Fed officials are expected to announce another 0.75 percentage point interest rate hike Wednesday as both job growth and price growth rose, according to federal data.
The Fed has aggressively boosted interest rates since March to bring prices down after waiting in vain for months for inflation to decline. The bank has already hiked its baseline interest rate range by 1.5 percentage points this year, including a 0.75 percentage point hike in June.
“To the Fed, obviously job No. 1 is getting inflation down, and hopefully down without setting the economy in recession, but that isn’t a prerequisite,” said Mark Zandi, chief economist at Moody’s Analytics.
“That’s really hard because a lot of inflation is coming from things that are out of their control.”
The U.S. economy has shown signs of slowing under the pressure of higher Fed interest rates, which is a key step in the bank’s goal of bringing inflation down. Housing sales have plunged as mortgage rates rise, stock values have dropped and businesses are pulling back on plans to hire and expand with profit margins narrowing.
But the war in Ukraine and ongoing supply chain issues driven by the pandemic have kept up pressure on food and energy prices, pushing the Fed to go even further with rate hikes.
Karen Shaw Petrou, a managing partner at Federal Financial Analytics, said the pressures facing the Fed “have only gotten” worse since the bank raised rates in June, forcing the Fed to make tough choices.
“You got no meaningful curb on inflation, even with a sharp rate rise. At the same time, financial market stresses and the impact of this inflation on household spending are curbing economic growth,” Petrou said, arguing the Fed should have begun hiking much sooner.
“It’s the worst of both worlds. There’s no good answer.”
Federal Reserve Chairman Jerome Powell and other top officials at the central bank have stressed for months that they will raise interest rates as high as necessary to bring inflation down. While Powell said the U.S. may be able to avoid a recession in the process, he acknowledged it has become harder for the Fed to avert a downturn.
Powell previously said reducing inflation back to the Fed’s target range is far more important to the long-term health of the economy.
“We fully understand and appreciate the pain people are going through dealing with higher inflation. We have the tools to address that and the resolve to use them,” Powell said last month.
“The process is likely — highly likely — to involve some pain, but the worst pain would be from failing to address this high inflation and allowing it to become persistent.”
How much pain the economy feels depends largely on how far the Fed believes it needs to go to curb inflation. And economists say that’s far from clear.
Inflation has steamed ahead throughout the summer even as the broader economy slows under the weight of higher interest rates and shock waves from the war in Ukraine.
Prices rose 9.1 percent annually in June and 1.2 percent last month alone, according to Labor Department data released last week, even though gross domestic product likely declined for the second straight quarter. Weekly unemployment claims still remain low but have risen to their highest level since November as a growing number of companies shed jobs amid a slowing economy.
Consumer confidence in the economy has also fallen sharply, and while retail spending has grown, further pressure from inflation and interest rate hikes could soon lead to a nosedive in spending.
“Consumers’ increased pessimism is consistent with our view that consumer spending and the broader economy are downshifting to a much slower growth path amid high inflation, rapidly-rising interest rates, and financial market volatility,” Lydia Boussour, lead U.S. economist at Oxford Economics, wrote in a Tuesday analysis.
“While we still see strong economic fundamentals preventing the US economy from slipping into recession this year, the pathway to a softish landing is narrowing.”
Most economists do not believe the U.S. is in a recession yet despite mounting signs of the economy slowing.
The country has added 2.5 million jobs since the start of 2022, including 372,000 in June alone, with an unemployment rate of 3.6 percent. In fact, the resilience of the job market and a record ratio of open jobs to unemployed workers are among several factors preventing the Fed from bringing inflation down.
Zandi said the U.S. is “not even close” to being in a recession right now because of the strength of the job market, but he acknowledged that the risks of a recession are rising.
“We’re on the precipice. It won’t take a lot to push us over,” Zandi said.
Zandi said the Fed should signal that it won’t be hiking interest rates as fast in the future.
Some left-leaning policy experts and lawmakers, including Sen. Elizabeth Warren (D-Mass.), have urged the Fed to stop hiking rates entirely, insisting it would doom the economy.
“Rising costs are an urgent problem, and interest rates play a key role in maintaining price stability. But urgency is no excuse for doubling down on a dangerous treatment,” Warren wrote in a Monday op-ed for The Wall Street Journal.
But Petrou said the Fed has no choice but to push ahead with interest rate hikes to curb inflation, insisting job losses and deep despair would visit the economy no matter what if the bank doesn’t get prices under control.
“Households are already starting to curb discretionary spending, and they will do so more and you’re going to have higher unemployment anyway. That’s the devil the Fed has created.”