The Federal Reserve seems not to believe in a pullback in the economy, as it focuses on the numbers showing job applications exceeding jobless numbers.
The Federal Reserve (Fed) is once more expected to raise rates steeply (0.75%) at its meeting ending on Wednesday July 27. The main reason will once once more be the persistent malaise of very high inflation which the Fed is struggling to grasp and understand.
Its “reaction function” ie framework for analyzing economic data has been quite erratic and changing lately. Recently, the Fed seemed to put more emphasis on real-time inflation (necessarily shockingly above 9%) as well as (erratic) household inflation expectations, while brushing aside the forecasts of its internal economists showing a sharp fall in inflation in the coming months, or the expectations of the bond market, which also predicts a sharp fall. Without saying so, the Fed is also under intense political pressure from the Biden administration, which is itself looking for solutions to this inflation, even though its roots are precisely above all budgetary, commercial and geopolitical. One might wonder if the Fed nevertheless does not conduct its policy too much “in the rearview mirror”.
The historical reaction function of the “modern” Fed is the preservation of a certain stability of the markets and the avoidance of a recession, because of the fear of collateral damage. By the way, we don’t think the Fed “wants” recession as the drastic solution to bring inflation down. It’s just that right now she doesn’t seem to believe it, while she’s focused on the numbers showing applications for employees exceeding the number of unemployed. Rather, signs of recession are to be found in the housing market, overstocked inventory, and shaky business sentiment suggesting an impending fall in investment, off its radar.
Former Fed Chair and now Finance Minister Janet Yellen recently hinted that she doesn’t believe in recession either.
In a context of high debt, the US (and global) economy remains very sensitive to interest rates and it seems that we are already starting to reach the limits of the system. One might wonder if the sharp 75 basis point hikes were wise in this context of high sensitivity and fragility, even though they don’t really leave time for “digestion”. In any event, the United States seems to be heading into a true NBER-type recession with rising unemployment as a result, given the tightening of financial and credit conditions in recent months.
We don’t put too much weight on what Chairman Jerome Powell will say at the press conference following the meeting. We think a lot can still change between now and the Jackson Hole seminar at the end of August, which we believe might start to show a pivot towards recession risk and a Fed easing its monetary tightening zeal.
Against the backdrop of a generalized deterioration in the economy already seen in GDP figures and ISM-style surveys, we expect the Fed to slow the pace of rate hikes to 25bps at its next meeting in March. September, and therefollowing. It is difficult to see the Fed being able to continue to raise rates in 2023. The market is also starting to have doubts, predicting rate cuts as early as next year. The soft landing promised by the Fed will certainly not take place.
