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Historically high inflation: the US Federal Reserve in trouble


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Status: 06/15/2022 13:47

Critics accuse the Federal Reserve of initiating the turnaround in interest rates too late. The US central bank must now take increasingly drastic countermeasures to keep inflation in check.

By Angela Göpfert, tagesschau.de

The US is heading towards the largest rate hike since 1994. 75 basis points – Fed Chairman Jerome Powell shouldn’t do it below. The markets are now convinced of this. According to CME Group’s Fed Watch Tool, an overwhelming 98% of market participants are expecting a large 75 basis point rate hike at tonight’s Federal Reserve meeting.

The benchmark interest rate in the United States would therefore rise from the current 0.75 per cent to 1.0 per cent to 1.5 to 1.75 per cent. “The US Federal Reserve has no choice but to continue to act hard and fast,” said Franck Dixmier, bond expert at Allianz Global Investors.

US base rate already at 4.25 percent in early 2023?

Indeed, the market is now bracing for a whole series of sharp rate hikes. Another 75 basis point rate hike in July has already been priced, points out market expert Robert Rethfeld of Wellenreiter-Invest. For September and November, markets are expecting rate hikes of 0.5 percentage points each.

Only in December could the Fed shift gears and possibly raise it by just 25 basis points, so that the US benchmark interest rate is expected to hover between 3.5 and 3.75 percent by the end of the year. After two further interest rate hikes in January and March 2023, the benchmark interest rate would reach its temporary high of between 4.0 and 4.25%.

Criticism of hesitant action

But why does the Fed feel compelled to tighten monetary policy so drastically? According to critics, the US Federal Reserve initiated the monetary policy reversal too late. “Although it had the leeway, the Fed did not move at all in 2021 and therefore only at a snail’s pace,” criticizes Helaba’s Patrick Franke.

The central bank risks losing control of inflation expectations. To “move forward” again, as central bankers say, they must now take more drastic countermeasures than would have been necessary if they had intervened earlier and with more courage.

When central bankers are wrong

According to critics, the fact that the currency controls around Jerome Powell are really gaining momentum when it comes to interest rates is based on a fallacy in reasoning. For a long time, the US Federal Reserve considered high inflation rates to be merely a “temporary” phenomenon. Central bank countermeasures were simply not needed in this interpretation.

However, this was a miscalculation, as the Fed has since had to admit. The widespread hope that inflation will soon peak has also proved to be a mistake. In May, US consumer prices rose 8.6% year on year, the fastest in over 40 years. The expected decline in inflation rates is not yet in sight.

danger of a recession

Against this backdrop, the Fed cannot avoid significant interest rate hikes. This would aggressively limit the demand for goods and services, said Peter De Coensel, head of wealth management firm DPAM. “This would deal a severe blow to inflation.”

But the course of monetary tightening is likely to have further consequences for the real economy. Higher government bond yields are already impacting interest-sensitive parts of the economy, says Christian Scherrmann, a US economist at DWS. For example, more expensive mortgages are likely to cause a slight slowdown in construction activity and real estate markets. Commerzbank foreign exchange expert Antje Praefcke goes one step further and warns that the tough fight against inflation hides the great risk of a recession.

Global Earnings Expectations at Lowest Level from Lehman

The foreign exchange analyst is not alone with this fear. The current Bank of America / Merrill Lynch survey of fund managers demonstrates this: In terms of further developing global growth, fund managers are more negative than they have been since 1994. They see the greatest risk in braking maneuvers by central banks. Here the fear had recently increased significantly again.

The fund managers are more pessimistic about the prospects for improving global profits compared to last September 2008. Remember: at the height of the US financial crisis, the US investment bank Lehman Brothers went bankrupt.

Is history (financial crisis) repeating itself?

This crisis also has a history. Not a few economists believe that the Fed’s monetary policy under the direction of Alan Greenspan (1987 to 2006) was partly responsible for the devastating market turmoil between 2007 and 2009.

His accusation: Greenspan contributed significantly to the rising bubble in the US housing market by intervening too late against high inflation and not taking sufficient action. Low interest rates would have made the housing boom possible in the first place. Did Jerome Powell learn anything from his predecessor’s story?

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