Economic crisis: the Federal Reserve is considering more aggressive interest rate hikes to curb inflation | Economy and business
The Federal Reserve is looking for a way to rein in inflation without causing a recession, but the path is narrowing. The upward pressure on prices is unrelenting, and in May its annual rise marked a new 30-year high of 8.6%. Economists now think it is very likely that the Fed will raise interest rates more aggressively than expected until recently.
The first step could be taken during the two-day meeting that started on Tuesday. In May, after raising rates by half a point, the biggest hike in 22 years, Federal Reserve Chairman Jerome Powell indicated that policymakers expected two more half-point hikes in the rate. interest rates in June and July. However, the market began to talk about a three-quarter point rise, which would be the highest since 1994, as the most likely outcome of the meeting (some analysts are even talking about a full point). For central banks, being predictable has become an asset. They try to anticipate what their movements will be to avoid scares and distortions in the markets, but this is not always possible.
In fact, the market has already adjusted its expectations. The sharp fall in the stock market is a clear symptom that combines the fear of higher interest rates and weaker growth. The dollar has strengthened and is trading again near 20-year highs against major currencies, hurting the balance sheets of US multinationals. But it is on the debt market that there has really been a change of direction which concerns almost exclusively interest rate expectations. The yield on three-year U.S. Treasuries soared, posting the biggest two-day rise since 1987, rising from 3% to 3.49%, according to Bloomberg data.
In the money market, interest rate derivatives, which more accurately gauge market expectations for policy rates, show that investors expect the fed funds rate to be at 4% by the midpoint. next year, compared to 0.75% to 1% currently. If the Fed was trying to avoid surprises, a 0.75 point hike has almost ceased to be, although some also believe the central bank could still get away with half a point this week and postpone the hikes. most aggressive rate hikes in July. or September.
Even Wall Street gurus are unsure of the outcome of Wednesday’s meeting. For the chief economist for the United States at JP Morgan, the most likely result is a rise of 0.75 points, although it is possible that the Fed could amplify it to a whole point. Head of global economic analysis at BoFA Securities, Ethan Harris, estimates the upside will be 0.5 points, according to two reports sent to clients on Monday. However, Harris predicts that Fed Chairman Powell will adopt a “no matter what” tone in the fight against inflation, in reference to the famous 2012 statement by the then head of the European Central Bank, Mario Draghi, to save the euro.
The problem is that what it takes may be a recession. Or, more specifically, what is needed to rein in inflation may be rate hikes that eventually cause a recession. Rising interest rates discourage businesses and consumers from borrowing because they make loans more expensive, cool the real estate market and, in short, slow the economy.
Morgan Stanley CEO James Gorman warns: “There was a legitimate risk of recession. I thought it was around 30%. It’s probably more like 50% now – it’s not 100%. It’s up to you to be a little careful. Speaking at a business meeting on Monday, he said “it was inevitable that this inflation would not be transitory, it was inevitable that the Fed would have to move faster than they anticipated.” His colleague Jamie Dimon, of JP Morgan, had already warned weeks ago that he saw an economic hurricane coming.
The markets are showing another sign of this risk: the inverted yield curve. Normally, interest rates on debt are lower in the short term and higher in the long term, since the risk is greater in the long term. By plotting interest rates at different terms on a graph, they generally show an upward curve. Sometimes, however, the curve flips. This inverted curve, at least in a certain sense, is interpreted by the market as an indicator that a recession is approaching (and that when inflation is brought under control, rates will have to be lowered again).
Part of the price increases is linked to the reactivation of demand, but there are other reasons which are exogenous or result from supply problems, and it is not certain that the price increases are very effective for fight them. For example, gasoline prices are skyrocketing due to rising oil prices. The price of a gallon (3.78 liters) averaged over $5 for the first time in history across the country, but in California it reached around $8, prices never seen before. .
The nightmare scenario would be stagflation, ie stagnation with inflation. Rate hikes could cripple the economy, but that might not be enough to ensure price stability. The political implications of the price increases are already dire for President Joe Biden’s popularity and for Democrats’ expectations ahead of November’s midterm elections, in which just over a third of the Senate and the entire House are rising. for renewal. If you add an economic downturn to that, things could get even worse.