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As prices rise at their fastest pace in a generation, the Federal Reserve is hoping another aggressive rate hike will help it tame high inflation.
Wall Street expects the Fed to raise its benchmark interest rate an additional three-quarters of a percentage point on Wednesday.
The central bank has its work cut out for it. Its objective is to contain inflation without triggering a recession.
Fed Chairman Jerome Powell and his colleagues are trying to do this by tackling demand. They’re driving up the cost of credit — what consumers and businesses pay to borrow money — and they’re trying to cope with a job market that the Fed chairman called “unsustainably hot,” where wages are rising rapidly because many companies are paying more to find workers.
Although achieving what economists call a “soft landing” for the economy is difficult, Powell sounded confident during recent testimony before Congress.
“We have both the tools we need and the determination it will take to restore price stability on behalf of American families and businesses,” Powell told the Senate Banking Committee last month. “Our main objective is to use our tools to bring inflation back to our 2% target and to keep long-term inflation expectations well anchored.”
To do this, the Fed raises its interest rates. But it is not a precise or painless process. As policymakers continue to hike rates, growth will slow further and the unemployment rate, which is near its pre-pandemic low, will rise.
The Fed would like these adjustments to happen in a measured way, but that’s easier said than done.
In June, inflation rose 9.1% from a year earlier, and the Fed is tackling a problem shaped by factors beyond its control.
The central bank is equipped to deal with demand, which surged as the United States emerged from the darkest days of the pandemic, but it cannot solve supply chain problems or end the war in Ukraine, both of which have led to higher prices, particularly of gasoline and food.
Economy continues to create jobs, but housing slows
Powell and his colleagues at the Federal Open Market Committee are watching the economic data closely, but it’s been mixed.
On the one hand, inflation did not peak in May. The consumer price index rose in June, largely due to higher energy prices.
On the other hand, the labor market remained strong. In June, it added 372,000 new jobs, more than Wall Street expected, bringing the total number of jobs added in the first half to 2.7 million.
Meanwhile, the housing market has slowed, thanks to higher interest rates.
According to Freddie Mac, the average rate on a 30-year fixed-rate mortgage is now 5.54%, nearly double since the start of the year, which has put many buyers off. Construction and sales of new homes also fell.
Then there is the stock market. This year, the broad-based S&P 500 is down about 17% and the Nasdaq, which is in a bear market, is down about 25%.
Later this week, the Commerce Department will release its quarterly economic growth bulletin. During the first three months of the year, the gross domestic product fell by 1.4%.
“There is plenty of evidence that economic growth has slowed in the first half of this year,” says Ryan Wang, US economist at HSBC.
Economic numbers are hard to process
But there is no clarity in the data.
Michael Gapen, head of US economic research at Bank of America Securities, says “cross-currents” make these numbers difficult to process.
“When you have data points that conflict with each other, you have to ask yourself, ‘Which ones do you believe?'” he says. “Trust the instruments you believe in.”
Economists know that distortions in data tend to diminish over time. The US Department of Labor is revising its monthly employment figures, for example, and the GDP figures we will have on Thursday are only the Commerce Department’s first estimate.
But right now, it’s hard for Powell and his colleagues to be patient. Inflation has become a political issue because rising prices weigh so heavily on consumer morale.
According to a recent Morning Consult/Politico poll, 65% of registered voters think the US economy is currently in a recession. This is despite the fact that a recession has not been declared by the National Bureau of Economic Research, the nonprofit group that officially makes this decision.
“Doing nothing at this point – not getting the inflation problem under control – probably means it’s even harder to correct course later,” says Gapen. “If inflation becomes entrenched and long-term inflation expectations rise, history says breaking this spiral is much harder and the downturn would likely be much deeper.”
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Some prices drop
Like Powell, economists scour the data, looking for signs that Fed policies are working.
Michelle Meyer, chief U.S. economist at the Mastercard Economics Institute, sees promising signs.
Oil is trading lower and gasoline prices have fallen. According to AAA, the average price of a gallon of regular gasoline is $4.33, about $0.69 lower than its record high set in June.
“If you look at a wide range of commodity prices in the markets, they start falling,” Meyer said. “Inventory levels are starting to rise for certain categories. Supply chains are starting to open up, so the cost of production is coming down.”
This data can give Powell confidence that what he and his colleagues are trying to design works.