I. Introduction + Background
The Federal Reserve (Fed) has a dual mandate: keep unemployment down and prices steady. At this moment, in a post-covid environment, with messed up supply chains, inflation has proven to be the focus. The Fed has been tackling inflation as prices have been the highest since the 1970s and don’t seem to be coming down. With this issue at hand, the Federal Reserve has been attempting to combat inflation by raising the interest rates, however, many are now wondering how long the Fed will continue to hike and if the tightening will send the economy into a recession.
II. What just happened?
On Wednesday November 2nd, The Federal Open Markets Committee conducted their November meeting and in a unanimous vote, raised interest rates by 75 basis points, to a range of 3.75% to 4%. While this is their fourth consecutive increase, it is the 6ththis year. The interest rate being raised is the federal funds rate, which is essentially the overnight lending rate for U.S. banks to provide funds for one another. This rate affects us (the consumers) every day. More to come on this below.
In a statement by Jerome Powell, the chairman of the Federal Reserve “Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures,”. The ongoing war in Ukraine is a significant contributing factor to continued high inflation, the committee noted. It is important to note that the Fed is trying to bring inflation down to their historic goal of 2.0%, though some state this should change.
The Fed will have its final meeting this year in December, after the midterm elections.
III. Consequences of the hike
- Impact on consumers
This hike, and ones in the past, do not just effect banks and investors, they have an impact on every-day people and consumers. One way it affects us is when the Fed raises interest rates, credit card debt becomes more expensive for consumers. This is because the interest rates on consumer debt -like carrying a balance on a credit card- tend to move in tandem with the federal funds rate. Ultimately, a higher fed funds rate means more expensive borrowing costs, which can decrease the demand in banks seeking to borrow money[1]. Another consequence of a Fed hike on consumers is that those borrowing to buy a house will most likely face a bigger housing bill in the nearby months. If we observe the housing market now, we can see that with the Fed continuing its aggressive rate-hikes, mortgage rates hit a new 20-year high of 7.08% last week. Mortgage rates are actually directly impacted by the bond market- which is quite sensitive to Fed’s decisions and hikes.[2]
- Impact on markets
When observing the stock and bond market’s reaction to the Fed hike announcement, it is important to dissect its confusion, as it originally brought up stock prices and pulled bond yields down (a good thing). However, by closing, the market was once again down. While the shifting of asset prices can be impacted by a variety of factors, there are a few things to highlight here. First of all, some argue that the 75-point increase was not the shock to markets- as many were expecting this hike and since markets are forward looking, this announcement was very much priced in. What did, shock the markets, and for a while had stock prices up, was the Feds use in forward guidance. In a semi-unexpected statement, Powell hinted that the Fed may soon be easing up their aggression as a sign that they are listening to the opinion of scholars and economists warning that their hikes may lead to a recession. Powell stated, “That time is coming, and it may come as soon as the next meeting, or the one after that.” This ultimately may have given investor some sense of optimism as immediately after the announcement, stock prices went up. However, this “optimism” was not long lived as the S&P 500 index closed 2.5 per cent down in New York while the tech-heavy Nasdaq fell 3.4 per cent.
IV. Should the Fed keep hiking?
Many people, including the President of the United States, are claiming that the Fed needs to “keep at it” till prices begin to come down. Right now, inflation seem to persist, despite the Fed hikes, thus, Powell is reinforcing the fact that the Fed will continue to be aggressive till there is a change. So far, the hikes this year have not had a significant shift on not only prices, but the unemployment numbers and the labor market. Inflation continuing and the robustness of the labor economy will probably keep the Fed hiking till we begin to see significant movements. For some, though, this approach is a dangerous one. Certain economists and scholars are arguing that the aggressiveness of the Fed needs to be paced down as the hikes threaten to topple the economy into a recession. Many claim that if the Fed is not more careful in their approach, they will create disastrous consequences that we will not be able to reverse- though most economists agree that the potential recession would be a mild one.
This debate has even opened another disagreement amongst economists- the inflation target rate. Inflation right now is above 8% on the headline measure, which mean it exceeds 6% on the index tracked by the Fed—to its 2% target. Many argue that this target – being treated as sacred- has really “flimsy foundations” and getting there could require a painful recession. The 2% goal was first adopted in New Zealand in the early 1990s and over time, the framework was adopted by central banks around the world. The Fed has been formally shooting for 2% since 2012, however, some economists believe that this rate should be higher. While no one thinks the current 8% is appropriate, some are pushing for the rate to be increased to 3% or 4% as it could be more useful in future crisis and would have been during the great recession[3].
V. Recession nearing?
With all the uncertainty ahead, this seems to be the million-dollar question. Yes, we have experienced two consecutive quarters of negative GDP growth (the rule of thumb for a recession) however, The National Bureau of Economic Research, the institution who “calls it”, has been silent thus far. So, many individuals continue to debate whether we are in a recession/or nearing one soon.
Let’s dissect our situation: some indicators have been clearer than others, for example, Mortgage rates have more than doubled over the past year, exceeding 7% which has led to a stark decrease in house purchases. The labor market, however, continues to be resilient as there are still about two job openings for every unemployed person, which is consequently pushing up wages. Unemployment, while at a low 3.7%, did increase from the previous 3.5%, ultimately showing the minimal effects of the feds hike. With these robust numbers, and small reaction to the Fed hikes, it is hard to see a world where the tightening stops anytime soon. The indicators ultimately do not show a dark, heavy, recession in the future and instead suggest a mild one. Most likely, the Fed will continue to tighten till prices begin coming down and inflation decreases back to its target of 2%- what comes after, only time will tell.
[1] https://www.forbes.com/advisor/investing/another-75-point-fed-rate-increase/
[2] https://www.forbes.com/advisor/investing/another-75-point-fed-rate-increase/
[3] https://www.economist.com/graphic-detail/2022/11/02/inflation-is-too-high-when-the-public-notices-it
Policy Interns 