Fed Holds Steady on Rates, But Some Economists Worry About Recession Risk
The Federal Reserve has kept interest rates unchanged for the third consecutive meeting, signaling a cautious approach to further tightening even as inflation shows signs of cooling. This decision, while welcomed by some, has sparked concerns from prominent economists like Claudia Sahm and Jeffrey Gundlach, who warn that the Fed’s persistence in keeping rates high could push the economy into recession.
Key Takeaways:
- The Fed is playing a waiting game: Despite acknowledging progress in reducing inflation, the Federal Open Market Committee (FOMC) emphasizes the need for "greater confidence" that inflation is headed back to 2% before considering any rate cuts.
- Markets anticipate aggressive rate cuts: While the Fed remains steadfast, markets are pricing in a series of rate cuts beginning in September, culminating in a potential full percentage point reduction by the end of the year.
- Sahm Rule and recession risk: Claudia Sahm, the economist behind the Sahm Rule, argues that the Fed’s stubborn adherence to high rates is pushing the economy closer to recession. The unemployment rate is nearing the threshold for triggering the Sahm Rule, indicating potential economic weakness.
- DoubleLine CEO warns of impending recession: Jeffrey Gundlach, CEO of DoubleLine Capital, shares Sahm’s concerns, suggesting that the Fed’s policy is jeopardizing economic growth. He predicts significant rate cuts in the coming months, potentially exceeding the Fed’s projected path.
- Real interest rates and room for cuts: Gundlach highlights the already high real interest rates – the difference between interest rates and inflation – suggesting ample room for rate cuts without exceeding the Fed’s inflation objectives.
Cautious Fed Faces Growing Pressure for Rate Cuts
The Fed’s decision to hold rates steady reflects their cautious approach to managing the remaining inflation risks. The post-meeting statement acknowledged that while inflation has "moderated somewhat," they need “greater confidence” that inflation is sustainably heading back towards the 2% target before loosening monetary policy. This stance, however, has ignited a debate amongst economists and sparked concerns about the potential for a recession.
The Sahm Rule and its Warning Signs
Claudia Sahm, known for her Sahm Rule, a tool for identifying economic recessions based on changes in the unemployment rate, is one of the most vocal critics of the Fed’s strategy. Her rule states that if the three-month average of the unemployment rate surpasses its 12-month low by half a percentage point, the economy is likely in recession.
The current unemployment rate of 4.1% is dangerously close to triggering the Sahm Rule, underscoring Sahm’s fears that the Fed’s policy is inadvertently jeopardizing economic stability. She believes that the Fed is prioritizing the fight against remaining inflation at the cost of potentially triggering a recession, arguing that even slight easing of rates would be beneficial.
Market Expectations and Aggressive Cuts
Markets, however, are displaying a contrasting sentiment. Investors are already anticipating a series of rate cuts starting in September, with some analysts even forecasting a full percentage point reduction by year-end. This suggests that investors may be more optimistic about the inflation outlook or anticipate the Fed to eventually cave to market pressure and respond to potential economic weakness.
DoubleLine CEO: A Recession is Coming
Adding weight to Sahm’s concerns, Jeffrey Gundlach, CEO of DoubleLine Capital, shares her skepticism about the Fed’s approach. Gundlach believes that the Fed’s refusal to acknowledge the potential for recession and its insistence on maintaining high rates will ultimately lead to a more severe downturn. He predicts a wave of rate cuts in the coming months, potentially exceeding the Fed’s projected path.
High Real Interest Rates and Room for Easing
Gundlach further stresses the already high real interest rates, which occur when interest rates exceed the inflation rate. He argues that the significant difference between current interest rates and the declining inflation rate provides ample room for the Fed to lower rates without jeopardizing their inflation targets.
Balancing Inflation and Growth
The Fed faces the challenging task of balancing inflation control with the promotion of economic growth. While their commitment to conquering inflation remains unwavering, the growing chorus of dissent from economists like Sahm and Gundlach raises legitimate concerns about the potential for unintended consequences. The Fed’s decisions will continue to be scrutinized as they navigate this delicate balancing act, with the possibility of a recession looming in the background.