The US economy stumbled through a bout of high inflation, with employment staying strong last year despite inflation hitting a 40-year high. Now, the markets are signaling that the chaos is about to end and something worse is to replace it.
The Federal Reserve, the BFF of markets for most of the past decade, is now more like the enemy. On September 21, the Fed raised interest rates by three-quarters of a percentage point, as expected. He also pointed to more sharp interest rate increases in the future.
This is a very loving Fed that may have to do some economic damage, in order to prevent the bigger damage that would come from hyperinflation.
“The chances of a soft landing will likely diminish to the point where policy needs to be more restrictive or restrictive for longer,” Fed Chair Jerome Powell said on September 21.
Here’s what he means: With inflation still uncomfortably high, the Fed will have to keep raising interest rates. This increases the odds of a recession, including the possibility that more people will lose their jobs and suffer the ravages of unemployment.
It hasn’t happened yet.
Inflation peaked at 9% in June and fell to 8.2%. The unemployment rate, at 3.7%, remains near a cyclical decline.
But inflation is not falling fast enough for the Federal Reserve, which boosted short-term interest rates from around 0 to around 3%. Long-term interest rates on consumer and commercial loans rose by similar margins. As prices rise and borrowing becomes more expensive, spending and hiring usually slow. Light demand relieves pressure on prices and lowers inflation.
A soft landing may be a steady decrease in inflation that does not disrupt the labor market or put pressure on economic growth too much. The stock market rallied from July to August due to lower oil and gasoline prices and some other factors indicating that inflation will subside without drastic action by the Fed. Investors are betting on a soft landing.
But inflation in August turned out to be surprisingly hot, sending the Federal Reserve into a state of shock and awe. Bank of America warned clients on September 23 that “the Federal Reserve is on the path to war.” Central banks will rise until something collapses.”
Like other forecasters, Bank of America lowered its forecast for the economy on the back of inflation news and the Federal Reserve’s shift to tighter monetary policy. The bank now expects a recession in the first half of 2023, with unemployment rising from 3.7% to 5.6% by the end of next year.
“The Fed’s actions indicate to us that it is committed to lowering inflation and appears prepared to accept some deterioration in labor market conditions,” Bank of America researchers wrote. “We believe our outlook is in line with the Fed taking ‘strong action’ to slow demand, and erring on the side of doing too little.”
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Other indicators of stagnation began to flash.
The spread between the yield on 10-year Treasuries and 2-year Treasuries – known as the yield curve – has been negative since July, meaning short-term rates are higher than long-term rates. An inverted yield curve, as it is known, is a condition that usually occurs before a recession, with very few false positives.
Moody’s Analytics notes that a measure of change in unemployment, known as the Sahm rule, could also indicate that a recession is on the way. If unemployment rises as the Federal Reserve’s latest forecast indicates, the pace of deterioration will reach a threshold by next May that is usually associated with a recession. Moody’s Analytics believes that the US economy will hardly prevent an economic downturn, but also says that “unwinding from a soft landing … is an increasingly low probability.”
To be sure, the markets are getting bleak. Stocks have fallen over the past month, with the S&P 500 stock index down 13% since mid-August. On September 23, it reached its lowest level since late 2020, when the economy was still constrained by the Covid virus and vaccines were not yet available. Oil prices fell below $80 a barrel, despite tight supplies – indicating recession fears not only in the US but globally.
The political fallout may depend on the timing of the hard landing.
Consumer confidence has already improved from the dismal levels of early summer. This is due to the significant drop in gas prices, which seems to affect confidence more than anything else. President Biden’s approval rating rose as gas prices fell.
Biden appears to have got the connection between gas prices and presidential popularity. His plan to release 1 million barrels of oil per day from the national reserve was supposed to end in October, but the Energy Department recently said it would release another 10 million barrels in November.
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It must be a coincidence that the midterm elections will be held on November 8th.
The market sell-off appears to be lower asset repricing, in anticipation of a recession that may not happen for a few months yet. The Fed can raise interest rates by another point or more until the end of the year, then pause and see what happens.
If a hard landing and a recession followed, that should lick inflation, even though unemployment would only get worse. Some economists believe that the Fed will cut interest rates again by the end of 2023, to fight the recession it may eventually cause. Whether the landing is soft or hard, you have to fly again.
Rick Newman is a columnist for Yahoo Finance. Follow him on Twitter at Tweet embed
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