Federal Reserve Chair Jerome Powell gave his most explicit acknowledgment to date that steep rate hikes could tip the US economy into recession, saying one is possible and calling a soft landing “very challenging.”
“The other risk, though, is that we would not manage to restore price stability and that we would allow this high inflation to get entrenched in the economy,” Powell told lawmakers on Wednesday. “We can’t fail on that task. We have to get back to 2% inflation.”
The Fed chair was testifying before the Senate Banking Committee during the first of two days of congressional hearings. In his opening remarks, Powell said that officials “anticipate that ongoing rate increases will be appropriate,” to cool the hottest price pressures in 40 years.
“Inflation has obviously surprised to the upside over the past year, and further surprises could be in store. We therefore will need to be nimble in responding to incoming data and the evolving outlook,” he said.
“Very challenging” is likely a gross understatement. I was surprised to hear him say the economy is very strong and capable of withstanding additional interest rate hikes. Instead, I suspect we are going to see an abrupt fall off in the volume of goods traded as the cumulative effects of inflation cut into disposable income.
The spread between the 10-year and the 3-month continues to contract. Liquidity conditions continue to tighten and US mortgage rates have doubled this year. The KBW Regional Banks Index is breaking lower. Copper broke below the psychological $4 area today. High yield spreads also continue to hold the move about the problematic 5% level.
The stock market is steadying because investors are willing to bet that the unfolding economic slowdown will curtail inflation enough for the Federal Reserve to declare victory and stop tightening. My guess is this steadier action is not representative of a meaningful low but is simply some short-term steadying in the region of the 1000-day MA for the S&P500 and the Nasdaq-100. Major lows generally coincide with announcements of looser financial conditions which are not yet apparent in the USA.
Japan is still engaged in quantitative easing, China’s credit impulse is now trending higher but the absolute quantity of money being created is rather small. Europe has begun to talk about raising rates but there has been little in the way of action just yet. This both helps to highlight that the bulk of tightening has come from the USA, and then by commodity producers and emerging markets. Removing accommodation is less than eager elsewhere.
The total assets of central banks index continues to contract. That has been driven by the strength of the Dollar. This contraction is already more than the decline seen in 2018 which was the last time Wall Street pulled back by 20% before the pandemic.