The Federal Reserve has again massively raised interest rates, raising the risks of a sharp economic downturn and job losses.
At the end of its two-day policy meeting on Wednesday, the US central bank raised its policy rate by 75 basis points for the third time, to a range of 3 percent to 3.25 percent, the highest level since the 2008 financial crisis.
The Fed is trying to cool the economy to contain rampant inflation, which remains stubbornly high at 8.3 percent, but as interest rates rise, the path to a so-called ‘soft landing’ for the economy narrows.
Rising prices are putting pressure on American families and businesses and have already become a political liability for President Joe Biden as he faces midterm congressional elections in early November.
But a sharp contraction of the world’s largest economy would deal an even bigger blow to Biden, the credibility of the Fed and the world at large.
The US economy has been showing warning signs for some time now, including six consecutive months of contraction in the first half of the year, meeting one informal definition of a recession — but Biden denies that a recession has begun.
The Fed’s next rate decision will be announced at 2 p.m. and will be followed by Fed Chair Jerome Powell’s press conference, which will be closely watched by investors
If the Fed passes its expected 75bp rate hike as expected (see above), it would push key rates to the highest level since the 2008 financial crisis
Last week, the average fixed mortgage rate was 6 percent, its highest point in 14 years, meaning home loan rates are about twice as expensive as a year ago
Economists had expected Fed officials to forecast their key rate could rise as high as 4 percent for the new year.
They are also likely to signal additional increases in 2023, perhaps as high as about 4.5 percent.
Short-term interest rates at that level would make a recession more likely next year by sharply raising the cost of mortgages, auto loans and business loans.
Earlier this month, Powell warned that Americans are in for “some pain” as the Fed works to end inflation, hoping to prevent what would otherwise be a much worse outcome.
The Fed plans to use higher borrowing costs to slow growth by cooling a still strong labor market, keeping wage growth and other inflationary pressures in check.
Still, there is a growing risk that the Fed will weaken the economy to the point of a downturn that would lead to heavy job losses.
By raising its key short-term interest rate, the Fed is trying to cool the economy to contain rampant inflation, which remains stubbornly high at 8.3% in August
Despite the pain many Americans feel from inflation, the job market remains robust, with an unemployment rate of nearly five decades at 3.7 percent.
The economy has added nearly 3 million jobs since the start of the year, a surprisingly high number in the context of shrinking gross domestic product.
“While the Fed probably still sees a soft landing as a modal outcome, the window appears to be narrowing,” Bank of America economists wrote in a note.
“Recent statements from the Fed have partially acknowledged this by leaning more toward slowing labor markets and accepting the risks to business that come with it.”
The economy has not seen interest rates as high as the Fed predicts since before the 2008 financial crisis.
Last week, the average fixed mortgage rate was 6 percent, its highest point in 14 years.
Higher mortgage rates have already had a significant impact on the housing market, with buying activity falling sharply this summer.
According to Bankrate.com, credit card borrowing costs have reached their highest level since 1996.
Last week the average fixed mortgage rate was 6 percent, the highest point in 14 years
The Fed rate hike expected for September can be seen above
Powell and other Fed officials still say the Fed’s goal is to achieve a “soft landing,” which would slow the economy enough to tame inflation, but not so much as to trigger a recession .
Last week, however, that target seemed further out of reach after the government reported inflation was a painful 8.3 percent over the past year.
Worse, so-called core prices, which exclude volatile food and energy costs, rose much faster than expected.
The inflation report also documented how widely inflation has spread throughout the economy, complicating the Fed’s job.
Inflation now appears to be increasingly fueled by higher wages and consumers’ constant desire to spend money, rather than the supply shortages that had ravaged the economy during the pandemic recession.
“They’re going to try to avoid a recession,” said William Dudley, former president of the Federal Reserve Bank of New York. “The problem is that the space to do that is virtually non-existent at the moment.”
The Fed’s policy moves during the last eight presidential administrations can be seen above
The Fed’s rapid rate hikes reflect steps other major central banks are taking and add to concerns about a possible global recession.
The European Central Bank raised its benchmark interest rate by three quarters of a percentage point last week. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all made significant rate hikes in recent weeks.
And in China, the world’s second largest economy, growth is already suffering from the government’s repeated COVID lockdowns. If the recession sweeps through most major economies, it could also derail the US economy.
At his press conference Wednesday, Powell is unlikely to hint that the central bank will ease its credit-tightening campaign. Most economists expect the Fed to stop raising rates by early 2023. But for now, they expect Powell to strengthen his tough anti-inflation policy.
“It’s going to be a hard landing,” said Kathy Bostjancic, an economist at Oxford Economics.
“He’s not going to say that,” Bostjancic said. But referring to the most recent Fed meeting in July, when Powell raised hopes of an eventual backlash from rate hikes, she added: “He also wants to make sure that the markets don’t sink and recover. That happened last time.’
The US economy contracted in the first two quarters of the year, meeting one definition of a recession. White House cites strong labor market by saying there is no recession
Investors responded by raising stock prices and buying bonds, lowering yields on securities such as the benchmark, the 10-year Treasury. Higher stock prices and lower bond yields generally stimulate the economy – the opposite of what the Fed wants.
The central bank is already on the fastest string of rate hikes since the early 1980s. Still, some economists — and some Fed officials — argue they have yet to raise interest rates to levels that will slow borrowing and spending and slowing growth.
Loretta Mester, president of the Cleveland Federal Reserve Bank, and one of 12 officials to vote on the Fed’s decision on Wednesday, said she believes it will be necessary to raise the Fed’s interest rates to “early next year.” slightly above 4%’ that there.’
“I don’t expect the Fed to cut interest rates next year,” Mester added, beating the expectations of many Wall Street investors who had hoped for such a turnaround. Comments like Mester’s contributed to a sharp drop in stock prices last month that began after Powell’s stern anti-inflation speech at the Jackson Hole conference.
“Our responsibility to ensure price stability is unconditional,” Powell said at the time — a comment widely interpreted to mean that the Fed will fight inflation, even if it requires major job losses and a recession.
Many economists sound convinced that a recession and widespread layoffs will be needed to slow rising prices. Research published earlier this month under the auspices of the Brookings Institution concluded that unemployment may need to rise to 7.5 percent to bring inflation back to the Fed’s 2 percent target.
According to a paper by economist Laurence Ball of Johns Hopkins University and two economists from the International Monetary Fund, only a downturn this hard would reduce wage growth and consumer spending enough to cool inflation.