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Fed's Planned Mega-Sized Rate Hike Will Fuel More Downside Risk To The Economy

July 26, 2022

The Federal Reserve is set to escalate its war against inflation this week with another super-sized interest rate hike, risking a deeper recession when the U.S. economy is already slowing.  

With inflation unexpectedly accelerating to a fresh 40-year high in June and the job market still growing at a healthy clip, the Fed is under mounting pressure to move more aggressively to tame demand and slow surging consumer prices. 

But there are signs the economy is starting to cool off: The number of Americans filing for unemployment benefits has gradually increased, companies have announced layoffs or hiring freezes, and the housing market is softening.

Gross domestic product slowed in the first quarter of the year by 1.6%, and is expected to decline again in the second quarter.

Despite that, Fed policymakers remain laser-focused on bringing inflation under control as higher prices prove persistent — even if it triggers a recession. Fed Chairman Jerome Powell told reporters last month that failing to restore price stability would be a "bigger mistake" than crushing growth and causing a downturn.  
 

"The Fed will continue on its very aggressive path of rate hikes to fight off the inflation, which has been so devastating to American families," said Dan North, senior economist at Allianz Trade North America. "But in doing so, the Fed is really slamming the brakes hard on the economy, raising the risk of recession."

Central bank policymakers raised the benchmark interest rate by 75 basis points in June for the first time since 1994 and signaled that another increase of that magnitude is possible in July.


Hotter Inflation
Inflation ran even hotter than expected last month, with the consumer price index, a broad measure of the price for everyday goods, including gasoline, groceries and rents, increasing 9.1% in June from a year ago. It marks the fastest pace of inflation since December 1981.  

In an even more alarming development, so-called core prices, which exclude more volatile measurements of food and energy, climbed 5.9% from the previous year. Core prices also rose 0.7% on a monthly basis — higher than in April and May — suggesting that inflation is becoming increasingly sticky as it broadens throughout the economy. 

Given the dismal inflation report, the Fed is widely expected to impose a second three-quarter-point hike after its two-day meeting on Wednesday. That would mark the fourth consecutive hike since March and would put the key rate in a range of 2.25% to 2.5%, the highest since the COVID-19 pandemic began more than two years ago.
But a 100-basis point rate increase could also be on the table: Investors lifted their expectations of a super-sized rate hike following the scorching-hot Labor Department report, with about one in four traders penciling in a full percentage point increase.



Implications for the hiked rates

That would be the first rate hike of its size since the Fed started announcing moves in the overnight federal funds rate in 1994 and would put the benchmark range between 2.5% and 2.75%. 

Hiking interest rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending. Mortgage rates are already approaching 6%, the highest since 2008, while some credit card issuers have ratcheted up their rates to 20%.

Policymakers have remained confident that they can slow growth enough to tame inflation without dragging the economy into a recession. But experts are increasingly skeptical that the Fed will be able to achieve that type of outcome — referred to frequently as a "soft landing." 

That's in part because at least some of the inflationary pressures stem from unexpected supply disruptions like the Russian war in Ukraine and COVID-19-related lockdowns in China. While the Fed can control demand, it does not have the necessary tools to address supply. 

"Fed policy cannot directly impact food or energy inflation, while rate hikes so far have done little to slow core CPI components, which are, traditionally, more responsive to monetary policy," said Seema Shah, chief global strategist at Principal Global Investors. "As such, the Fed must continue hiking aggressively if it wants to get a handle on the inflation problem, even if it means speeding up a recession problem."























SOURCE:FOXNEWS                                                                  IMAGE SOURCE: PIXABAY