Can a hawkish Fed balance the risks and avoid a US recession amid its aggressive rate increases?
- The latest meeting suggests there are no doves left as the Fed signals an accelerated path of rate rises to fight a hot summer of inflation
- But, with a cooling housing market and strong dollar among factors set to slow growth, an overly hawkish Fed could slow demand and even spark a recession
The relatively strong US consumer continued to spur demand in a supply-constrained car market, which saw prices for new and used vehicles rising by 1 per cent and 1.8 per cent respectively from April. Inflation linked to the reopening of the economy was also particularly strong, with airfares up 12.6 per cent for the month and 37.8 per cent for the year.
On the bright side, core inflation (excluding food and energy), which rose by 6 per cent year on year, continued to moderate, while core services inflation picked up slightly due to rising rents.
Recognising these risks, the Federal Open Market Committee (FOMC) also published a new set of economic projections, cutting the expected economic growth rate to 1.7 per cent for 2023, with the core personal consumption expenditure inflation rate slowing to 2.7 per cent but the unemployment rate moving up to 3.9 per cent.
While the labour market continues to expand and growth is expected to recover, the committee recognises that the aggressive path of interest rate rises will cool demand for labour and act as another drag on the economy into next year.
Despite the prospective macroeconomic slowdown, Federal Reserve chairman Jerome Powell needs to balance the risks, and doing “too little” is the bigger risk to the economy in his view. What is clear from the latest FOMC meeting is that the Fed is on an accelerated path of rate increases and is committed to fighting inflation.
Importantly, there are clearly no doves left on the committee, given that no members see the federal funds rate being lower than 3 per cent by the end of the year. And, given that inflation may remain high through the summer, it seems possible that the Fed will raise rates by a further 75 basis points in July, 50 basis points in September, followed by 25 basis points in November and again in December.
On the back of the more hawkish path and rate increase trajectory the Fed has laid out, the odds of a recession next year have risen, especially as the Fed has restated its commitment to getting inflation back to its 2 per cent target, which means it may be willing to sacrifice growth to achieve this.
The Fed has the unenviable task of staying patient and maintaining a balanced approach while managing the expectations of people who have lost patience with it. The US central bank needs to stick to controlling what it can control without being overly aggressive in its policy normalisation.
Above all, it must avoid inadvertently slowing demand and triggering a recession to contain an inflation problem with a relatively blunt toolkit.
Clara Cheong is a Singapore-based global market strategist at JP Morgan Asset Management