Fed: Recession assessments from Powell

Fed Chairman Powell touched on both the current rate perspective and recession scenarios in his 6-month Senate presentation, which is an explanation of the 75 bps rate hike on June 15. In this environment, the nature and outlines of the July FOMC decision, as well as the question of whether the next direction will lead to a recession, are primarily taken into consideration, and it is thought that this risk will gain weight as the Fed moves forward in rate hikes. Powell’s guidance at the June FOMC meeting suggests the committee could raise rates by another 75 basis points in July. Thus, the Fed will have taken an important step in exceeding neutral federal funds rates, and financial conditions above the equilibrium interest rate will significantly increase the possibilities of recession.

In Powell’s speech after the FOMC, it was revealed that rate hikes of 50 or 75 bps, depending on the situation, could go in series for July and beyond. The fact that short-term interest rates exceed the interest paid on Treasury bonds and mortgage-backed securities is especially questionable in terms of financial composition, because the Fed’s rate adjustments affect debt rates as well as bank rates. The clearest indicator of this is analyzed over the current situation in US bond yields. The issue of using high interest rates to fight inflation is a method that politicians do not find very popular in general. Since inflation is mainly fed by factors such as global supply problems and fuel prices, they are also controversially approaching the issue of whether rising interest rates are a solution at the moment. The first effect of aggressive rate hikes is to reduce demand growth, thus, the effect on the economy is slowing down and, depending on the situation, contractionary. The perspective that Powell and the Fed currently form is based on the economy’s ability to sustain higher interest rates, the higher interest rates will contribute to price stability through a healthier supply-demand balance, and the lower demand inflation thanks to consumers who spend less. It is believed that rate hikes will also strengthen the dollar, thereby reducing inflation driven by import prices.

While choosing to act in line with this perspective, Powell does not exclude some possibilities in his assessments of recession. Powell said it was a “likelihood” for a recession and a soft landing would be “very difficult” to achieve. While Powell stated that the Fed is not trying to cause a recession and there is no need for it, the US economy’s negative growth for a few more quarters after the 1Q22 contraction will create an image that will fully fit the definition of recession, and such a possibility, in combination with cyclical factors, will lead to high-dose rate hikes, especially in the Fed. If it continues, it may appear on the horizon. Stating that the American economy is in a very strong position, Powell thinks the economy is well positioned to manage a tight monetary policy. In this context, it does not seem very likely to take a step back from this tight path, as the evaluations by the Fed still reveal the low probability of the economy entering a recession.

With the rise in crude oil and other commodity prices and the Russia-Ukraine war worsening the situation in energy prices, there is a serious deviating inflation situation. Inflation is now the main objective and the Fed’s perspective of aggressive rate hikes in the near term continues. While the Fed still thought its planning was appropriate, the abrupt plan change from 50 bps before the June FOMC to 75 bps did not indicate the usual guidance. Therefore, since it is not a static plan, but a dynamic plan, the data has the potential to cause flash changes in the direction of the Fed. Acknowledging that it is still far from its inflation targets, the Fed paints a very different picture from its perspective last year.

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