[Economics] Guggenheim Investments warns: the Fed and the US economy are like two trains that are going to collide

[#Wittels-]

One train is the aggressive adjustment plan telegraphed by the Federal Reserve"
"The other is the US economy and the signs of a slowdown"

 

The word recession is everywhere. Threats to the economy have multiplied in a matter of months, while the central bank has set its sights on inflation. This confluence of factors means that the global economy is going to face a restrictive monetary cycle while dealing with threats of all kinds. This time the central banks will not be there to cushion the economic impact, inflation prevents them from coming to the rescue as they have done in recent times, so the recession seems an inevitable cost to avoid a major catastrophe,

The expansionary cycle that began after the deep recession of covid has generated a somewhat unique situation in the economy. The strong and sudden recovery has been accompanied by an unexpected guest: the explosion. The price increase was unleashed when the economy had not yet recovered the GDP levels prior to the covid, so the central bank kept maintaining all the stimuli deployed despite the fact that with each CPI data things got uglier. With such bad luck, moreover, that when the Federal Reserve decided to act, growth began to slow down (GDP even fell in the first quarter of the year in the US). Now, with inflation still near highs, the Fed has no choice but to continue to tighten while the economy loses steam.

 

a train collision
"If two trains go towards each other at different speeds, when will they collide?" Guggenheim Investments asks in a letter in which they mark the editorial line of the investment house.

"This elementary arithmetic problem exemplifies the execution of the monetary policy of the Federal Reserve (Fed). In this case, one train is the aggressive adjustment plan telegraphed by the Fed, and the other is the US economy, which, although it continues to Being strong, it shows some signs of cooling. Investors want to know when the collision will happen: a recession, "say the economists of this financial firm.

The Fed's dual mandate calls for full employment and price stability. Historically, the Federal Reserve moved short-term interest rates (known as the fed funds rate) in response to changes in the unemployment rate and in inflation. Normally, when unemployment fell and inflation rose, the Fed would react quickly by raising interest rates. When the opposite happened, the Fed lowered interest rates.

 

However, over the last year there has been a notable divergence in this relationship. The sharp drop in unemployment and sharp acceleration in inflation were met by an unresponsive Federal Reserve. This break in the typical Fed reaction can be attributed to the unique nature of the pandemic shock, the new Fed policy, and a misinterpretation of rising inflation as transitory, say experts at Guggenheim Investments. "The result is that the Fed, as it now acknowledges, is well behind the curve and has to move quickly with 50 basis point hikes to keep inflation expectations in check and protect its reputation."

The problem is that the Fed has started to support its policy at full speed, just when the economy is slowing down. For the experts at Guggenheim Investments, this is like two speeding trains heading for a head-on collision. The Federal Reserve's delay in acting has not only put inflation expectations at risk, but is also now leading the US economy into a new recession.

"If the Fed had followed the historical pattern, the fed funds rate would be in the 2.5% zone now and the Fed could start to lower the price of money as the economy cools. Instead, now the The Fed appears poised to raise rates to 3.5% next year as inflation slows and the unemployment rate stabilises," the Guggenheim Investments letter explains.

 

The big risk is that both events will coincide at the same time. A more restrictive monetary policy will reduce credit, weigh down consumption and affect the price of assets (shares, housing...), which in turn will have second-round effects on consumption and investment: "The risk that The Fed overshoots will grow, causing a financial crash and starting a recession. An asynchronous monetary stance should exacerbate the cyclical slowdown in the economy and trigger a recession as early as the second half of next year," economists at Guggenheim Investments say.

 

Link: https://www.eleconomista.es/mercados-cotizaciones/noticias/11792166/05/22/Guggenheim-Investments-avisa-la-Fed-y-la-economia-de-EEUU-son-como-dos-trenes-que-van-a-colisionar.html