Friday, April 14, 2023

Fed Now Fears a Recession

 Financial FAQs

BEA.gov

It is no longer lost on the Fed Governors that the record speed they have raised short-term interest is causing a possible recession. They have even said so in their just released minutes from the latest FOMC minutes.

Three medium-sized regional banks have already failed and several dozen are on the FDIC watchlist, who have overinvested in uninsured assets that are devaluing fast as interest rates have risen.

And inflation is now plunging, so effective have been rate hikes from essentially zero percent just one year ago to 4.75 percent today.

In fact, the Producer Price Index for final demand that measures wholesale goods and services declined -0.5 percent in March. Prices for final demand goods decreased -1.0 percent, and the index for final demand services moved down -0.3 percent—all plunging the largest monthly amount in three years.

So, alarm bells are sounding for the Fed to move in the opposite direction—to not only pause but reverse course, if they believe what they say—and inflation is no longer a problem.

Prices for final demand have risen just 2.7 percent for the 12 months ended in March, from 4.6 percent the previous month. It is now approaching the Fed goal of a 2 percent inflation rate for wholesales goods that end up as consumer products.

It turns out the Fed Governors have been too good at their job, catching banks and regulators flat-footed from the effects of their rate hikes and a probable cause of a recession sometime later this year.

Why? Because Fed officials are now seeing signs that banks are tightening their credit standards as well, following the Fed’s guidance, which will harm business investments and even homebuyers who will find it more difficult to qualify for a loan or mortgage.

“Financial conditions tightened considerably over the intermeeting period as a whole,” said the minutes. “Market contacts observed that the recent developments in the banking system will likely result in a pullback in bank lending, which would not be reflected in most common financial conditions indexes.”

Given their assessment of the potential economic effects of the recent banking-sector developments, the Fed’s staff now sees “a mild recession starting later this year with a recovery over the subsequent two years.”

The minutes also show that “many” officials said that the likely effects of the banking stress had led them to lower their estimate of the peak rate that would be needed to bring inflation under control, according to the minutes of the March 21-22 meeting.

With such fears it would be far wiser to anticipate other inflation indicators plunging as fast. And once that happens what other dominoes may fall?

But instead, FOMC officials ultimately voted to increase the benchmark borrowing rate by 0.25 percentage point, the ninth increase over the past year. That brought the fed funds rate to a target range of 4.75%-5%, its highest level since late 2007.

Other economic sectors are beginning to plunge as well. Sales at retailers dropped 1 percent in March and declined for the fourth time in the past five months, said the Census Bureau. Watch out below if this reflects consumers beginning to close their wallets.

The problem the Fed Governors haven’t understood in their panicked reaction to the initial inflation surge was that conditions outside of the Fed’s control have caused most of the inflation. A historic pandemic that shut down worldwide economic activity and a European war have been the main cause shrinking world-wide production, while governments pumped in excess liquidity to keep their economies afloat.

There is now the real possibility that the Fed intends to cause a recession, which is the only result that will bring down the inflation rate to 2 percent, which they seem fixated on doing, despite the possibility of more bank failures.

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

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