Could the Fed push US economy into recession?
US policymakers have vowed to keep raising interest rates until soaring inflation is tamed. But time could be running out for the Federal Reserve to pause before it causes a downturn or financial instability
Normally a central bank will tighten monetary policy when an economy overheats and will stop or slow rate hikes when it starts to cool. But, for the first time since the 1980s, the US Federal Reserve has been raising interest rates amid a slowing economy.
The Fed was late to react to soaring inflation, insisting that supply chain issues in the wake of the coronavirus pandemic were only “transitory.” Though prices started rising in March 2021, the Fed only began hiking rates a year later, first by 25 basis points, then 50 and, over the past three meetings, by 75 basis points — effectively emergency moves.
It has now been 19 months since US inflation was last near the Fed’s target of 2%. Food, gas and shelter costs, in particular, have risen dramatically, and in June the consumer price index (CPI ) reached 9.1%, the highest in over 40 years.
Inflation falls, Fed still hawkish
Despite signs that inflation may now have peaked — the CPI settled lower at 8.3% in August — the Fed says it will continue to hike rates until the inflation beast has been tamed.
The Fed’s continued hawkish stance, and accusations that it has been behind the curve, have sparked concerns that measures could cause the US economy to fall into recession.
“The truth is, no one can be sure how clear and present a danger recession is in the US,” Daragh Maher, head of research for the Americas at HSBC bank, told DW. “But, the more stubborn inflation proves, the greater the risk of recession.”
Maher added that weaker growth was not an “acceptable side-effect of this inflation fight,” but rather “a necessary element.”
Indeed, policymakers are fearful about the prospect of stagflation: the combination of stagnant economic growth and persistently high inflation that was seen in the 1970s and early ’80s.
Fed has few options
Some have questioned whether the Fed’s current approach is similar to 1979, when Federal Reserve Chairman Paul Volcker crushed inflation with a series of historic rate rises but sparked a two-year recession, during which the US unemployment rate reached 10%.
Financial markets have now priced in a fourth consecutive 75-basis-point rate hike in November, with some analysts predicting more to come.
“I believe 75 is the new 25 until something breaks, and nothing has broken yet,” Bill Zox, a portfolio manager at Brandywine Global Investment Management, told Bloomberg News, adding that he believes the Fed is nowhere close to a pause or a pivot.
Could more rate hikes cause market instability?
Warnings against further rate hikes grew louder this week, first from veteran market analyst Ed Yardeni, who said tightening was a blunt tool that risked destabilizing financial markets.
“When you also have QT2 [quantitative tightening] and a soaring dollar, there are very restrictive monetary developments,” Yardeni told Bloomberg News. ” Because the issue of financial stability will become a top concern, I believe that they will only raise rates once more, in November.
Rate hikes in West hurt developing world
The United Nations also has also taken a stand on the issue, warning Monday that interest rate hikes by the world’s wealthiest nations risk a painful global recession that would hurt developing nations the most.
The UN Conference on Trade and Development (UNCTAD) said monetary tightening by the Fed, along with the Bank of England and the European Central Bank, was an “imprudent gamble” that could backfire dangerously.
Kundan Goyal has 6+ years of experience in news editing and market research. He has helped businesses of all sizes make strategic decisions and predict future trends. Kundan only publishes content that will help them grow their sales and revenue. He publishes business news in many different categories to help industry’s learn more about any product.In his spare time, he enjoys cooking and listening music .