JACKSON HOLE, Wyoming, Aug 27 (Reuters) – U.S. economic growth, still running at a potentially inflationary pace as other major parts of the world slow, is on the way if it prompts Federal Reserve officials to raise interest rates higher than currently expected. If forced, a global risk can arise.
The Fed’s aggressive rate hikes last year were expected to put pressure on the global financial system as the US dollar soared, but were carried out by monetary authorities to prevent largely synchronized central bank rate hikes and widespread dollar funding problems for companies. The effect was mitigated by other actions. Balance the effect of weaker currencies.
Now that Brazil, Chile and China have begun cutting interest rates, with others expected to follow, the action taken by international officials and central bankers at last week’s Jackson Hole conference is largely based on this. based on expectations that the Fed would not raise its rate by more than an additional quarter percentage points.
While U.S. inflation has fallen and policymakers largely agree they are nearing the end of rate hikes, economic growth remains unexpectedly strong, Fed Chairman Jerome Powell said Friday in comments that likely weighed on inflation. But progress may stop and a central bank response may begin.
Such a policy blow, at a time of US economic discord with the rest of the world, could have significant implications.
“If we get to a point where there needs to be more than what was previously priced in, then at some point the markets will start to panic… Then you will see a big increase in the risk premium across different asset classes. International Monetary Fund chief “Emerging markets, including the rest of the world,” said economist Pierre-Olivier Gourinchas. “The risk of financial tightening, very sharp financial tightening, I think we can’t rule out.”
Cleveland Fed President Loretta Mester told Reuters on the sidelines of the Jackson Hole conference on Saturday that policy divergence is now normal after the shock of the pandemic and a rebound in inflation that saw most countries raise rates in unison.
But a lot depends on getting the Fed right.
Meester said, “The economy is a global economy, right? It’s an interconnected economy.” “What we do with our policy – if we can get back to 2% in a timely, sustainable way, if we have a strong labor market – that bodes well for the global economy.”
global divergence
Fed policymakers will give a key update on their economic outlook at their September 19-20 meeting, when they are expected to leave their policy rate unchanged at 5.25% from 5.5%.
If inflation and labor market data continue to show an easing of price and wage pressures, the current forecast of just another quarter-point increase may hold.
Yet Fed officials are puzzled and somewhat concerned about the conflicting signals in the incoming data.
Some point to weakness in the manufacturing sector, a slowdown in consumer spending and a tightening of credit, all consistent with the effects of tighter monetary policy and lower price pressures.
But GDP is still growing at a much faster rate than the non-inflationary growth rate of about 1.8% projected by Fed officials. US gross domestic product grew at a 2.4% annual rate in the second quarter, and some estimates put the current quarter’s pace at more than double that.
The contrast with other major global economies is sharp. The euro area grew an annualized 0.3% in the second quarter, at an essentially steady pace. Meanwhile, a prolongation of difficulties in China could weigh on global growth.
Asked about the divergence after a speech here, European Central Bank President Christine Lagarde said after the Russian invasion of Ukraine last year, a recession in the euro-zone was likely, and parts of it potentially deep. There was a recession.
Growth continues, albeit at a slower pace, and inflation declines, overall dynamics not dissimilar to the US
Lagarde said, “We expected it to be much worse. It has turned out to be much stronger, much more resilient.”
US fiscal policy is making some headway and $6 trillion in pandemic-era aid is still boosting consumer spending. Recent investment incentives from the Biden administration are supporting manufacturing and construction.
Economists say that China can also play a role in this. For example, its slowdown after a brief spurt of growth earlier this year could hit Germany’s exports and slow Europe’s growth.
But, said Nathan Sheets, chief economist at Citigroup, “When you hear economists give you three or four reasons for something, it’s usually because we don’t really know.”
Too Strong for Comfort?
The longer the US economy continues to underperform, the more Fed officials will wonder whether they understand what’s going on.
For example, recent improvements in productivity may explain how inflation is falling even as growth remains strong.
A period of below-trend growth is needed to sustainably return inflation to the 2% target under current Fed thinking. The core inflation measure is currently more than double.
Most officials think the economy will slow as tighter policy and tighter debt are fully realized and less of pandemic-era savings are spent. Consumer loan delinquencies are starting to mount, and the resumption of student loan payments could push up costs for services less affected by the Fed’s actions so far.
“There could be more significant drags in the pipeline, which is a reason to hold off on further increases and study how the economy develops,” Powell said on Friday.
But he said the Fed is “paying attention to signs that the economy is not slowing down as expected,” consumer spending has been “particularly strong” recently, and the housing sector is “showing signs of rebounding.”
Any significant increase in home prices or rents would undermine the Fed’s view that a reduction in shelter costs would be critical in helping slow the overall pace of price increases.
While the focus is on inflation data, headline economic growth that remains above trend could undermine confidence that inflation will fall, and raise concerns that it could rise – an outcome that Fed officials are particularly concerned about. considered harmful and promised to avoid it.
“Evidence of continued upward-trending growth could put further progress on inflation at risk and may necessitate further tightening of monetary policy,” Powell said.
This is the moment for which other countries need to watch and prepare, Gourinchas said.
“The rest of the world has to make sure they are prepared for the potential risk that we are not there yet in terms of US deflation.”
Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci
Our Standards: The Thomson Reuters Trust Principles.
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