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The Federal Reserve has issued another super-sized increase to interest rates in a move intended to fight inflation, but which deepens the risk of a sharp economic downturn and job losses.
At the end of its two-day policy meeting on Wednesday, the US central bank raised its policy rate by 75 basis points for the third time, to a range of 3 percent to 3.25 percent, the highest level since the 2008 financial crisis.
The Fed is attempting to cool down the economy in order to tame rampant inflation, which remains stubbornly high at 8.3 percent — but as interest rates climb, the path to a so-called ‘soft landing’ is narrowing.
Economists are increasingly projecting a ‘hard landing’ marked by a sharp increase in unemployment, and Fed Chair Jerome Powell admitted on Wednesday that achieving a soft landing will be ‘very challenging’.
‘We have always understood that restoring price stability, while achieving a relatively modest…increase in unemployment would be very challenging,’ he said.
‘No one knows whether this process will lead to a recession, or if so, how significant that recession would be,’ he added.
Soaring consumer prices have been putting the squeeze on American families and businesses and are already a political liability for President Joe Biden, as he faces midterm congressional elections in early November.
But a sharp contraction of the world’s largest economy would be an even more damaging blow to Biden, to the Fed’s credibility and the world at large.
The US economy has been flashing warning signs for some time, including six straight months of shrinking GDP in the first half of the year, meeting one informal definition of a recession — but Biden denies a recession has begun.
Federal Reserve Chair Jerome Powell speaks at a news conference Wednesday. Intensifying its fight against chronically high inflation, the Federal Reserve raised its key interest rate by a substantial three-quarters of a point for a third straight time.
The latest increase takes the Fed’s policy rate (seen since 1980) to the highest level since the 2008 financial crisis
Last week, the average fixed mortgage rate topped 6 percent, its highest point in 14 years, meaning that rates on home loans are about twice as expensive as they were a year ago
Fed policymakers issued this projection showing their beliefs about the future US unemployment rate, which currently sits near at five-decade low at 3.7%. Powell said taming inflation without sharply increasing unemployment will be ‘challenging’
The Fed’s new projections also showed its policy rate rising to 4.4 percent by the end of this year before topping out at 4.6 percent in 2023 — higher increases than economists and markets had projected.
Short-term rates at that level would make a recession likelier next year by sharply raising the costs of mortgages, car loans and business loans.
‘Focusing on the Fed’s interest rate decision totally misses what’s most important,’ said Morning Consult’s chief economist John Leer.
Leer noted that Fed policymakers ‘significantly increased their projections for inflation, unemployment and interest rates over the next two years and lowered their GDP growth forecasts.’
‘Even the Fed is growing less confident in its ability to achieve a soft landing,’ he added.
Wall Street’s main indexes ended Wednesday’s session sharply down, after a day of wild swings driven by the latest Fed policy announcement.
The S&P 500 lost 1.7 percent, as did the Dow Jones Industrial Average, which plunged 522 points to 30,183, while the Nasdaq Composite fell 1.8 percent.
Powell said central bank officials are ‘strongly resolved’ to bring down inflation from the highest levels in four decades and ‘will keep at it until the job is done.’
He said policymakers see the need to lift the policy rate to a ‘restrictive level’ and ‘keep it there for some time.’
‘We’re committed to getting inflation back down to 2 percent,’ he said.
Earlier this month, Powell warned that Americans are in for ‘some pain’ ahead as the Fed works to end inflation, hoping to prevent what would otherwise be an even more dire outcome.
The Fed intends to use higher borrowing costs to slow growth by cooling a still-robust job market, controlling wage growth and other inflation pressures.
Yet the risk is growing that the Fed may weaken the economy so much as to cause a downturn that would produce heavy job losses.
The Dow Jones Industrial Average plunged 522 points Wednesday after a day of wild swings
By raising its key short-term interest rate, the Fed is attempting to cool down the economy in order to tame rampant inflation, which remains stubbornly high at 8.3% in August
The Fed measures inflation using an alternate index, Personal Consumption Expenditures. The PCE is at 6.3% now, and FOMC members expect it to decline in the coming years
Despite the pain many Americans are feeling from inflation, the job market remains robust, with an unemployment rate near five-decade lows at 3.7 percent.
The economy has added nearly 3 million jobs since the start of the year, a surprisingly high number in the context of shrinking gross domestic product.
‘While the Fed is still likely to view a soft landing as a modal outcome, the window appears to be narrowing,’ Bank of America economists wrote in a note.
‘Recent Fed communications have acknowledged this, in part, by leaning more strongly in the direction of needing to slow labor markets and accepting the risks to activity that come with it.’
The economy hasn’t seen rates as high as the Fed is projecting since before the 2008 financial crisis.
Last week, the average fixed mortgage rate topped 6 percent, its highest point in 14 years.
Higher mortgage rates have already had a significant impact on the housing marking, with homebuying activity dropping off sharply this summer.
Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.
The Fed’s ‘dot plot’ shows where policymakers expect future interest rates to go. Each dot represents the view of one member of the FOMC, but the specific member behind each dot remains anonymous
Last week, the average fixed mortgage rate topped 6 percent, its highest point in 14 years
The Fed’s projected rate hike for September is seen above
Powell and other Fed officials still say the Fed’s goal is to achieve a ‘soft landing,’ by which they would slow the economy enough to tame inflation but not so much as to trigger a recession.
By last week, though, that goal appeared further out of reach after the government reported that inflation over the past year was a painful 8.3 percent.
Even worse, so-called core prices, which exclude volatile food and energy costs, rose much faster than expected.
The inflation report also documented just how broadly inflation has spread through the economy, complicating the the Fed’s task.
Inflation now appears increasingly fueled by higher wages and by consumers’ steady desire to spend and less by the supply shortages that had bedeviled the economy during the pandemic recession.
‘They’re going try to avoid recession,’ said William Dudley, formerly the president of the Federal Reserve Bank of New York. ‘The problem is that the room to do that is virtually non-existent at this point.’
The Fed’s policy moves over the last eight presidential administrations are seen above
The Fed’s rapid rate hikes mirror steps that other major central banks are taking, contributing to concerns about a potential global recession.
The European Central Bank last week raised its benchmark rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all carried out hefty rate increases in recent weeks.
And in China, the world´s second-largest economy, growth is already suffering from the government´s repeated COVID lockdowns. If recession sweeps through most large economies, that could derail the U.S. economy, too.
At his news conference Wednesday, Powell isn’t likely to drop any hints that the central bank will ease up on its credit tightening campaign.
Most economists expect the Fed to stop raising rates in early 2023. But for now, they expect Powell to reinforce his hard-line anti-inflation stance.
‘It’s going to end up being a hard landing,’ said Kathy Bostjancic, an economist at Oxford Economics. ‘He´s not going to say that.’
But, referring to the most recent Fed meeting in July, when Powell raised hopes for an eventual pullback on rate hikes, she added: ‘He also wants to make sure that the markets don´t come away and rally. That’s what happened last time.’
The U.S. economy shrank in the first two quarters of the year, meeting one definition of a recession. The White House cites a strong job market in saying there is no recession
Indeed, investors responded then by bidding up stock prices and buying bonds, which lowered rates on securities like the benchmark the 10-year Treasury. Higher stock prices and lower bond yields generally boost the economy – the opposite of what the Fed wants.
The central bank has already engaged in the fastest series of rate hikes since the early 1980s.
Yet some economists – and some Fed officials – argue that they have yet to raise rates to a level that would actually restrict borrowing and spending and slow growth.
Many economists sound convinced that a recession and widespread layoffs will be necessary to slow rising prices.
Research published earlier this month under the auspices of the Brookings Institution concluded that unemployment might have to go as high as 7.5 percent to get inflation back to the Fed’s 2 percent target.
Only a downturn that harsh would reduce wage growth and consumer spending enough to cool inflation, according to the a paper by Johns Hopkins University economist Laurence Ball and two economists at the International Monetary Fund.