- The Fed is prepared to accelerate interest rate hikes if macroeconomic data make it necessary.
- Consequently, recession would be absolutely inevitable in 2023.
- The problem is the political cost. With just over a year to go before the U.S. presidential election, Democrats do not want a vote with a country in recession.
A few hours after the most aggressive members of the Federal Reserve System demonstrated that the positive evolution of the economy allowed room to increase the pace of interest rate hikes, its chairman, Jerome Powell, confirmed it.
The executive believes that rates will “probably” rise “more than expected” and that the Fed is prepared to “accelerate the increase” if the macroeconomic data support it. Consequently, recession would be absolutely inevitable in 2023.
In his last appearance before the Senate Banking Committee, the head of the institution pointed out that despite the fact that inflation fell in recent months, the process to restore prices to the 2 percent target has a long way to go.
“The latest data on the economy were firmer than expected, which means that the rate level will probably be higher than originally estimated,” he said.
In other words, Powell is preparing the market for a possible rate hike.
“If all the data indicate that an acceleration of tightening is warranted, we would be prepared to increase the pace of rate hikes,” the Fed chairman said.
Jerome Powell and the pressures
The response from investors was not long in coming. Wall Street, which was trading mixed, began to lose volume between Thursday, March 9 and Friday, March 10.
The Dow Jones stock index, meanwhile, fell by 0.3 percent, while the Nasdaq, which fell by 1 percent, traded flat.
The European stock markets, meanwhile, were dragged down by the change of sign and at the close of trading fell by 0.5 percent.
The debt market reacted more exaggeratedly, especially the short-term bond market, the most affected by the increase in rates.
U.S. debt maturing in 2025 is approaching 5 percent, a record high since mid-2007, shortly before the financial crisis. Fed funds futures are deducting a final rate in excess of 5.5 percent, versus the 5.2 percent estimated by the Fed’s dot plot, the path forward under monetary policy.
Policy enters the rate dispute
Fed members are working to slow inflation without causing a recession.
The one fact that stands out in all of this is political: with just over a year to go before the next presidential election, Powell is beginning to experience the political tensions between the major parties vying for the White House.
Democratic Party senators are wary of rate hikes and the possibility of some putting even more pressure on the chairman of the institution is beginning to resonate.
The point is that if there is a recession, voters will blame Biden and his chances of being re-elected will become slimmer.
Jerome Powell and the consequences of interest rate hikes
One of the mainsprings of the Federal Reserve is the change in interest rates, the rates at which banks can borrow money from the central bank.
If the Fed raises interest rates too much, it can have serious implications for the economy. Let’s see.
One of the most immediate impacts of a rate hike by the Fed (or any central bank in any country in the world) is a possible recession.
High interest rates make borrowing more expensive, which slows economic growth.
If businesses and consumers have to pay more to borrow money, they may cut back on spending, which can lead to a recession (almost without exception). Globally, this was seen in the early 1980s, when the Federal Reserve raised interest rates to combat inflation, leading to a severe and prolonged recessionary period.
Another potential impact of a Fed rate hike is inflation. If the cost of borrowing increases, companies may raise prices to maintain profitability.
This can lead to an inflationary process, which erodes consumer purchasing power and generates higher costs for businesses.
In that case, it would be stagflation, i.e. recession with inflation. The worst of all worlds.
The idea is for central banks to strike a delicate balance between keeping inflation under control and, at the same time, promoting economic growth.
Unemployment on the horizon
A third impact of a Fed rate hike is unemployment. If borrowing becomes more expensive, companies are less likely to invest in new projects or hire new employees.
This can lead to higher unemployment rates, which can have a ripple effect throughout the economy.
Conversely, if interest rates are too low, it can lead to labor shortages, as companies have more access to cheap capital and can expand more easily.
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