[US]Fed rate hike: Biden's blessing and curse
Wu Lou
Persistently high inflation, the Russia-Ukraine war, soaring food and oil prices, falling real wages, slowing economic growth, concerns about monetary tightening and frequent stock market shocks have been a regular theme in the US economy of late. Against this backdrop, the Federal Reserve voted 10-1 on 15 June to raise its benchmark interest rate by 75 basis points to a range of 1.50%-1.75%, the sharpest rate increase since 1994. The Fed will continue to raise rates for some time to come, and one of the goals of doing so is to convince the American public, as Biden expects, that the Fed is taking charge of the fight against inflation.
On the day of the Fed's rate hike, Biden met with Congressional Democratic leaders Pelosi and Schumer at the White House to discuss addressing inflation. From the White House statement, Biden and the Democrats clearly characterised inflation as a "global issue" that affects every major country. The White House's statement was designed to lead US voters to cut inflation from the effectiveness of Biden's administration and the Democratic midterm elections. A week before the Fed raised interest rates, Biden also claimed that the US was actually the fastest growing economy, but that may not be the case.
These actions by the Biden administration may have been a brief political relief, but the reality of the economic situation remains brutal and grim. Economists, the financial community and business executives generally agree that the Fed's easing of inflation will inevitably lead to a recession in the US, and Biden and the Democrats will inevitably take a hit.
US domestic reaction to interest rate hikes: risky and difficult to land softly
Interest rates were raised, in line with expectations. on 12 June, former US Treasury Secretary LAWRENCE SUMMERS mentioned that the severity of inflation in the US might allow the Fed to extend its aggressive rate hike cycle. On the same day, MOHAMED EL-ERIAN, Dean of Queens College, Cambridge University, UK, and Chief Economic Advisor to Allianz, said that at the current rate, US inflation is likely to reach 9%. Continued inflation will eventually lead the US economy into recession.
Fed officials expect the unemployment rate to rise this year and next, reaching 4.1 per cent by 2024. The Fed's rate hike also revised its policy statement, acknowledging that its efforts to curb inflation will not be painless, removing the previous language that Fed officials expect the "job market to remain strong".
On June 12, former Fed Chairman Ben Bernanke took a more optimistic stance on CNN's "FAREED ZAKARIA GPS" program. He said that as long as supply-side inflationary pressures improve, a soft landing could be achieved. The US economy is likely to be "recession-proof" or only in a "very mild recession". He noted that political support for the Fed's independence would underpin this. However, Bernanke remained optimistic on the premise that "supply chains have improved", that is, "oil and food prices are stable or have slowed down".
Matthew Luzzetti, chief US analyst at Deutsche Bank, said the process of reducing inflation would be far tougher than they had previously expected. Invesco's chief global market strategist Kristina Hooper is hopeful that the US will avoid a recession and that the Fed will succeed in achieving a "soft landing" by being tough enough. However, she acknowledges that the US economy is clearly heading for a significant slowdown and a "soft landing" is becoming increasingly difficult.
Roger W. Ferguson Jr., who served as Fed chairman from 1999 to 2006:
With the Fed now announcing the steepest rate hike in more than a decade, the debate is now whether the US economy will experience a similar recession to reduce inflation or a soft landing to avoid negative growth.
Forces outside the Fed's control are now making this already challenging "anti-inflation" task even more difficult. These include global supply chain disruptions caused by the reopening of the economy after the pandemic; the war between Russia and Ukraine and other geopolitical tensions; rising oil prices; increased recessionary fears among many US trading partners; and uncertainty caused by ongoing epidemic control in economies such as China.
Martin Wolf, an economist who worked at the World Bank in the 1970s and chief economic commentator for the Financial Times:
The global economy today is characterised by similarities to the 1970s. That phase of economic turmoil only ended in the early 1980s, when harsh monetary tightening in the US reduced inflation but also triggered a wave of debt crises in developing countries, particularly in Latin America. According to the World Bank's Global Economic Prospects, published last week, there are a number of mistakes to avoid when comparing the situation now with the 1970s: don't be overly optimistic; don't take hyperinflation lightly.
In the 1970s, in addition to hyperinflation, two wars broke out, the Fourth Middle East War and the Iran-Iraq War, and this time it is the epidemic and the Russo-Ukrainian War. Today, optimists believe that economic growth will return to pre-pandemic trends. However, according to the World Bank: in 2020-30, potential global economic growth is expected to be 0.6 percentage points lower than the average of the 2010s.
There are also dangers associated with the drastic action taken by the Fed, most notably an unnecessarily sharp slowdown and the ensuing economic costs. In the longer term, demographic change, slowing technological change, de-globalisation, the exhaustion of important past growth opportunities and rising populism could weaken the forces of deflation. This will make it more difficult to achieve and maintain the goal of low inflation.
One aspect that is more vulnerable now than it was 40 years ago is the size of the debt stock, particularly in foreign currency terms. Crucially, this does not only apply to emerging and developing countries. For the eurozone members hit by the crisis, the euro is also essentially a foreign currency. If the tightening of US monetary policy is substantial and prolonged, then a chaotic and costly debt crisis is likely to emerge.
What is harder to be optimistic about is that the shock to the real economy is not yet over. The hidden dangers of the virus remain, and no one knows how long the Russo-Ukrainian war will last. Some of the measures being discussed at the moment, notably the ban on marine insurance regarding Russian oil shipments, could lead to further increases in global oil prices. Russia could also cut off its gas exports to Europe, triggering further shocks.
The rich in the US: raising cash, focusing on short-term gains and becoming pessimistic about the economic situation.
The Measure of CEO Confidence, published jointly by the World Federation of Large Companies (Conference Board) and the Business Council in May, has fallen for the fourth consecutive quarter. This quarter's CEO Confidence Index registered 42, down from 57 in the first quarter (an index below 50 indicates a predominance of pessimistic CEOs).
Nearly 60% of CEOs expect inflation to fall in the next few years, with the US experiencing a very short but mild recession and a "reverse soft landing" by the Federal Reserve, while 11% of CEOs expect the US to face a challenging recession. 20% of respondents say inflation will remain high in the next few years and US economic growth will be significant. 20% of respondents said that inflation would remain high and that US economic growth would slow significantly (stagflation) in the coming years.
In terms of geopolitical challenges, more than 1/3 of CEOs said that the Russia-Ukraine war and sanctions against Russia will lead to input shortages and supply chain problems in 2022 and early 2023.
According to a recent survey, some 750 millionaires ranked inflation as the biggest risk to the economy and personal wealth, said NBC Business on 16 June.
Opinions were divided on the Fed's ability to slow inflation or reduce demand without triggering a recession, with 35 per cent of respondents saying they had "no confidence at all" in the Fed's ability to manage inflation. More than a quarter of millionaires believe the US is already in a recession and another 34% believe it will fall into one this year.
The survey shows that about 90 per cent of the stocks held by individuals in the US are held by millionaires. So far, they have not felt panicked or sold off. But given rising interest rates, most companies are raising more cash and putting more money into short-term fixed income investments. Wealthy investors are usually the first to take advantage of falling markets to buy when they fall, as they can afford to take more aggressive action. But so far, there is little indication that they will buy on recent market declines, suggesting that they are not bullish on later market developments.
Fifty-eight per cent of millionaires expect the economy to be weaker or "getting weaker" by the end of the year. Most also expect the S&P 500 to end the year with a double-digit decline: more than half of those surveyed expect the S&P 500 to fall by at least 10%, and nearly a fifth expect it to fall by at least 15%.
The Economist: US inflation conundrum worsens, Democrats next to be hit
Rising prices are arguably Biden's biggest enemy to date. However optimistic Biden himself may be, the grim figures reveal an even more depressing reality: inflation is far from peaking and has major implications for the Federal Reserve, investors and US politics.
The prospect of the Fed putting the monetary brakes on has unnerved markets. Since the inflation data was released, the WSJ 500 has fallen by 5%. From Amazon to Tesla, the sell-off in technology stocks has been even bigger. For some risky assets, the disaster has been far worse, with the price of bitcoin falling by more than 10% on 13 June after cryptocurrency lender Celsius suspended all withdrawals from its platform due to "extreme market conditions". The historical record shows that the US would be "lucky" to avoid a recession when the Federal Reserve tightens monetary policy so aggressively.
The mid-term elections in November are not going well for Biden's Democrats. Very high inflation could be a political disaster, as the Republicans are expected to wrest control of the House and Senate from the Democrats. Biden is trying to divert attention to the millions of jobs that the US has recovered from the epidemic over the past year. But the soaring cost of living and the growing prospect of recession are instead the main concerns.
For the Biden administration, the economic setbacks have only deepened. On the one hand, inflation is not just a US problem. In the UK, prices are rising even faster, reaching a 9 per cent increase in April. From Germany to Australia, inflationary pressures are on the rise. Even Japan, which has long been in deflation, has not been spared. The rapid rise in food and energy prices, caused in large part by the Russo-Ukrainian war, is a global problem. The situation was made worse by the continuing disruption to cross-border supply chains caused by the new crown pandemic. Mark Zandi, an economist at Moody 's Analytics, part of the credit rating agency, estimates that the war in Russia and the lingering epidemic have contributed to nearly two-thirds of the annual inflation rise over the past year.
On the other hand, American voters will be less dispassionate in their analysis of price trends and less forgiving in their assessment of Biden's responsibility. According to a poll calculated by the analysis website FiveThirtyEight, more than 500 days into Biden's presidency, 53.6% of Americans are dissatisfied with his performance, while 39.7% are satisfied with it. the 13.9 percentage point gap is the worst of any president since World War II.
Summing up:
While the Federal Reserve and the Biden administration express optimism, there is great uncertainty about the road ahead. According to economists' analysis, the uncertainty caused by the epidemic and the Russian-Ukrainian war, in addition to technological innovation, anti-globalisation and populism, remain key factors affecting the performance of the US economy. In addition, even if the Federal Reserve does not trigger a recession to curb inflation, raising interest rates will still put pressure on the stock market. The S&P 500 has fallen by more than 20% so far this year. And stock market shocks are bound to affect the economic and life confidence of US investors and voters.
According to current, more pessimistic forecasts, it is unlikely that the US will be able to contain inflation without causing a recession (even if brief). A US recession is likely to occur at the end of the year, in 2023, or even in the election year of 2024. This means that the challenges facing a Biden Democratic administration will be even more daunting, and the chances are that any attempt to consolidate power and win elections by stimulating economic recovery and ensuring steady economic growth will fall flat.