HCH Chart, page-515

The Fed is ready to choke the US economy to kill inflation

The conversion of the US Federal Reserve Board’s rate-setting committee’s members from doves to hawks is complete, with the Fed now pursuing an ultra-aggressive interest rate trajectory to tame the rampant inflation in the US.

The Fed’s Open Market Committee (FOMC) raised the federal funds rate (the US equivalent of our Reserve Bank’s cash rate) by 0.75 percentage points on Wednesday, its third consecutive hike of that magnitude. That lifted the federal funds rate to within a range of 3 to 3.25 per cent, as had been expected. What surprised financial markets, however, were the signals the committee sent about the future path of rates.

The majority of the FOMC members now expect there to be at least one more 0. 75 percentage point increase and another hike of at least 0.50 percentage point before the end of the year. This would raise the federal funds rate to close to 4.5 per cent by the end of this year. Moreover, the FOMC’s median forecast expects the rate above that level next year, with a significant number of the members – about half -- anticipating a peak of almost 5 per cent.

The projections for the rest of this year and 2023 are far more aggressive than those the markets had expected and priced in.

The Fed’s belated recognition that the inflation breakout wasn’t, as it insisted last year, transitory almost guarantees a recession in the US.

The Fed’s new-found aggression means it is likely that it won’t just be the US that flirts with recession. Most other major central banks are raising rates and siphoning liquidity out of their systems.

Europe, with its particular challenges as a result of Russia’s invasion of Ukraine, is destined to experience shrinking economies even though it badly lags the Fed in raising its policy rates. China’s economy has faltered badly and is stalling because of its COVID policies and the implosion of its property markets.

The simultaneous slowing of the world’s three biggest economies and the global tightening of monetary conditions that the Fed is now leading makes it increasingly likely, perhaps inevitable, that there will be a global recession.