As mandated by Congress, the U.S. Federal Reserve is tasked with managing our nation’s monetary policy. By adjusting the cost and availability of credit, the Fed seeks to manipulate spending, inflation and employment to promote the general health of the American economy.
But the Fed currently finds itself in a very unenviable position. In Wall Street jargon, the Fed is trying to engineer what’s called a soft landing. Its task — to reduce inflation without somehow sending the economy spiraling into a deep recession.
Since March, the Fed has been aggressively raising the benchmark fed funds rate, which often serves as the basis for many forms of consumer debt. As the fed funds rate is increased, so do interest rates on credit cards, bank loans and home mortgages, among others. By increasing the cost to borrow money, the Fed hopes to reduce consumer spending and thus ease the upward pressure on prices.
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Navigating a soft landing is a very delicate process. Ideally, Wall Street wants any interest rate hikes to be done at a gradual and measured pace. This would allow both consumers and businesses to better absorb the impact of rising rates while gently tapping the brakes on consumer spending. Again, the key word is gently.
But in a time span of just five months, the Fed has increased the fed funds rate from near-0% to 2.5%. This has been the most aggressive pace of rate hikes in nearly half a century. If the Fed raises interest rates too fast, it risks a hard landing. Under this scenario, surging interest rates would force consumer spending to a grinding halt, sending the economy into a deep, painful recession.
The current state of inflation has been caused by a massive increase in the U.S. money supply. Another term for inflation is “too much money, chasing too few goods.” Since February 2020, the amount of U.S. dollars circulating throughout the economy has risen by 40%. Conversely, in that same time, industrial production has increased by just 3%. As one might expect, 40% more money chasing just 3% more goods is a sure-fire recipe for high inflation.
It was government, not the Fed, that saturated our economy with money. But the Fed is not completely shielded from some element of mismanagement. A legitimate criticism of the Fed is that its current dilemma is, to some extent, self-induced. From February through April 2021, inflation soared from 1.7% to 4.2%. By December, inflation had reached 7%. Despite a mountain of evidence to the contrary, the Fed maintained its argument that inflation would be transitory. By the time the Fed enacted its first rate hike in March 2022, inflation was being reported at 8.5%. In June, inflation reached 9.1% before falling back to 8.5% in July. The Fed now finds itself in panic mode trying to get this inflationary cycle under control.
Whether the Fed achieves a hard or soft landing is yet to be seen. One of the key obstacles to a soft landing is that the Fed is not done raising interest rates. It’s expected to raise the fed funds rate from its current 2.5% to 3.5% by year-end and to 3.75% by next year. Simply put, the more rate hikes the Fed has to enact, the greater the likelihood of a hard landing in the months ahead.
Mark Grywacheski is an expert in financial markets and economic analysis and is an investment adviser with Quad-Cities Investment Group, Davenport.
Disclaimer: Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Quad-Cities Investment Group LLC is a registered investment adviser with the U.S. Securities Exchange Commission.
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