Rupa Jack: A cadre of dovish Fed governors, including Chair Powell, keep suggesting monetary policy is restrictive. This seems hard to square with historical data, as in every other tightening cycle fed funds were set meaningfully above core personal consumption expenditures (PCE). Despite that spread having turned positive only recently, the U.S. labor market is at full employment, with July data revealing a falling unemployment rate. Additionally, only a modest amount of demand has been destroyed by the Fed.
Most amazingly, financial conditions — a measure of the degree to which liquidity is ample — are at the same level as in March 2022. The Fed may want to declare victory for its tightening campaign, but a premature shift toward accommodation risks reigniting inflation in an economy that at worst has only now come into better balance.
Eric Keating: The inflation we endured in 2022 was the worst we have seen since 1978-1982. An uneasiness was felt by investors considering many of them had not experienced inflation at this level before. You might be looking back on the 80s and thinking, “Wasn’t that a booming economic period?” Yes, it was. It didn’t start out that way, however.
Early inflation battles were combated with strategies such as controls on supply, wages, and prices. This provided temporary relief. When the controls were lifted, however, there was a slingshot effect in pricing which brought us back to square one.
In the early 80s, Fed Chair, Paul Volcker, introduced a new way to fight inflation. Moderate increases in interest rates through the late 70s were not having much effect, so they took extraordinary measures with massive hikes. This caused two recessions and it took a toll on many people, but the economic run that almost immediately followed shows it was effective.
The Fed is currently acting in a similar manner, just on a much smaller scale. This will almost certainly have a short-term effect on our economy, but letting inflation get out of control would be disastrous. The ultimate goal is a soft landing and avoiding a prolonged recession.
Ray Lent: It’s been a difficult balancing act for the Federal Reserve to tamp down inflation rates that reached 40-year highs. To do so, they steadily raised interest rates, yet didn’t want to run the risk of unemployment rising dramatically. To date, unemployment is still low, modest growth continues in spite of a run up in rates. What I believe is we can see this higher level of rates last longer than originally expected.
Jacob Margo: We’ve historically seen success from the Federal Reserve’s monetary policy of reducing inflation by limiting the money supply. That means increasing interest rates to lower corporate and household expenditures in the form of debt (corporate bonds, private credit, home and car loans, credit card debt, etc.). The biggest argument against the policy is the precipitous rate at which they are hiking at currently. That being said, anticipated increases in government spending create an additional headwind for the Fed, which justifies aggressive action from their committee.
William Ryan: The Federal Reserve has a dual mandate of full employment and price stability. While unemployment remains at or near historic lows, inflation due to a variety of factors caused by the Covid-19 pandemic became a concern in late summer and early fall of 2021. The Federal Reserve began its interest rate hiking regime in March of 2022 and continued to raise the Federal Funds Rate as inflation eventually soared to a cycle high of 9% in June of 2022. To date, they have raised interest rates 11 times and the Fed Funds rate currently stands at 5.5 percent.
Most analysts and experts, even the Federal Reserve itself, agreed that this rapid increase in interest rates would accomplish two things: the economy would slow to the point that there would be negative growth, and unemployment would undoubtedly increase. In other words, the U.S. would experience a recession and with any luck it would be mild and short-lived. And that would move inflation back closer to the Federal Reserve’s inflation target of 2 percent.
Then a funny thing happened; unemployment remained low, the economy continued to grow, and inflation fell from a high of 9% in June of 2022 to the most recent reading of 3% in June of this year. That would be a textbook definition of a ‘soft landing’ for the economy. Few believed this would be the outcome of such an aggressive policy response from the Federal Reserve, yet here we are.
6.2 million jobs have been added since the Federal Reserve began hiking rates in March 2022, the unemployment rate currently stands at 3.5%, second quarter GDP growth was 2.4% (initial reading), and early indications suggest that third quarter GDP growth will be even stronger. The S & 500 is up +20 percent this year as of July — within shouting distance of all-time highs. Consumer and corporate balance sheets are strong and credit markets are well behaved, despite hiccups with a few banks in March.