The Federal Reserve has tackled its battle against inflation in 2022, with Chairman Jerome Powell saying price stability is now “unconditional” even if the path to get there is not “painless” for Americans .
The central bank raised interest rate five times this year, marking the fastest pace of rate increases since the 1980s.
It’s a hawkish turn that came after a series of criticisms from Wall Street and top economists, who repeatedly argued that Fed officials were wrong to claim inflation was “transitional” in 2021.
Economists like former Treasury Secretary Larry Summers and the president of Queens’ College at the University of Cambridge, Mohamed El-Erian, believe the Fed burst an asset bubble and exacerbated inflation when it extended supportive policies designed to ensure a strong long-term economic recovery. after pandemic restrictions ended last year.
Now, however, a new chorus of critics is beginning to emerge from Wall Street. The one that warns, not against the risk of excessive inflation and an overly accommodating monetary policy, but rather against the risk of recession in a context of excessive tightening of financial conditions.
“We continue to believe the Fed is making yet another policy error,” said Jay Hatfield, CEO of Infrastructure Capital Management. Fortunearguing that central bank interest rate hikes are now too aggressive.
Hatfield said the Fed is “lagging the curve” – raising rates even as inflation slows – because it focuses on lagging indicators like the jobless rate, inflation expectations and inflation. consumer price index (CPI).
He argues that central bank officials should instead use “leading indicators” like money supply, exchange rates and energy prices, noting that Fed policies have already led to “a collapse” in commodity prices since June, soaring mortgage rates and a major drop in the stock market.
On top of that, the Fed has already cut money supply by 15% this year as it continues to shrink its balance sheet, which has ballooned to nearly $9 trillion during the pandemic, Hatfield said. It’s the fastest decline in the US money supply since the Great Depression.
The Fed has used a policy called quantitative easing – which involves buying mortgage-backed securities and government bonds to increase the money supply, thereby boosting lending and investment – to help stimulate the economy. after the pandemic. But now it has reversed the script, opting to shrink its balance sheet and reduce the money supply through quantitative tightening in its fight against inflation.
“The impacts of the 15% decline in base money are very likely to cause inflation to fall steadily over the next year,” Hatfield said. “Therefore, the current rapid increase in the federal funds rate is unnecessary and significantly increases the risk of a recession in the United States, despite the tailwinds of the end of the pandemic.”
Rick Reider, BlackRock’s chief investment officer at Global Fixed Income, said Fortune that he also thinks the main risk to the economy now is an overly aggressive Fed.
“The risk to the economy today is of the Fed tightening policy too much from here, without allowing the time needed for a very large, broad and flexible economy to adjust to these new levels of interest rate and money flowing through the system,” he said.
However, Reider added that he thinks the Fed could return to a more dovish stance over the next few months that rewards stocks and other risky assets, alluding to what market watchers commonly call a “pivot” of the Fed.
“The Fed should be closer after today to being receptive to signs of inflection points. We think they are and are looking for places to pause and watch their aggressive policy work their way to through the system. There’s a good chance they’ll see these signs in the next few months,” he said.
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