Some funny things are going on with the Federal Reserve. And by funny, I mean like the way you sometimes giggle while watching a horror movie and the monster is about to jump out and devour a bunch of people.
Here's the thing: The Fed right now is wearing blinders, and it only cares about bringing down inflation, my colleague Paul R. La Monica writes.
Jay Powell and Co. are on the warpath, convinced that everyone will be better off in the long run if we accept the pain of higher interest rates — and a possible recession — now rather than let inflation become entrenched. They may be right, but that doesn't mean all of this doesn't suck.
And there is growing concern among economists and analysts who think the Fed is overcorrecting. After all, the central bank spent much of last year playing down the inflation threat as "transitory," a word Jay now wakes up screaming in the middle of the night.
On the Silver Fox's watch, inflation clearly got out of control, and now he's going all Inigo Montoya on it with the biggest sword in his arsenal: interest rates.
Investors are pricing in a high probability of a yet another three-quarters of a percentage point hike at the Fed's next meeting on November 2. That'd be the fourth in a row. Wagers on a fifth such hike in December are also on the rise.
We get it, Jay: You were too blasé about inflation early on and now you're very, very sorry.
But maybe you don't need to go quite so hard? After all: Inflation seems to have peaked at 9% in June; supply chains are healing; and the housing market is cooling significantly.
The Weed Gummy Theory...
There's an analogy offered by investment analyst Peter Boockvar last month that I can't stop thinking about. He compared the Fed to an eager but inexperienced consumer of weed gummies, which, notoriously, take longer than anyone expects to kick in. (Note: Boockvar wanted to be clear that he does not partake, but he's heard things. (I got you, Pete.) )
Anyway, the classic newbie mistake is to eat more gummies before the effects of the first dose have set in, only to find yourself tripping too hard when all of the not-so-groovy feelings hit at once.
Fed vice chair Lael Brainard even nodded to concerns about the long lag effects of rate hikes in a speech this week, noting that "policy actions to date will have their full effect on activity in coming quarters."
In other words, we may find ourselves in 2023 doing the macroeconomic equivalent of curling up in the fetal position on the couch, murmuring to no one in particular that that last gummy was too much, man.
The unintended consequences are hard to predict.
But analysts Paul spoke with pointed to a few areas of concern:
- Credit crunch: The surge in interest rates could lead to a "consumer credit crunch being more pronounced," said Michael Weisz, president of investment firm Yieldstreet. That means loans, including mortgages, would become more expensive and harder to get.
- Bankruptcies: Rate hikes make it more expensive for companies to pay down debt, increasing the risk of corporate bankruptcies and defaults.
- Stagflation: The rather ugly one-two punch of stagnant growth and higher prices. Think wages going down, more people unemployed, but prices stay elevated.
Bottom line: "The Fed runs a real risk of over-tightening, as the impacts of the restrictive policy may not flow through inflation and unemployment data until it's too late," Weisz said.
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