Federal Reserve Chairman Jerome Powell speaks during a news conference in Washington, DC May 4, 2022.
Jim Watson | AFP | Getty Images
Has the Federal Reserve effectively completed its tightening cycle, despite the fact that central bank officials, most economists and some high-profile Wall Street commentators just don’t realize it yet?
There is anecdotal and statistical data showing that recent central bank rate hikes and the end of quantitative easing are already slowing the economy and potentially dampening ongoing inflationary pressures.
The Fed is expected to start quantitative tightening in June, but one wonders whether a shrinking of the central bank’s balance sheet will be necessary after the economy appears to be picking up with only a modest nudge from policymakers.
As I mentioned earlier, there is no lag between the implementation of the Fed’s policy changes and the impact on the real economy. This fact is happening in real time today.
Possible signs of cooling appear
Housing construction, the most interest rate sensitive sector of the economy, has already expanded in terms of mortgage applications, pending and actual home sales, both existing and new.
Lumber prices, which rose twice last year, have plummeted for the second time in less than a year.
Retailers are also reporting bloated inventories of consumer goods. Walmart, for example, recently reported cost pressures related to higher inventory levels, overstaffing and higher fuel prices. Higher discounts and lower-than-expected merchandise sales also impacted Target’s first-quarter results.
Jobless claims have edged up slightly in recent weeks, albeit remaining low by historical standards.
In addition, higher costs eat into profit margins and potentially change consumer spending habits. These are factors behind many of the disappointing corporate results we’ve seen.
Also, China’s economy, which may be shrinking, is holding back global growth, and manufacturing activity in Europe has suddenly slowed.
Incidentally, the US is expected to grow faster than China in 2022 for the first time since 1976.
The Federal Reserve Bank of Atlanta’s second-quarter GDP estimate shows the US economy recovering from a first-quarter contraction to an annual growth rate of 1.8%. Incidentally, that’s down from a 2.4% growth rate that was expected just a week ago.
Finally, inflation expectations have also fallen sharply, with 5-year and 10-year breakevens collapsing in recent weeks.
Fiscal stimulus is drying up
Fiscal stimulus, which helped in part to generate the surge in inflation we have seen since the depths of the pandemic, is also fading.
In the absence of a nearly $2 trillion “Build Back Better” plan, the termination of a generous child tax credit, the cessation of expanded unemployment benefits (the latter of which is appropriate given the unemployment rate near record lows), and a whopping decline in the face of the FY2022 budget deficit, one could argue that fiscal policy is now even more restrictive than monetary policy on a relative basis.
The federal budget deficit was $360 billion through April, a fifth from the same period in 2021. It’s on track to show the largest annual decline in the deficit ever — albeit from record levels.
In short, last year’s tailwind has turned into this year’s headwind.
Perhaps the Fed is closer to the finish line than anyone is currently suggesting.
I’ve long held the view that it would be impossible for the Fed to get its interest rates much higher than 2% in a world effectively leveraged to zero interest rates.
While that’s about double the current benchmark rate, the Fed has committed to raising its target rate to at least 2% at the next two meetings.
We’re halfway there and will probably reach that level before the summer is over.
It is true that China needs to reopen and start shipping goods, and that the war in Ukraine needs to end to ease the pressure on energy and food prices. However, the central bank may already have done what it can to weaken demand while we wait for supplies of commodities and finished goods to return to normal.
If anyone at the Fed should publicly voice such a notion, wait for the stock market to get off its funk and start a new run.
If not, this bear market still has legs and will continue to fall until a new bull can bounce back.
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