The Fed’s Three Stage Process: Avoiding a Hard Landing or Risking Recession?
By The U.S. Federal Reserve (Fed) is currently in the middle of a three-stage process where the central bank is reducing the pace at which it is hiking rates and reaching a stage of neutrality.[0] At this point, the Fed is faced with the risk of reaccelerating inflation and is attempting to bring inflation back to its 2% target.[1] To do this, the Fed has shifted its rate hikes to a slower pace and raised the federal funds target range by 25 basis points to 4.5–4.75%.[2] However, markets are pricing in rate cuts in the second half of 2023, suggesting investors do not believe the Fed.[3]
Fed Chairman Jerome Powell has expressed concern about the risk of over-tightening and said that the Fed needs “substantially more evidence” that inflation is on a real downward path.[2] He noted that the disinflationary process has begun and is visible in the goods sector.[4] Despite this, investors remain unconvinced, with the riskiest assets doing especially well on the news.[5]
The Fed's recent actions suggest that the central bank is attempting to avoid a hard landing later on by overshooting to make sure it conquers inflation.[6] However, some analysts suggest that the Fed is declaring victory too soon and that investors may be misreading the outlook for inflation.[7] Prices are moderating but services inflation and shelter inflation are still running hot, and Fed funds futures suggest that the central bank will end its tightening streak by June and predict that it will ease interest rates by half a percentage point by the end of the year.[8] This outcome is at odds with the Fed’s own verbal guidance and with its summary of economic projections.[8] Thus, the risk remains that the Fed may trigger a deep economic recession by overtightening.[9]
0. “A Type of Trading That Works Despite Market Volatility” Rogue Economics, 1 Feb. 2023, https://www.rogueeconomics.com/inside-wall-street/a-type-of-trading-that-works-despite-market-volatility/
1. “On My Mind: Fed To Markets – Keep Dancing” Seeking Alpha, 3 Feb. 2023, https://seekingalpha.com/article/4574980-on-my-mind-fed-to-markets-keep-dancing
2. “Mortgage rates tumble again despite a hawkish Fed” HousingWire, 2 Feb. 2023, https://www.housingwire.com/articles/hawkish-fed-couldnt-curb-market-optimism-and-mortgage-rates-tumbled/
3. “Trying to Make Apple Juice from Oranges: The Problem with Comparing Market Pricing and Fed Projections” Advisor Perspectives, 1 Feb. 2023, https://www.advisorperspectives.com/commentaries/2023/02/01/trying-to-make-apple-juice-from-oranges-the-problem-with-comparing-market-pricing-and-fed-projections
4. “Just one more cut to come for the Fed?” FXStreet, 3 Feb. 2023, https://www.fxstreet.com/analysis/just-one-more-cut-to-come-for-the-fed-202302030915
5. “When the Fed's suspected of bluffing, it has a problem” The Business Standard, 5 Feb. 2023, https://www.tbsnews.net/bloomberg-special/when-feds-suspected-bluffing-it-has-problem-580406
6. “Friday’s Market Minute: Stocks and Bonds Paint a Very Different Picture” Benzinga, 3 Feb. 2023, https://www.benzinga.com/markets/23/02/30708971/fridays-market-minute-stocks-and-bonds-paint-a-very-different-picture
7. “Analysis: Wall Street shrugs off ‘Fed's tough talk' to cheer smaller hikes” Crain's Cleveland Business, 1 Feb. 2023, https://www.crainscleveland.com/economic-outlook/analysis-wall-street-shrugs-feds-tough-talk-applauds-smaller-hikes
8. “Wall Street is ignoring the Fed. That could be dangerous” erienewsnow.com, 27 Jan. 2023, https://www.erienewsnow.com/story/48247551/wall-street-is-ignoring-the-fed-that-could-be-dangerous
9. “Market vs Fed” Philstar.com, 29 Jan. 2023, https://www.philstar.com/business/2023/01/30/2241107/market-vs-fed
