Reason Roundup

Recession 'Virtual Certainty' as Interest Rates Spike

Plus: Libertarian Party drama, how rent control hurts renters, and more...

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man holding empty wallet | imageBROKER/Isai Hernandez/Newscom
(imageBROKER/Isai Hernandez/Newscom)

Interest rates are now 1.5 percentage points higher than they were a few months ago. On Wednesday, the Federal Reserve raised interest rates by three-quarters of a percentage point, following a 0.5 percentage point increase in May and a 0.25 percentage point increase in April.

Yesterday's rate increase is the single biggest interest rate hike since 1994.

And this isn't even the ceiling, said Federal Reserve Chairman Jerome Powell at a Wednesday press conference. Americans can expect "ongoing rate increases," Powell said, and "either a 50 or 75 basis point increase seems most likely at our next meeting."

The Fed didn't think it would come to this. Back in May, Powell said "seventy-five basis points is not something the committee is actively considering."

"By this point, we had actually been expecting to see clear signs of inflation flattening out and ideally beginning to decline," Powell admitted yesterday. "Contrary to expectations, inflation surprised to the upside. We thought that strong action was warranted at this meeting in the form of a 75 basis point rate hike."

The goal, of course, is to combat the rampant inflation we've been seeing.

"Inflation remains well above our longer-run goal of 2 percent," said Powell in his opening statements. "Over the 12 months ending in April, total [personal consumption expenditures, or PCE] prices rose 6.3 percent; excluding the volatile food and energy categories, core prices rose 4.9 percent. In May, the 12-month change in the Consumer Price Index came in above expectations at 8.6 percent, and the change in the core CPI was 6 percent."

"Aggregate demand is strong, supply constraints have been larger and longer lasting than
anticipated, and price pressures have spread to a broad range of goods and services," Powell said by way of an explanation. And, in response, the Federal Open Market Committee has "revised up" its inflation projections. "The median projection is 5.2 percent this year and falls to 2.6 percent next year and 2.2 percent in 2024," said Powell.

Meanwhile, the Biden administration still refuses to try and halt inflation through smart policy changes, like repealing tariffs on steel and aluminum (or any/everything else) and cutting federal spending. And, at the same time, it's pushing policy changes—like expanding antitrust action—that could make inflation worse. Instead, all hopes are pinned on interest rate changes—recession potential be damned.

"By raising rates from near zero at the start of the year, the central bank is making it more expensive for businesses and people to borrow money," writes Allison Morrow at CNN Business:

Which obviously sucks if you're a business owner looking to expand or if you're looking to buy a home, or take out any kind of loan for any kind of reason in the near term.

Life's already so expensive, and now you're going to jack up the interest rate on my credit cards, Jay? What, I'm supposed to just stop shopping now?

And the answer is yeah, pretty much.

So the powers that be hope higher interest rates mean less demand and, eventually, lower prices.

But this strategy comes with risks. Which is why one can find recession predictions all over the place right now.

"It's a virtual certainty that we're going to go into recession next quarter," Destination Wealth Management's Michael Yoshikami told CNBC, adding that he expects it will be a "shallower recession."

A June survey of 49 U.S. macroeconomics experts found two-thirds expect an economic contraction to happen within the next year.

The Fed insists that there's "no sign" of a wider downturn and Powell yesterday noted some economic upsides:

"The labor market has remained extremely tight, with the unemployment rate near a 50-year low, job vacancies at historical highs, and wage growth elevated," he pointed out. "Over the past three months, employment rose by an average of 408,000 jobs per month, down from the average pace seen earlier in the year but still robust."

Nonetheless, there's a lot of doom and gloom coming from financial experts and investors at the moment.

"The economy is going to collapse," Michael Novogratz, CEO of of the cryptocurrency-focused Galaxy Investment Partners, told MarketWatch. "We are going to go into a really fast recession, and you can see that in lots of ways. Housing is starting to roll over. Inventories have exploded. There are layoffs in multiple industries, and the Fed is stuck," having to "hike [interest rates] until inflation rolls over."

"They are hiking into the popping of a bubble," Novogratz said.

"Wells Fargo & Co. now forecasts a 'mild recession' starting in mid-2023," notes Bloomberg. "Meanwhile, Moody's Analytics said that chances of a soft landing are lower."

A "growing number of economists have recently said a contraction next year would be difficult to avoid," it adds. "Wells Fargo's Jay Bryson said he was expecting a soft landing just a week or so ago -- but now his base scenario is for a mild recession."

"The Federal Reserve is going to hike interest rates until policymakers break inflation," Ryan Sweet of Moody's Analytics said in a research note, "but the risk is that they also break the economy."

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