‘Financial markets are throwing in the towel’: Recession fears escalate as Fed slams brakes on the economy

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Economists say the prospect of increasingly higher interest rates has heralded another recession within a year. Yet some still expect the US to grapple with a period of slow growth rather than an outright decline.

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In a move widely expected by financial markets, the Federal Reserve last week planned another major hike in US interest rates. The central bank’s aggressive forecast for even higher rates in the coming year was unexpected.

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The surprising forecast triggered a major downtrend in the stock market DJIA,
-0.43%

spx,
-0.21%
As the realization sinks in, the Fed is determined to eliminate the highest US inflation in 40 years – no matter the cost.

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And costs are likely to be bearish sharply, analysts say.

“The risk of a recession in the next year has now climbed above 50%,” said Douglas Porter, chief economist at BMO Capital Markets.

Business leaders also seem worried. Financial research firm Grant Thornton found that a survey of chief investment officers shows 72% think higher rates will lead to a recession.

The Fed last week raised a key short-term interest rate by three-quarters of a percentage point to a top range of 3.25%, and forecast another 1.25 point increase by the end of the year, giving the fed-funds rate 4.5. reached. ,

He is not everything. The Fed predicted that its benchmark short-term rate would climb to 4.75% in 2023 – and perhaps even higher – in a frontal attack on inflation. Inflation has risen to 9.1% from a low of 2% two years ago.

“I wish there was a painless way to do this,” Fed Chair Jerome Powell said after announcing the latest rate hike on September 21. “It’s not like that.”

Higher interest rates generally slow down the economy by making it more expensive for people and businesses to borrow money.

Till now, most of the pain caused by high rates has been experienced by new and potential home buyers. For example, the rate on a 30-year mortgage is moving from a low of 3% a year ago to 7%. Home sales have slowed since then.

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Higher rates also mean that it costs more to buy a car, replace equipment, repair a home or keep a credit card balance.

If consumers cut spending, businesses are likely to react as they usually do by hiring or even laying off workers. They will also borrow less and stop making new investments.

The result: economic “pain,” as Powell predicted.

“The Fed may have to accept a prolonged slowdown in the economy, if not a mild recession,” said Steven Ricciutto, chief economist at Mizuho Securities, in a note to clients.

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US stock markets sank last week – and equities fell again on Monday – following this new reality.

Ahead of last week’s Fed actions, many investors were hopeful that the central bank might ease up and cut interest rates next year to support a slowing economy.

“Financial markets are throwing in the towel, now fully convinced that the Fed will do whatever it takes to contain inflation, including bringing a recession,” said Bob Schwartz, senior economist at Oxford Economics.

Now some, including Schwartz, worry that the Fed may be going too far.

“Looking at the past, the Fed runs the risk of raising rates higher than necessary to accomplish the task,” he said.

Economists say high inflation is not as prevalent in the economy today as it was in the 1970s and 1980s, when the Fed launched two recessions in its fight to ease price pressures.

Powell has often approved of the Paul Volcker-led Fed and its fight against inflation four decades ago. But times are different, others point out.

For one thing, a much smaller unionized labor force means workers cannot demand and receive higher wages. And the supply shortfalls caused by the pandemic that initially triggered the rise in inflation are beginning to fade.

This is why a shrinking but still large number of economists think a recession is avoidable.

JPMorgan’s chief US economist Michael Feroli is sticking to his forecast that the economy will hit a recession, if barely. The Fed would be able to halt its rate hikes, he argued, if inflation slowed faster than expected.

“We are sticking with a soft landing,” he wrote in a report, referring to the Goldilocks scenario in which the Fed is able to reduce inflation without inducing a recession. However, this is a goal the Fed has rarely achieved.

Credit: www.marketwatch.com /

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