The Fed took this stance even though markets started to see commodity prices decrease. Inflation in the US shows signs of easing. Oil prices have gone south on fears of demand shrinking, albeit volatility in the oil prices remains a cause for concern. Further, Canada is to increase gas production and export to Germany in an effort to ease energy prices.
The argument against further interest hikes stands on two grounds. Firstly, many economists and commentators believe that the current inflation is a supply-side one due to the Russia-Ukraine conflict and the bottlenecks in the supply chains. Fighting inflation through interest rates works well when driven by higher demand.
The second ground on which the argument against interest hikes stands is the fear of a looming recession. We have recently seen some signs of economic slowdown in terms of employee layoffs (Ford company, for example) and lower household spending observed by some consumer goods companies. The National Association of Realtors reported a 5.9% sale decline in July 2022 and 20.2% compared to last year.
Furthermore, many real estate agreements were called off in July due to higher mortgage rates. These numbers mark a slowdown in the housing market. Let us not forget that the housing market was the sector that sparked the 2008 financial crisis.
The Fed is now in an unenviable situation struggling to strike the right balance between reducing the inflation rate to the target level of 2.5% over time and simultaneously avoiding driving the economy into recession.
The impact of such a policy on the stock markets is yet to be felt. On the day of Powell's speech, the S&P 500 and Nasdaq composite indexes lost 3.37% and 3.94%, respectively. The upcoming weeks might also see further declines. Over time, such persistent declines will lead investors to seek safe shelters such as gold and fixed deposits now that they can earn higher interest. This act on the part of investors will send the economy into a recession. Experiences show that dealing with inflation is much easier than dealing with a recession since the latter takes a long time to subside. The 1929 recession is a case in point.
Another dilemma is the possible effect of a higher interest rate on employment. By increasing the interest rate, the Fed pushes unemployment to a new high. The recent data from the Bureau of Labour Statistics for the month of July showed that the rate of unemployment remains stable. However, historically the employment level is the first casualty of rising interest rates. This last factor is crucial given the imminent mid-term election in the US scheduled for November 2022.
Inflation is an international phenomenon. However GCC oil producers are on the other side of the equation because these countries benefited from higher energy prices. However, since the GCC's currencies are pegged to the dollar, the interest rate hikes will be felt somehow down the road.
Despite the many warnings addressed in Powell's speech, and in its next meeting, the Fed will most probably be cautious not to throw a monkey wrench into the economy. By that, I mean hiking interest rates too often and at a high level. History shows that the Fed, in many financial crises, was caught flat-footed. I suspect this last point drives the aggressive inflation fight policy followed so far by the Fed. The decisive factor in the next Fed step is the August figures that came out earlier this month ahead of the next Fed meeting scheduled on the 20th or 21st of September 2022. An increase of more than 50 bps would be too aggressive and risk higher unemployment and a possible recession.
On the other hand, an increase of 50 bps or less seems prudent and may play a balancing role and smooth facing out of inflation. Meanwhile, market participants will wait for the Fed's next meeting with their fingers crossed.
The argument against further interest hikes stands on two grounds. Firstly, many economists and commentators believe that the current inflation is a supply-side one due to the Russia-Ukraine conflict and the bottlenecks in the supply chains. Fighting inflation through interest rates works well when driven by higher demand.
The second ground on which the argument against interest hikes stands is the fear of a looming recession. We have recently seen some signs of economic slowdown in terms of employee layoffs (Ford company, for example) and lower household spending observed by some consumer goods companies. The National Association of Realtors reported a 5.9% sale decline in July 2022 and 20.2% compared to last year.
Furthermore, many real estate agreements were called off in July due to higher mortgage rates. These numbers mark a slowdown in the housing market. Let us not forget that the housing market was the sector that sparked the 2008 financial crisis.
The Fed is now in an unenviable situation struggling to strike the right balance between reducing the inflation rate to the target level of 2.5% over time and simultaneously avoiding driving the economy into recession.
The impact of such a policy on the stock markets is yet to be felt. On the day of Powell's speech, the S&P 500 and Nasdaq composite indexes lost 3.37% and 3.94%, respectively. The upcoming weeks might also see further declines. Over time, such persistent declines will lead investors to seek safe shelters such as gold and fixed deposits now that they can earn higher interest. This act on the part of investors will send the economy into a recession. Experiences show that dealing with inflation is much easier than dealing with a recession since the latter takes a long time to subside. The 1929 recession is a case in point.
Another dilemma is the possible effect of a higher interest rate on employment. By increasing the interest rate, the Fed pushes unemployment to a new high. The recent data from the Bureau of Labour Statistics for the month of July showed that the rate of unemployment remains stable. However, historically the employment level is the first casualty of rising interest rates. This last factor is crucial given the imminent mid-term election in the US scheduled for November 2022.
Inflation is an international phenomenon. However GCC oil producers are on the other side of the equation because these countries benefited from higher energy prices. However, since the GCC's currencies are pegged to the dollar, the interest rate hikes will be felt somehow down the road.
Despite the many warnings addressed in Powell's speech, and in its next meeting, the Fed will most probably be cautious not to throw a monkey wrench into the economy. By that, I mean hiking interest rates too often and at a high level. History shows that the Fed, in many financial crises, was caught flat-footed. I suspect this last point drives the aggressive inflation fight policy followed so far by the Fed. The decisive factor in the next Fed step is the August figures that came out earlier this month ahead of the next Fed meeting scheduled on the 20th or 21st of September 2022. An increase of more than 50 bps would be too aggressive and risk higher unemployment and a possible recession.
On the other hand, an increase of 50 bps or less seems prudent and may play a balancing role and smooth facing out of inflation. Meanwhile, market participants will wait for the Fed's next meeting with their fingers crossed.
* Dr. Ismail Hamad, [email protected]
