This week in Bidennomics: The killjoy Fed

If Donald Trump were still president, the Fed would be torn apart. President Biden, for his part, is keeping his mouth shut. But he can’t be happy about a dismal Fed that refuses to celebrate the steady improvement in inflation.

On December 13, markets rejoiced as the monthly inflation report showed a better-than-expected decline, from 7.7% annual inflation in October to 7.1% in October. The details were broadly encouraging. The price of goods has been stable as Americans have shifted spending back toward services, back to pre-COVID standards. Gasoline prices have fallen and are likely to fall further. Used car prices, which rose at an insane rate of 41% in January, are finally starting to fall.

Stocks rallied on the inflation news, as it suggested that the Federal Reserve may be able to ease a bit soon due to its rapid monetary tightening. Since raising interest rates for the first time in March, the Fed has raised interest rates by about 4 percentage points, one of the fastest tightening cycles in its history. The Fed had sent another cable to raise a half point on December 14th, which is what happened. So far, so good.

But the Fed’s public statement and Chairman Jerome Powell’s remarks after the increase suggest that the Fed is the last group in town to find inflation news encouraging. The Fed’s rate hike committee projected higher rates for 2023 than they did a few weeks ago, and indicated that they don’t think a new round of interest rate cuts will begin until 2024. That’s a more hawkish stance than markets expected. “Restoring price stability will likely require maintaining a restrained political stance for some time,” Powell said on December 14.

Markets fell for the rest of the week, with the S&P 500 (^GSPC) down more than 5% since the moment Powell started his speech on Dec. 14. Disappointment has become familiar. Since the summer, improving inflation prospects have gradually tricked the market into hollow highs that the Fed immediately chokes on with its next rate move. “This should be over soon,” Mr. Market seems to be thinking, before the Fed comes in and says, “No, this isn’t going to end anytime soon.”

Story continues

[Follow Rick Newman on Twitter, sign up for his newsletter or sound off.]

The risk is not just waiting too long for inflation to normalize and for the Fed to stop rising. Fed tightening could end up causing an economic slowdown too much, an outright recession, or a recession too bad. “Stocks Swing As Recession Fears Grow,” the Wall Street Journal headline cracked on Dec. 16, capturing gloom among investors.

Forecasters are now lowering their forecasts for 2023 and beyond, based on the Fed not seeming to care if it triggers a recession, if that is what it takes to crush inflation. In a December 16 report, Bank of America predicted a “policy error” caused largely by the Fed and other central banks, which would lead to “a sharp fall on Main Street.” Second-tier economists said, “It seems that unemployment, savings, late payments and default rates will rise sharply.” They also noted that while the current unemployment rate is 3.7%, the average for the past 50 years is 6.2%, and the Fed may not mind pushing it that high again, to slow wage growth and cut spending.

The Fed’s outlook now is for another half-point rate hike in February, followed by a quarter-point increase in March. So the Fed could pause for a while to see if it has tamed inflation for good – or done too much damage. The image gets blurrier after that. Many forecasters believe that the Fed will slow the economy so abruptly that it will have to start cutting interest rates again in late 2023, as a new form of stimulus. The Fed doesn’t see it that way yet – but it can change its mind as circumstances warrant.

Trump would chase the Fed whenever he backtracked with his first policies by raising interest rates to slow growth when Trump wanted a hot economy that would boost his re-election odds, for example. According to one statistic, Trump has bashed the Fed 100 times on Twitter alone, even though the Fed’s tightening under Trump has been moderate and short-lived.

Biden vowed to leave the Fed alone and not subject it to political pressure. But he must have doubts about whether the Fed is going too far, given that many economists do. “The US economy will need a lot of luck to avoid a recession next year because the headwinds are about to intensify,” Oxford Economics advised clients on December 16. [rates] More than we or the financial markets can expect.”

There are already signs that higher rates inhibit growth. Retail sales are slowing. Consumers are spending less on the savings they accumulated during the coronavirus downturn. Industrial production has fallen for four consecutive months. A few more months of this could point to an actual recession.

It is not known in real time if the Fed is tightening too little, too much, or just the right amount, because it takes months for the Fed to dose up the economy. Inflation can be harmful, so the Fed may have decided it was safer to take the risk of overdoing it than underdoing it. Next time inflation seems to be improving, remember that the most important arbiter of that might see things differently.

Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @employee

Click here for policy news on business and finance

Read the latest financial and business news from Yahoo Finance

Download the Yahoo Finance app for apple or android

Follow Yahoo Finance on Twitter TwitterAnd the FacebookAnd the InstagramAnd the FlipboardAnd the linkedinAnd the YouTube