Members of the Federal Reserve, the central bank tasked with bringing inflation down from 8.3% to its target of around 2%, are now raising interest rates to cool the economy.
That’s okay: medicine doesn’t have to be easy to get across if it works quickly and works well. But inflation rates have been rising sharply since August 2021, staying outside the normal range of 2% to 4% for a full year. Now, a growing distrust in the Fed’s abilities and a belief that it is mired in a policy blunder has begged the question: What happens if the Fed fails to control inflation and we get stuck in a long-term cycle of increases? Inflation and recession? Why it matters: Record high inflation has created a complex crisis. At its core, it represents a political crisis for Democrats, who are defending their very narrow majority in Congress, and a crisis of faith for economists who have misjudged the persistence and importance of rising prices as a “temporary” outlier and may have missed their chance before Curve. Most importantly, it is a crisis for the American purse. The average price of a gallon of gasoline in all 50 states has surpassed the $4 mark for the first time ever. Food prices in April 2022 were 9.4% higher than in April 2021, the largest annual increase in 41 years. Americans have seemingly slipped into survival mode: Target and Walmart reported last week that discretionary spending is easing as customers struggle to cover basic necessities like groceries, fuel and shelter. That is different: The Federal Reserve is likely borrowing ideas from its 1994 playbook, the last time the central bank successfully raised interest rates and staged a soft landing. But things are different now. We are dealing with a serious labor shortage caused by baby boomers poised to retire from the labor market, a significant pandemic-related labor force participation rate and a slowdown in productivity. Globalization is in retreat as the pandemic and war in Ukraine have led to major energy price shocks and supply chain disruptions.
“This is new territory for all of us,” said Liz Young, head of investment strategy at SoFi. “Inflation hasn’t been this high since I was born.” The economy will recover, she said, but it will be a “slow burn.” Markets will continue to fall and prices will remain high for a while, she added: ‘I think we might have to stay there for a while. I don’t know if we’ll recover from that very quickly.”
Confidence in the central bank is also falling. Investors are calling for a three-quarter-point hike at the end of the Fed’s June meeting, despite assurances from Fed Chair Jerome Powell that such a large hike is out of the question. Even former Fed Chairman Ben Bernanke said the central bank was wrong in its approach to tackling 40 years of high inflation.
Part of the lack of confidence stems from the rise of broader and faster social media and communication channels — and has nothing to do with what’s going on at the central bank, said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. A continuous, real-time feed of news and analysts makes it easier to judge the Fed’s actions rather than its outcomes.
“You know her a lot better now,” Silverblatt said. “You can see all nooks and crannies.”
Timing is everything: Inflation rates are not always falling. Just look at the 1970s when the US economy suffered three recessions in which the underlying problem of inflation never went away.
“Stagflation is probably the worst word for financial markets because it’s the worst of both worlds. Inflation remains high and the economy is slowing,” said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management. “I think we’re getting a touch of stagflation now.”
But the spirit of the 1970s lives on in the minds of all Fed governors, and they’ve said they’ll step up their hawkishness no matter what that means for markets and the economy.
“The process of bringing inflation down to 2% will also involve some pain, but ultimately what would be most painful would be if we failed to deal with it and inflation became entrenched at high levels in the economy, and we know what that’s like,” Powell said in a recent Marketplace interview.
Grohowski says he sees inflation persisting for the rest of this year and some of the next few years, but that it’s not yet anchored in the economy and will come down by 2023.
Still, sentiment among investors and consumers is not the same. Among economists and analysts, Grohowski said, “there is an expectation that there will be some relief and that we are most likely living through the peak of inflation.” But consumers are “concerned that today’s inflation rates will continue for longer.
You can’t be wrong. While the prices of certain goods will fall quickly, the Fed says energy and housing prices are likely to remain high for some time.
We don’t think inflation has taken hold,” Grohowski said. “But we recognize there are concerns because parts of inflation are more persistent than most economists, and even the Fed, anticipated.”
Davos is back and the world has changed
The World Economic Forum – which famously combines high-profile panels with flashy parties – is back in person in Davos, Switzerland for the first time in two years. The conference aims to bring together key figures to address pressing issues such as inequality, climate change, the future of technology and geopolitical conflicts. But the logic behind inviting some of the world’s wealthiest people to solve these problems from a vacation spot looks even shakier today.
Billionaires have added $5 trillion to their fortunes during the pandemic, according to a report by Oxfam released in January. The 10 richest men in the world saw their collective wealth more than double. Meanwhile, another ten million people around the world have been pushed into extreme poverty.
The event takes place against the backdrop of the worst cost of living crisis in decades in both developed and many developing countries. Rising food and fuel prices are already causing hunger and deprivation, fueling instability, sparking protests and emboldening political insurgents.
The main event is likely to be a speech by Ukrainian President Volodymyr Zelenskyy on Monday, who is expected to participate via video conference. Chancellor Olaf Scholz and European Commission President Ursula von der Leyen are also scheduled to deliver speeches later in the week, which will be scrutinized as EU countries struggle to agree on a formal oil embargo on Russia.
Next
Monday: Esther George, President of the Federal Reserve Bank of Kansas City, speaks; Revenue from Zoom video communications,
Tuesday: new home sales in April; Revenue from Intuit, AutoZone, Best Buy, Toll Brothers, Petco, and Nordstrom
Wednesday: April Core Durables Orders, FOMC Minutes, Weekly Crude Stocks; Revenues from NVIDIA Corporation, Williams-Sonoma, and Dick’s Sporting Goods
Thursday: Q1 GDP (second estimate), initial jobless claims, upcoming home sales in April; Earnings from Alibaba, Costco, Dollar General and Dollar Tree
Friday: James Bullard, President of the Federal Reserve Bank of St. Louis and a voting member of the FOMC, speaks