction in the second quarter.

But there are signs of cracks, including a drop in home sales, a significant drop in mortgage applications, and an increase in the share of spending on essentials.

Officials have said the US economy is strong enough to withstand higher rates without a dangerous deflation, but others, including former Treasury Secretary Lawrence Summers, say they are overly optimistic and job losses will have to rise sharply in order to tame inflation.

Cohn said it will be important for Powell to communicate clearly about what data the Fed is looking for to slow down or pause the rate-raising cycle.

“I think a fairly shallow recession, with unemployment above the 3.7% Fed forecast last month,” he said, “would be necessary to break this inflation spiral.”

“But, boy, the amount of uncertainty surrounding her is just too huge.”