Denver Charles Evans was the first to step out of the cover: It’s time for the US Federal Reserve (Fed) to slow down the pace of interest rate hikes, he said last week on the US stock exchange broadcaster CNBC. “Monetary policy works with a time lag and we’ve been moving very quickly recently,” said the head of the regional central bank in Chicago. He was therefore “a bit nervous” that the Fed is no longer waiting to understand the impact of its moves on the economy.
Evans has long been viewed as a monetary policy dove. As such, he is willing to leave inflation slightly higher to prevent other damage to the economy and markets. He’s also retiring early next year – perhaps that’s why his words resonate so well.
With his demand, the long-serving central banker is opposing most of his colleagues, above all Fed Chairman Jerome Powell. At the most recent meeting in September, he had announced that “there will be further large interest rate hikes until we get closer to the interest rate level that is necessary”.
At the meeting, the central bank raised interest rates by 0.75 percentage points for the third time in a row. It is thus in a range of three to 3.25 percent and could be over four percent by the end of the year, according to the central bankers’ forecasts.
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But among economists and analysts, there are increasing numbers of voices siding with Evans – also with a view to the turbulence on the financial markets. The leading index, the Dow Jones, lost a good eight percent in September. The broad S&P 500 ended the month down 9.3 percent. The tech-heavy Nasdaq was down 10.5 percent.
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The British central bank had to intervene surprisingly on Wednesday and announce a program to buy government bonds. This is intended to dampen the sharp increase in yields on long-term government bonds and to ensure the stability of the financial markets. Since then, there has also been growing concern in the US that the markets could become unbalanced due to the Fed’s aggressive monetary policy.
“The Fed has raised rates too far and too fast,” believes Daniel Alpert, co-founder of boutique investment bank Westwood Capital, who also teaches macroeconomics at Cornell Law School. He expects inflation to ease in the coming months without the need for any further major rate hikes by the Fed.
“The days of big rate hikes are over. Inflation will continue to fall and the US economy will cool off noticeably before the next Fed meeting,” is his forecast. At the same time, Wall Street is becoming increasingly concerned about market chaos.
There have been unusually high swings across many asset classes in recent weeks. “We are on the verge of a bigger break in financial markets than what we have seen in the UK,” warned Schroeders’ wealth manager Ron Insana.
Star economist Paul Krugman made a similar statement in his column he writes for the New York Times. The risks that the Fed would be too slow in raising interest rates have decreased. On the other hand, the risks “that high interest rates will cause serious economic damage have increased – and significantly so,” says Krugman. “I would urge monetary policymakers to take a look at the situation and reconsider their rate hike plans for the coming months.”
A United Nations organization also got involved in the discussion on Monday, an unusual move. The Fed’s current course would primarily harm developing countries and risk a global recession, according to a report by the United Nations Conference on Trade and Development (UNCTAD).
However, the economic situation in the USA is ambiguous: there has recently been a series of data that indicate that inflation has weakened: the prices for oil and other raw materials have recently fallen, the same applies to falling transport costs and falling prices for used cars .
Housing market sends signals of crisis
The consequences of the aggressive interest rate policy can already be seen very clearly on the housing market. Interest rates on a 30-year mortgage rose to over 7 percent last week. They are more than twice as high as at the beginning of the year. That caused house prices to fall for the first time since 2020. “We’re seeing the biggest reversal in the housing market since the 2008 crisis,” said broker Redfin.
Tech investor Cathy Wood believes there could be not just lower inflation but deflation in the coming months if you compare month-to-month prices. This means that prices would fall instead of just rising less sharply. That too would speak in favor of a more moderate course by the Fed. At the same time, the price development index, which is important for US monetary policy, rose by 0.3 percent on Friday, more than expected.
However, it is unclear whether monetary policymakers will be persuaded to reverse the trend. At the end of the week there will be fresh data from the US labor market, which was also recently crisis-proof. The week after that, new inflation figures for the month of September will come out. The central bankers around Jerome Powell will take these into account when making their interest rate decision. The upcoming Fed meeting is scheduled for November 1st and 2nd. Oil prices could also rise again given the planned reduction in oil production.
However, a number of central bankers spoke out in favor of staying the course last week. When asked if a US recession would make the Fed relent, Loretta Mester, chief executive of the Cleveland regional Fed, said, “We have to do what we have to do to get back to price stability – so no.”
Dollar strength increases inflationary pressures
Fed Vice Chair Lael Brainard spoke out on Friday against weakening the course “too soon”. “Inflation is still too high and not moving back to our 2% target fast enough,” she warned. However, she acknowledged that monetary policymakers are keeping an eye on possible spillover effects and the risk of “negative shocks”.
The dollar has appreciated significantly against a range of currencies, driven by the Fed’s interest rate policy. The euro is weaker than it has been for over 20 years. The British pound hit an all-time low against the dollar last week. US Treasury yields have also risen sharply in recent weeks.
The strength of the dollar would add to inflationary pressures worldwide, Brainard warned. “A stronger dollar tends to make US import prices cheaper. But the associated weakness in other currencies could add to inflationary pressures and require additional rate moves there to offset the effect.”
The fact that the Fed could stick to its course also has something to do with public perception, believes Harm Bandholz, professor of economics at Kiel University of Applied Sciences, who was America’s chief economist at Unicredit in New York for many years. Star economist Larry Summers, influential market analyst Mohamed El-Erian and others have been criticizing the Fed for over a year for starting inflation-fighting too late. The central bankers “do not want to be accused again of being too cautious”.
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