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The Federal Reserve’s ongoing attempts to stuff the inflation genie back in its bottle will slowly trickle down into the jobs market and trigger a recession before the year is out, warns J.P. Morgan.
The Wall Street bank’s chief U.S. economist Michael Feroli expects the Fed is prepared to stifle growth and destroy demand in order to ensure expectations of continued price increases in the medium term do not take root among American businesses and consumers.
“I don’t think it’s going to be a very happy year,” he told Bloomberg TV. “We are expecting the economy to slip into recession by the end of the year just due to the lag effect of the tightening in financial conditions that the Fed has engineered here as well as the additional rate hikes they’re signaling.”
Last year the Fed went from stoking inflation through zero interest rates and monthly bond market purchases at the start of 2022, to eventually hiking rates by 75 basis points at four consecutive policy meetings.
Eventually, Fed chair Jay Powell brought the Fed funds rate to a full 4.5% in order to clamp down on 9%-plus inflation rates.
In the process, risk assets crashed with the S&P 500 shedding nearly a fifth of its value, its worst performance since the 2008 global financial crisis, while unregulated crypto coins and tokens took a nosedive along with their digital collectible cousins, NFTs.
Investors are hoping to see the Fed finally pivot from applying brakes to the economy to stepping back on the accelerator by cutting rates.
That’s because many have been conditioned to think the Fed will always be there to bail them out ever since Alan Greenspan took over as Fed chair from inflation slayer Paul Volcker in the early 1980s.
The so-called “Greenspan put” counteracted persistent stagnant wage growth by making Americans feel wealthier by inflating the value of their assets—stocks, bonds and real estate.
Overheating economy
As long as globalization and offshoring kept a lid on pricing pressure, the strategy of adding more and more stimulus worked. But it encouraged leveraged one-sided bets by speculators that lead to the creation of the 2000 dotcom bubble, the 2006 housing bubble and finally the 2020 “stonks” bubble.
The COVID pandemic’s effect on just-in-time global supply chains combined with Russia’s war in Ukraine however sparked a return in inflation to levels not seen since the 1970s, and that’s why Feroli believes maneuvering room this time is minimal.
The J.P. Morgan economist forecasts U.S. consumer price rises will not return towards the Fed’s 2% target rate until probably the earlier part of next year.
“Just given the severity of the inflation problem that we’re dealing with, they realize the risk of over-tightening here is just something they have to swallow and stomach because the risk of unanchoring inflation expectations is still there,” he explained. “I think the message you got here today is more hikes are coming.”
Not only are they coming, but Feroli believes the Fed will hold rates at their ultimate peak for possibly a full year. Powell’s chief concern is a vicious circle of spiraling inflation leading to rising wage demands that feed through to yet higher prices.
To break that negative feedback loop, he needs to anchor inflation expectations firmly in place by dousing an overheated U.S. economy with cold water.
“We still have industrial production near the highs of the cycle we still have home construction near the highs of the cycle, so we really haven’t seen the effects of higher mortgage rates, of a stronger dollar really hit,” Feroli explained.
“The labor market hasn’t cooled in a convincing way and wage growth remains pretty strong.”
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