Hike rates

The global race to hike rates is tipping economies into recession

The Fed seems willing to tip the US into a slump if that is what is needed to defeat inflation. Other central banks are ready to make the same bet

Rich Miller, Bloomberg

September 19, 2022, 9:40 PM

Last modification: September 19, 2022, 9:45 PM

Photographic illustration: 731; photos: Getty Images/Bloomberg


Photographic illustration: 731; photos: Getty Images/Bloomberg

Central banks intend to drive the global economy dangerously close to a recession.

Late to see the worst inflation in four decades coming, then slow to rein it in, the Federal Reserve and its peers around the world are no longer hiding their determination to win the fight against soaring prices — even at the cost of seeing their economies shrink. grow more slowly or even contract.

About 90 central banks have raised interest rates this year, and half of them have raised at least 75 basis points all at once. Many have done so more than once, in what the chief economist of Bank of America Corp. Ethan Harris calls it “a competition to see who can grow the fastest.”

The result is the broadest monetary policy tightening in 15 years – a decisive break from the era of cheap money ushered in by the 2008 financial crisis, which many economists and investors had come to see as the new normality. The current quarter will see the biggest rate hikes by major central banks since 1980, according to JPMorgan Chase & Co., and it won’t stop there.

‘Bring pain’
This week alone, the Fed is expected to raise its key rate by 75 basis points for the third time, with some calling for a full burst of percentage points after US inflation rose above 8% again in August. The Bank of England is expected to raise its benchmark by 50 basis points, with hikes also expected in Indonesia, Norway, the Philippines, Sweden and Switzerland, among others.

As they step on the brakes, policymakers are beginning to mix their language with gloom as they publicly acknowledge that the more they raise rates to stifle inflation, the more likely they are to hurt growth and jobs.

Fed Chairman Jerome Powell said last month that his campaign to rein in prices “will hurt households and businesses.”

Isabel Schnabel, member of the executive board of the European Central Bank, speaks of the “sacrifice ratio”, jargon designating the loss of output that will be necessary to control inflation. The BOE goes so far as to predict that a recession in the UK will be underway by the end of this year and could stretch into 2024.

There is no doubt that monetary medicine will hurt. The question is how much? Analysts at BlackRock Inc. estimate that bringing inflation back to the Fed’s 2% target would mean a deep recession and 3 million more unemployed, and hitting the ECB’s target would require an even bigger contraction.

Adding to the uncertainty is the delay before rate hikes affect the economy, in addition to the composition of current inflation, much of which stems from energy and other supply shocks. that central bankers cannot control.

Investors will not escape the fallout.

Last week’s higher-than-expected US inflation figure for August sent the stock market into its biggest tumble in more than two years, driven by bets on Fed policy tightening . Billionaire hedge fund manager Ray Dalio sees the prospect of a more than 20% crash in stock markets as rates continue to rise.

“Credibility is everything”
Central bankers prefer to keep their economies running. They may at some point go back on their aggressive policy to try to guarantee that. But their overarching goal now is to avoid repeating the mistake of the 1970s, when their predecessors prematurely eased credit in response to slowing economies without first getting inflation under control.

This concern argues in favor of aggressively pursuing rate hikes, as allowing inflation to escalate would risk aggravating long-term economic woes.

Anna Wong, chief U.S. economist at Bloomberg Economics, estimates the Fed will eventually need to raise its benchmark rate to 5%, double the current level — an extra dose of tightening that could cost $3.5 million. jobs to the economy and dealing further blows to already battered markets.

The idea that they are already under attack for misjudging pandemic-era price pressures, even if Russia’s subsequent invasion of Ukraine also worked against them, is also likely to push bankers central.

Powell has spent much of 2021 describing the inflationary shock as “transient,” and he and his colleagues entered this year predicting that interest rates are only expected to rise 75 basis points in 2022. The Fed has already increased three times more.

Last November, ECB President Christine Lagarde said higher rates were unlikely in the euro zone in 2022, only to find herself pushing them up 75 basis points this month and eyeing a repeat. in October.

This action leaves policymakers with a lot at stake to win the inflation battle.

“Credibility is paramount for central banks, and it was shaken by getting transient inflation wrong,” says Rob Subbaraman, chief economist at Nomura Holdings Inc. 1970s.

‘It takes time’
In a sign that investors expect a recession in the United States, yields on short-term US Treasuries have risen above their longer-term equivalents over the century, with some bond traders betting the Fed will have to ease policy in the latter stages of 2023. Meanwhile, the S&P 500 is heading for its biggest annual loss since 2008.

US inflation again exceeded 8% in August. Photographer: Apu Gomes/AFP/Getty Images/Bloomberg

US inflation again exceeded 8% in August.  Photographer: Apu Gomes/AFP/Getty Images/Bloomberg

US inflation again exceeded 8% in August. Photographer: Apu Gomes/AFP/Getty Images/Bloomberg

A BofA survey of fund managers this month found that global growth expectations were near all-time lows.

One of the reasons for this concern is that monetary policy operates with a lag. It first weakens the financial markets, then the economy and finally inflation. Thus, repeated jumbo rate increases become dangerous.

“It takes time to calm inflation down,” says BofA’s Harris. “If you start talking about just focusing on current inflation as the main indicator, you’re going to be late to stop” the tightening cycle. Harris sees the UK and euro zone slipping into recession in the fourth quarter as soaring energy costs weigh on economies this winter, and he expects a slowdown in the US next year.

The US economy – and in particular the labor market – has so far proven surprisingly resilient. But economists say that just means the Fed will have to push even harder to calm demand.

“Inflation and the labor market have proven more resilient at higher rates than the Fed had expected,” said former Fed Vice Chairman Donald Kohn. “So they have to raise the tariffs more now.”

Until recently, it seemed obvious for central banks to tighten policy. Inflation was high, labor markets were strong and interest rates were at rock bottom.

But trade-offs are becoming more difficult as high rates begin to eat away at economies already suffering the backlash of a lingering pandemic and Russia’s war in Ukraine.

Borrowing costs in many economies, including the United States, are moving from stimulative to restrictive. The soaring dollar hurts debt-ridden emerging markets. A sharp cut in Russian natural gas supplies increases the risk of stagflation in Europe, as prices soar as recessions loom.

not now later
Policymakers are still expressing hope that they will succeed in slowing inflation without completely derailing growth, and that they will eventually rein in the tightening, but not yet.

“You have to think about common ground at some point,” Cleveland Fed President Loretta Mester said during an INM webcast this month. “But that’s not a consideration at this stage. It’s a consideration for the future.”

The focus on reducing inflation increases the chances that the Fed and other central banks will overdo it and bring down their economies.

Dartmouth College professor David Blanchflower, a former BOE policymaker, accuses US central bankers of ‘groupthink’ and accuses them of being on track to hammer a weakening economy to fight the coronavirus crisis. inflation which is already dissipating.

Complicate central bankers’ calculations: Inflation is partly driven by rising energy costs over which they have little or no control. This is particularly the case in Europe, although this has not deterred the ECB or the BOE from raising rates.

Central banks around the world are pushing in the same direction, increasing the danger, says Maurice Obstfeld, former chief economist at the International Monetary Fund.

“They are likely to reinforce each other,” says Obstfeld, who is now a senior fellow at the Peterson Institute for International Economics. They also effectively engage in competitive appreciation of their currencies and in doing so export inflation abroad, he says.

Since 1980, the world economy has posted an average growth rate of 3.4%. Right now, with monetary tightening adding to the drags of Covid-19 and the Russian war, Obstfeld sees a risk that it could slow “somewhere around 1%”.

In other words, former Fed Governor Kevin Warsh, now a visiting scholar at the Hoover Institution, said, “We have all the ingredients for a global recession.

— With help from Philip Aldrick, Zoe Schneeweiss, Maria Eloisa Capurro, Craig Stirling and Michael Mackenzie

Disclaimer: This article first appeared on Bloomberg and is published by special syndication arrangement.