In his speech in Jackson Hole, Wyoming, on Aug. 25, Fed Chairman Jerome Powell declared that inflation today “remains very high” and that the central bank is “willing to raise interest rates further if appropriate.” Although nearly every press report described the president’s comments as “hawkish”, analysts and pundits – and markets – found it reassuring that Powell stuck to his “wait and see” text, “we’ll rely on the data” and did not suggest a tougher lean.
This situation has left open the possibility that the Fed will not raise its benchmark index beyond the current target range of 5.25% to 5.50% at the September and November meetings. In fact, according to Fed funds futures trading on the Chicago Mercantile Exchange, the probability of a September rate hike has remained virtually unchanged from pre-speech levels at 19%, and the odds of a November rate hike have dropped slightly to around 45%.
Powell strongly indicated that the Fed will, at the very least, maintain the current range of 5.25%-5.50% for an extended period. But he did not say that additional increases are a sure thing. The stock market greeted Powell’s comments at a brisk pace, posting modest gains in the hours after the speech.
What Powell didn’t say: The Fed’s policy is already very strict
“We see the current policy stance as constraining, which puts downward pressure on economic activity, employment and inflation,” Powell said. He added that the task of taming what he saw as an excessively rapid pace of consumer prices “still has a long way to go”. But according to two senior economists, each looking at the picture from a different perspective, the central bank is already squeezing the economy hard, and the notion of “a long way to go” is wrong, because in the current clip, inflation is already approaching the Fed’s target.
Steve Hanke, professor of applied economics at Johns Hopkins University and known as the global “money doctor”, focuses on trends in the money supply, as defined by the broad measure M2. “It is the growth or decline in the money supply that determines the price level, and it is the exponential growth of M2 that has caused rampant inflation. Now, there is a sharp deflation of M2 that will hurt the economy,” he said. luck. Hanke points out that as of July, M2 was down 3.4% from its level in July of 2022. Two sources of this contraction: the Fed’s quantitative tightening (QT) campaign, through which it reduces its holdings of bonds and thus drains consumers’ savings. Bank lending, traditionally the largest source of M2 cash, declined. “In July we saw the first year-on-year decline in commercial bank credit in many years,” says Hanke.
For Hankey, we have yet to see the damage from the overwhelming combination of declining bank lending and QT eroding Americans’ spending power. But he is coming. “The time interval between the decline of M2 and recession is between six and 18 months,” he says. “The delay this time will be near the end of that range.” He notes that a downtrend in M2 will push inflation nowhere near the Fed’s 2% target by the end of the year. But the Fed is still doubling down on what it calls “extremely hawkish” monetary policy. “Because of this misguided policy, we are sleepwalking our way into recession,” Hanke says.
Will Luther believes that excessively high “real interest rates” could cause a sharp downturn
In his speech, Powell cited “positive real interest rates” as the main reason why Fed policy is currently “restrictive”. But for Will Luther of Florida Atlantic University, the central bank has raised this crucial measure – arguably the best measure of monetary tightening – to excessive levels. “In June and July, both the CPI (core) and the PCE price index (core), the latter of which is the Fed’s preferred measure, rose less than 2%,” says Luther. Yet Powell says he has a long way to go. These numbers show that he really exists.” For Luther, the Fed acts as a chauffeur whose goal is to reduce the speed of the car from 60 mph to 20 mph; The driver gradually slows down to 20mph, then keeps slamming on the brakes because the average speed has been so high at 45mph for the last three miles! He has to keep going at his current pace.”
The “real” rate Powell is talking about, which he doesn’t seem to see very high, is the difference between the 5.25% to 5.50% Fed funds rate and current inflation. And as we’ve just seen, month-on-month prices are now only rising by 2%. Hence, the real federal funds rate ranges from 3.25% to 3.50%. “This is very restrictive,” says Luther. “A real interest rate of 1.5% to 2.0% is sufficient to rein in inflation.” The mistake of making credit too expensive would destroy business investment and consumer spending, and would likely push the US into an unnecessary recession.
Powell’s explanation that persistently high, perhaps even accelerated, economic growth justifies maintaining a very hawkish policy in the face of low prices is not compatible with Luther’s. “On the contrary, the economy is still recovering from the blow of the pandemic,” he says. “We still have a lot of growth potential catching up to the pre-2019 path. We’re seeing a recovery on the supply side. It’s not inflationary at all, because it’s driven by higher productivity. In fact, the growth spurt is counterinflationary because the US is ramping up production of goods.” And services more quickly than the price rise.
US markets and consumers should never be reassured by Powell’s wait-and-see attitude. As both Hanke and Luther say, the Fed is slamming the brakes hard. Inflation is very much in the rearview mirror, and the Fed is now heading into recession.
This story originally appeared on Fortune.com
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