Fed’s High Wire Inflation Fighting Effort Risks Triggering a Recessionary Fall

Imagine a high-wire act performed without a net.  That describes the Federal Reserve’s effort to curb inflation without crashing the economy.  Success will bring applause and relief; failure, a brief downturn, at best, with a prolonged recession the worst case outcome. 

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Critics have sometimes complained that the Federal Reserve’s policy announcement are difficult to fathom. But there was nothing opaque about  the message Fed Chair Jerome Powell delivered following the January Federal Open Market Committee (FOMC) meeting: The Fed is going to begin raising interest rates in multiple steps beginning in mid-March.

“This is going to be a year in which we move steadily away from the very highly accommodative monetary policy that we put in place to deal with the economic effects of the pandemic,” Powell told reporters. 

While he didn’t specify how large the rate increases will be or how quickly they will come, Powell  did suggest the possibility that rates might jump in consecutive FOMC policy meetings, which are held approximately every  six weeks.

The central bank slashed short-term interest rates to near zero in 2020 and has held them there since, while increasing bond purchases, to help insulate the economy from the effects of the pandemic

 

Changing Policy Direction

When inflationary pressures surfaced last year (the 4.9 percent year-over year annual rise was the steepest in almost 30 years), Fed officials insisted initially that the surge was  temporary and would soon subside.  But when consumer prices continued to rise – spurred in part by supply-line disruptions – Fed officials began to worry.  And when employee wage gains threatened to spur a damaging wage-price spiral, they shifted policy course, laying the ground work for the rate hikes Powell announced in January.

“I don’t think it’s possible to say exactly how this is going to go,” Powell said in his press conference, having noted earlier, “I think there’s quite a bit of room to raise interest rates without threatening the labor market.”

The minutes of the December FOMC meeting indicated that Fed officials have discussed three quarter-percentage-point interest rate increases this year and three more next year, based on the assumption that inflation will ease significantly  by the end of this year. Since the December meeting, Powell told reporters, the inflation picture has worsened “slightly….To the extent that the situation deteriorates further, our policy will have to address that,” he said.

 

Employment Gains

Many analysts predicted that a weak January employment report, which was widely anticipated, would force the Fed to slow its rate-hiking timetable.  But the report was much  stronger than expected.  Nonfarm payrolls surged by 467,000 for the month, while the unemployment rate edged slightly higher to 4 percent.  That gain came despite the impact of Omicron, which forced a record 3.6 million employees – about 2.6 percent of the nation’s work force - to call in sick. 

Omicron notwithstanding, a strong economic recovery last year added 6.7 million workers to employer payrolls, the largest one-year gain in history. Although the January unemployment rate increased a bit, the long-term unemployment rate (reflecting workers unemployed for at least six months) declined by more than 300,000, accounting for about 26 percent of the unemployment total, down from 31.7 percent in December of last year. 

“Overall the job market is strong, particularly in the face of omicron,” Kathy Jones, chief fixed income strategist at Charles Schwab, told the Wall Street Journal. “It’s hard to find a weak spot in this report.”

 

Jagged Path for Housing

The same can’t be said for the housing market, which  followed a jagged path last year, rising for several months, losing ground during the traditionally busy spring buying season, rebounding in the fall and then slipping again in December, falling 4.6 percent below the November pace.

Despite that year-end decline, December’s annualized sales pace totaled 6.12 million transactions, up 8 percent year-over-year and a 15-year high.  Inflation fears, rising mortgage rates and rising prices deterred some buyers, but the prospect that rates will move higher as the Fed  focuses on inflation motivated many more buyers to remain in the market, analysts said, keeping overall demand strong. 

After increasing (unexpectedly) in October, pending sales slipped in November, December and January, as buyer demand collided with limited supply and rising prices intensified affordability pressures. The supply of homes for sale sank to an   all-time low (910,000 units) in December, Zillow reported, down more than 14 percent for the year. 

"Home shoppers picked the shelves clean this December, leaving fewer active listings than ever before in the U.S. housing market," Zillow’s senior economist, told reporters.  Jeff Tucker, Senior Economist at Zillow.

 

Demand vs. Supply

Reflecting intensifying buyer competition for scarce listings, Redfin reported that more than half of the homes listed by Redfin agents that went under contract in January had accepted offers within two weeks of being listed; 40 percent had offers after only a week on the market. 

That supply-demand imbalance continued to push prices skyward.  The National Association of Realtors (NAR) reported that  the median price of homes sold in January jumped by more than 16 percent year-over-year, reaching an all-time high of $365,000.

Looking ahead, Yun said he anticipates “neither a price reduction nor another year of record-pace price gains.  The market will see more inventory in 2022,” he predicts, “and that will help some consumers with affordability,  but it won’t make much of a dent in an inventory shortfall that, Yun said, “has been building for many years and will take years to correct.” 

Redfin analysts see a continuing footrace between rising prices and buyer demand, with demand prevailing the first half of the year, but rates taking the lead by this summer.  For now, a Redfin report notes,  the supply-demand imbalance “is pushing home prices up and up, because there are enough eager buyers to rapidly buy up nearly ever hoe that hits the market.  [But] by this summer, higher prices and [higher] rates may cause buyers to pull back from the market.”