The Big Fed Mistake US Economic Moonscape

The US Federal Reserve minutes from the last meeting are out, and we were not the only ones who thought the Fed should consider another 50 point rate hike?

Several Board members did too as it turns out.

There was disagreement on the extent of the hike, 25 or still another 50?

There was complete agreement, that rates would need to continue to be raised, probably significantly, until inflation was back at the 2% target.

The run of data since the FOMC had that meeting, has been nothing but alarming in terms of signs of re-accelerating inflation, and strong employment and perhaps greater than anticipated resilient demand.

It is therefore highly likely that if this recent data had been available to the committee, they would indeed have continued to hike rates by 50 points, and still to do so for several more meetings.

Now the Fed is stuck in the position of maintaining 25 point rate hikes so as to maintain credibility and not to alarm the consumer and businesses by returning suddenly to 50 point steps. To the Fed this means they must ‘hope’ that there is some cumulative impact of past rate hikes that is still to hit demand, and persistently maintain their now 25 point increments for much longer than they or most of the market had previously thought.

Our consistently ahead of the market, most hawkish in the global commentary forecast of a terminal rate in the 5.75% to 6.5% range, with risk even to 7.5%, looks to be very much on the money.

We have made this forecast not in advocation of such an aggressive Fed stance, but in our real time understanding that the Fed was missing the boat when calling inflation ’transitory’, and would end up having to do just this. To hike rates far too aggressively, far too late.

The damage being done to the real economy, already and continuing, that is largely unseen by the run of economic statistics, relates to the every day livelihoods and psychology of consumers and businesses. Especially, small to medium sized businesses which remain the backbone of the US economy.

The run of inflation is now seriously squeezing consumer behaviour as corporations and businesses generally begin to go on hold and layoff workers.

The great squeeze of inflation and interest rate/mortgage stress is going to be crippling the US economy to a far more profound depth than almost anyone is contemplating. The idea that all will somehow be OK, when the President, and oddly many economists, bizarrely suggest the US economy is strong, therefore no adaptive policy initiatives to be seen, is entirely absurd.

The US economy is now in a full 2-5 year stall. One that will remain at risk of recession, or even depression, should the Fed Funds Rate hit the top of our target range 6.5%.

Let there be no mistake, my further risk terminal rate of 7.5%, which I have called for many months now, has always been a very real possibility.

With inflation re-accelerating, and it has done so in the latest CPI and Producer Prices data, and with on the surface seemingly relatively resilient demand for the moment, all of this indeed pushes the actual terminal rate for the Fed Funds Rate out much further than financial markets have previously considered.

It is difficult in this scenario to see the US economy doing anything other than being brought to its knees. Possibly with a crash.

Stocks are down. Property prices are falling. Bonds are falling. Deficits are extreme. Manufacturing and housing are already in recession. The Services sector is struggling to tread water. Yet the deceptive employment data post Covid, will see the Fed maintaining a dangerously blinkered focus of attacking inflation.

Wall Street may be hopeful, but this hope exists on a rocky, crumbling, downward scoping Main Street environment.

The US economic outlook is currently more of a Moonscape than a Rainforest.

Clifford BennettACY Securities Chief Economist

The view expressed within this document are solely that of Clifford Bennett’s and do not represent the views of ACY Securities.

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