For Jerome Powell’s Federal Reserve, the easy part was to embark on an aggressive course of monetary policy tightening to rein in decades of high inflation while the economy was strong. Now, with the economy showing early signs of a broad-based easing, the road ahead is about to get tougher.
Take a look at
revenue warning as an example of where things are going. The company (tick: FDX ) cut its revenue forecast by half a billion dollars on Thursday and warned that volumes were slowing as “macroeconomic trends worsened significantly.” The news sparked fears of a global recession and sent the company’s stock down more than 20%.
Now consider the flurry of data released this week. Retail sales data for August showed, on the surface, a surprising increase from the previous month as falling gas prices left more room in household budgets for discretionary shopping and dining out. But the figures for July were sharply revised downwards. Overall, readings over the past two months were slightly negative, suggesting that a combination of higher prices and tighter policy is dampening consumer demand.
The manufacturing sector shows a similar trend. Industrial production fell 0.2% in August, below consensus. While manufacturing output rose 0.1%, it was also revised down in July, more than erasing any gains.
Separate surveys from the Federal Reserve Banks of Philadelphia and New York, released Thursday, also showed negative growth in manufacturing. For Philadelphia, August marked the third contraction in four months. New York posted its second straight contraction and fourth in five months.
Housing, meanwhile, “hit a brick wall,” as Comerica Bank chief economist Bill Adams put it this week. Mortgage rates topped 6 percent for the first time since 2008, Freddie Mac data released Thursday showed, while mortgage applications fell to their lowest level since 1999.
“We’re starting to see the lagged impact of the Fed’s previous policy hikes,” says Joe Brusuelas, chief economist at financial advisory firm RSM.
All of this could be seen as good news – or at least it should be what the Fed was expecting. The central bank had to slow things down and cool the economy to reduce consumer demand and rein in inflation, and the economy is showing the impact of that now.
But the manufacturing slowdown and softening retail sales come even as inflation continues to rage and the labor market remains almost as tight as ever. Initial jobless claims fell again on Thursday for a fifth week in a row, and the jobless rate for the insured has fallen below 1%.
This means the central bank will have to stay aggressive for longer as inflation becomes stickier or harder to control. It only increases the challenge for Powell, the Fed chairman, and opens a new phase in the central bank’s campaign to fight inflation – one that is occurring against the backdrop of a stagnant economy.
“It’s one thing to raise interest rates in what everyone agrees is a roaring economy,” says Tim Quinlan, senior economist at Wells Fargo. “It becomes much more difficult to keep raising rates when you’ve hit some of these major inflection points.”
Despite the broader easing, the August CPI data released this week was so hot that it prompted economists at Jefferies and elsewhere to raise expectations for the Fed’s so-called terminal rate to at least 4.5%, from 4% before the publication of the latest monthly data. The latest reading also delayed calls that the central bank could achieve a soft landing, dashing hopes that had risen after price gains held steady in July.
The question now becomes how painful the consequences of central bank interest rate hikes will be. While Fed officials seemed to recognize that “they should at least be aware of the negative economic effects of their tightening,” says Quinlan, “there is nothing about their mandate to Congress that suggests they should be paying attention to these deterioration in the economy.”
“If they’re going to stick with what they’re supposed to stick with,” he says, “then they shouldn’t be deterred by the deterioration of economic fundamentals.”
Powell has stressed for weeks that the central bank knows its actions will trigger painful consequences, but that it will not be deterred from doing what it takes to get inflation back to 2 percent. Not reining in price gains now will cause more pain in the future, he said, arguing that the Fed will remain firm as long as necessary.
Making sure investors understand this message is the first step. But following through as unemployment soars, small businesses close and the economy contracts would be quite another — one that would require a real test of resolve.
The relaxation the economy has shown this week is only the beginning.
Write to Megan Cassella at email@example.com