Hot inflation dims likelihood Fed can achieve ‘soft landing’
WASHINGTON For months, Jerome Powell has hoped that the Federal Reserve would be able to raise interest rate high enough to stop rampant inflation and not plunge the economy into recession.
But with the Fed expected to announce another sharp increase in interest rates after its meeting this week, just days after the government released a scathing inflation report, the chances of the central bank being able to engineer a “soft landing” seems to be diminishing. With inflation at 8.6% (a record high for four decades), Fed officials will likely raise borrowing rates this year, even more than was anticipated just weeks ago. When its policy meeting ends Wednesday the central bank could signal that it may raise rates to a level which could lower growth, increasing the risk of a recession.
Economists believe that the Fed could surprise the financial markets by raising its benchmark short term rate by three-quarters of an point this week, rather than the half-point Powell signaled last month. According to the CME Group, Wall Street traders have priced in a 30% possibility of such a drastic change.
Analysts believe that even if an economic downturn is avoided, it’s almost certain that the Fed will inflict some pain, most likely in the form higher unemployment, as a price for reducing stubbornly high inflation.
” They must accept that you can’t fight inflation without imposing some pain upon the markets and economy,” stated Ethan Harris, head of global economist research at Bank of America. “They shouldn’t coddle markets by implying that there is no major issue here, that we’re going to have an economic soft landing, I think it’s too late for that. We need to have a hard landing.” Monday’s sharp decline in the stock market was caused by the possibility that the Fed would accelerate its credit tightening and further increase borrowing costs for households and businesses. The broad S&P 500 index dropped into bear-market territory after losing more than 20% its value since the beginning of the year.
Fed officials were slow to recognize the persistence of inflation last year, believing that price spikes would prove temporary. They are now attempting to make up the delay.
If the policymakers increase their benchmark short-term interest rate by half-point on Wednesday — twice the usual size — the rate would rise to 1. 25% up to 1.5% A half-point increase in Fed interest rates is expected at the Fed’s meeting in July.
The officials left some uncertainty about what they might do at their September meeting. Analysts thought that the policymakers might halt rate increases altogether after Raphael Bostic’s comments.
However, analysts now expect another half-point increase in September after Friday’s inflation report did not show the expected easing. Goldman Sachs economists predict a fifth half-point increase in November.
In May, Powell set a precedent by stating that the Fed would continue raising rates until there is “clear and convincing evidence” that inflation is falling. He may now clarify this evidence at a Wednesday news conference.
Inflation is now permeating nearly every sector of the economy. Prices jumped in May for everything, from rents to airline tickets to used cars and clothing to medical services. According to AAA, the national average price for a gallon gasoline has risen to $5 due to rising oil prices. These high prices are reducing the freedom of consumers, who are the engine of most of the economy’s growth. The Fed also faces problems with energy costs because it cannot do much to reduce these supply shocks but can’t ignore their impact.
Another concern for the Fed was Friday’s University of Michigan’s monthly survey of consumer attitudes. It showed that Americans are increasing their expectations for future inflation. This is a worrying sign because it can lead to self-fulfillment. People who expect higher inflation in future will often alter their behavior to increase prices. They may make large purchases faster than they are more expensive. This can increase demand and fuel inflation.
Powell often referred to longer-term inflation expectations being “well-anchored” because consumer surveys and financial markets gauges showed that investors and consumers expected inflation to fall towards the Fed’s target rate of 2% in the next five-years. Policymakers can control price rises easier if inflation expectations are low.
The Michigan survey found that Americans expected inflation to rise to 3.3% in five years, which is the highest level since 2008. This is up from the May projection of 3%.
” The Fed’s rise in long-run inflation expectations will be a game changer, according to economists at Jefferies. Aneta Markowska and Thomas Simons wrote in an email. According to Jefferies economists, the Fed will increase its rate by three-quarters point on Wednesday. Barclays economists also predict a similar increase.
The Fed will update its quarterly forecasts on Wednesday. These projections will show slower growth and higher inflation estimates. Economists expect that the Fed will forecast a slightly higher unemployment rate. This would be the Fed’s first acknowledgment of the potential impact higher rates could have on the job market.
Fed officials predicted that their benchmark rate would range from 1. 75% to 2% by the year’s end. This level is expected to be attained in July.
Krishna Guha is an analyst at Evercore ISI and believes that the Fed’s interest rate will be at 2. 75% to 3 percent by the end this year. The Fed considers that rates above “neutral” will result in rates that are higher than the level that stimulates growth and is believed to neither restrain nor stimulate it. Powell acknowledged that neutral is not an exact figure, but generally the Fed believes it to be at 2.5%.
This meeting will also mark the first time that two of President Joe Biden’s new picks for the Fed’s board, Philip Jefferson and Lisa Cook, will meet. Cook is the first Black woman to sit on the Fed’s Board of Governors, and Jefferson is the fourth Black man. Both are economists, and both have pledged in Senate testimony support for the Fed’s efforts in reining in inflation.
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