Recession risks rise as soaring inflation adds to Fed’s daunting task

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The chances of a recession have increased. Drastically.

Wall Street is betting higher on that. Policy makers grit their teeth. And nervous Americans are starting to put off major purchases.

The latest inflation reading was meant to offer hope that the US economy had weathered the worst of the storm. But there was nothing reassuring about Wednesday’s report. In fact, inflation actually got much worse in June across the economy, making it even more difficult – and more unlikely – that the Federal Reserve could bring prices down without triggering a recession.

Price growth hit a new four-decade high, with inflation hitting 9.1% for the 12 months ending in June, according to Labor Department data. This surprisingly high reading, combined with a stronger than expected June jobs report, means the central bank will likely take even more aggressive action to cool the economy.

“The odds of a recession have definitely increased,” said Rodney Ramcharan, professor of economics at the University of Southern California and former senior economist at the Federal Reserve Board. “The central bank is a powerful institution, but there is no way it can carefully calibrate these interest rate hikes to avoid a recession.”

June inflation soared to 9.1%, a new 40-year high, amid soaring gasoline prices

During the pandemic, the Fed had let borrowing costs drop to near zero, to help the economy grow during a tense period when millions of people were suddenly losing their jobs. Now the economy seems to be bubbling, with prices showing no signs of slowing down. The Fed has already raised interest rates three times this year – most recently in June by three-quarters of a percentage point – in an attempt to control inflation. But stubborn price increases mean the central bank still has a lot of work to do.

Economists now expect the Fed to raise interest rates by 0.75 percentage points later this month, and there is talk again of a full one percentage point hike, which would be the largest one-time increase since the central bank began announcing rate hikes in the early 1990s. The Fed is trying to raise the cost of borrowing for businesses and households to slow spending. The slowdown in spending is supposed to slow inflation.

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The Fed faces a tough decision after that. If inflation continues to rise, central bankers should decide whether to keep raising rates and possibly halt all economic growth in the final months of 2022. In the past, the Fed has only been able to stave off a recession than with these types of rate hikes. a handful of times.

How far the Fed goes down this path will determine the likelihood of a recession.

“The Fed faces a daunting policy challenge,” said Gary Stern, who served as Federal Reserve Bank of Minneapolis president from 1985 to 2009. “Inflation has been found not only higher but more sustained than expected, and there’s no sign of it abating.

Essentials like fuel, food and housing have all become more expensive over the past year. Gasoline prices have almost doubled – although they have fallen slightly from their mid-June peaks – and the cost of basics like rice, milk, butter and baby food have all increased from 12 to 16%.

Housing costs, meanwhile, have risen nearly 6% and are expected to become an even bigger driver of inflation in the months ahead.

“Inflation reports so far have been disappointing, but this latest was just plain painful,” said Ellen Gaske, an economist at PGIM Fixed Income and a former senior economist at the New York Fed. “Households will feel this. Their wages are not keeping pace with this kind of generalized inflation.

On Wednesday, President Biden called inflation “our most pressing economic challenge” and spoke of the importance of curbing price increases. He also said a recession was “not inevitable”.

The White House has misjudged the persistence of inflation for more than a year. And now the global economy looks much choppier than it did six months ago. The World Bank warned in June that the global economy could face several years of weak growth. And recession fears are sweeping Europe.

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Canada’s central bank raised interest rates by one percentage point on Wednesday in hopes of curbing the country’s 7.7% rise in prices over the past year.

Wall Street is already forecasting a similar rate hike in the United States. Financial markets fell after the release of the new inflation data, as investors struggled with figures suggesting the peak of inflation had not yet arrived, which could prompt the Federal Reserve to put the brakes on even more. the economy.

All three major stock indexes fell on Wednesday. Market watchers will also be watching corporate earnings closely this week. Financial snapshots offer another signal as to how companies are coping with the high inflation environment and how Fed actions are influencing market conditions. Investors will also get a glimpse of trade projections for the second half of the year, providing more insight into the direction of the economy.

Although inflation hasn’t budged – and has actually gotten worse – some economists point to promising signs of a cooling in other parts of the economy signaling that a recession is not imminent or inevitable. Employment growth, while still exceptionally strong, is slowing. Consumers are beginning to think twice before spending on goods and certain services. And there are signs that rising mortgage rates are causing home sales to slow. All of these forces are helping to cool the economy and could help the Fed do its job without getting too deep into the restrictive zone.

“The totality of the data is more reassuring that these are all parts of the economy that need to slow down to bring down inflation,” said Jason Furman, an economist at Harvard University and senior economic adviser to the White House of ‘Obama. “I don’t think it’s time to start panicking yet. You should be nervous and wary, yes, but not panic.

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In Boise, Idaho, the mood of potential home buyers began to sour early this year, shortly after the Fed began talking about raising interest rates. Demand for new homes continued to decline as mortgage rates rise, Colby Henry, loan officer at Benchmark Mortgage. Rates for a 30-year mortgage rose from 2.9% to 5.3% last year, according to Freddie Mac.

“We used to talk to 20 people a day and they were all making offers, and now we talk to four or five,” Henry said. “There is a lot of confusion. A number of people we worked with were like, ‘No, we’ll wait and see what happens.’ ”

Economists say the most likely scenario is several months of even higher interest rates. The federal funds rate – the overnight lending rate controlled by the central bank – is currently 1.5-1.75%, although it may need to reach 6% before it can lower the inflation, said Jeffrey Lacker, an economics professor at Virginia Commonwealth University and former Richmond Fed chairman.

“This is another terrible inflation report and it’s just the latest sign that the Fed still has a long way to go,” he said. “There’s no way to contain inflation without a recession, and it won’t surprise me if we enter one this year.”

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Fed Chairman Jerome H. Powell argued that the central bank would be able to engineer a “soft landing” – slowing the economy enough to stifle inflation without causing a broad-based slowdown with losses of massive jobs – although he acknowledged growing concerns that it will be difficult to achieve this.

“Do I still think we can do this? I do,” Powell said at a press conference earlier this month. “The events of the last few months have increased the degree of difficulty, created great challenges… there is a much greater chance now that it will depend on factors beyond our control.”

Inflation data released Wednesday reinforced just how difficult Powell’s task has become.

“I’m not sure we’ve had a soft landing yet – people can talk about it and they can hope for it, but in my opinion it’s not going to happen,” said Stern, the former chairman of the Minneapolis Fed. “I expect we will have a recession – it will probably be relatively brief and relatively mild – but I personally doubt that a significant reduction in inflation is achievable without it.”

Hamza Shaban and Rachel Siegel contributed to this report.

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