Fed’s Policy Tightening May Lead to a Prolonged Slowdown in 2025: Abdrn
Despite predictions of a soft landing for the U.S. economy, concerns are rising about the potential for a prolonged slowdown in 2025. Kenneth Akintewe, head of Asian sovereign debt at British fund manager abdrn, has raised the question of whether the Federal Reserve (Fed) is "sleepwalking into a policy mistake" by maintaining a high policy rate in the face of declining inflation.
Key Takeaways:
- Revised Data Suggests Weaker Economy: Recent revisions to non-farm payroll data reveal that the U.S. economy created significantly fewer jobs than initially reported, pointing to a potentially weaker economic picture than previously thought.
- Policy Lags and the Risk of Overshooting: Akintewe highlights the time lag between policy changes and their effect on the economy, suggesting that if the economy is weaker than expected, the Fed will need to implement a substantial amount of easing. However, this easing may not fully manifest until the second half of 2025, potentially leading to a delayed response in a weakening economic environment.
- Current Policy Rate Questioned: Akintewe questions the rationale behind maintaining a policy rate of 5.5% when inflation has fallen to approximately 2.5%. He argues that this high rate may not be appropriate given the economic uncertainty and could further exacerbate any slowdown.
- Market Focus on Rate Cut Size: The market appears fixated on the size of any upcoming rate cut, overlooking the broader question of whether the policy rate is still too high. While recent data suggests a smaller rate cut is likely, the Fed’s decision remains uncertain.
Is the Fed Missing the Big Picture?
Akintewe’s concerns stem from the potential for the Fed to overtighten monetary policy, which could lead to a prolonged economic slowdown. The recent revisions to non-farm payroll data highlight the potential for underestimating the true state of the economy. This underscores the importance of carefully considering all available economic indicators and avoiding reliance on headline figures alone.
The time lag between policy changes and their effects creates a risk of delayed responses to economic shifts. By the time the full impact of easing measures become apparent, the economy might have weakened further, potentially necessitating more aggressive action from the Fed.
Furthermore, Akintewe’s call to reassess the rationale behind the current policy rate in light of declining inflation highlights the need for a more nuanced approach to monetary policy. Simply focusing on the size of rate cuts may miss the bigger picture, potentially leading to a policy decision that does not address the underlying economic vulnerabilities.
The Fed’s Balancing Act: Inflation vs. Growth
The Fed faces a challenging task in balancing the dual objectives of price stability and economic growth. While the recent decline in inflation is encouraging, concerns remain about the potential for a prolonged slowdown. The Fed’s upcoming monetary policy decision will be closely watched, with investors and businesses awaiting signs of its response to the evolving economic landscape.
The Fed’s decision will likely be informed by a range of economic indicators, including inflation data, employment figures, and consumer spending. However, it is essential for the Fed to consider not only headline economic data but also the potential for underlying weakness, as highlighted by Akintewe’s analysis.
Conclusion: A Looming Economic Challenge
The current economic environment is characterized by a delicate balance. The Fed’s policy decisions will play a crucial role in determining the trajectory of the U.S. economy in the coming months and years. While concerns remain about potential policy mistakes and their implications for growth, the Fed has a mandate to ensure stability and prosperity. This task will require careful consideration of all available economic data, a thoughtful approach to policy adjustments, and an open dialogue with stakeholders about the challenges and opportunities ahead.