What Are the Repercussions of the US Federal Reserve's Negative Rhetoric?

In just eight minutes, US Federal Reserve Chairman Jerome Powell sparked pessimism in the markets, which led to the loss of the richest Americans' enormous wealth and the decline of US stock market indices.

A BBC report on August 26, 2022, stated that Powell's speech came at a time when Americans are forced to pay more for basic goods, and inflation in the world's largest economy has exceeded its highest level in four decades.

The Fed has raised the interest rate 4 times since the beginning of 2022 to reach the range of 2.25% and 2.50% after it was near zero at the beginning of this year. It is expected to reach at least 3.8% next year, according to the latest average forecast of the Central Bank, released last June.

 

Strict Policy

US central bank chief Jerome Powell has vowed to use his tools aggressively to tackle inflation that is still near its highest levels in more than 40 years, even if it causes some pain for the US economy, Reuters reported on August 26, 2022.

In a speech to a central bank symposium in Jackson Hole, Wyoming, Powell said that the economy will need a strict monetary policy for some time before inflation is under control, warning that there is no quick cure and without side effects of high prices.

Inflation in the United States reached 8.5% at an annual rate, according to the Consumer Price Index, while the Federal Reserve set its goal to reduce this percentage to about 2%.

Powell said the Fed may impose more rate hikes in the coming months and could keep them high for some time.

It is noteworthy that investors are awaiting the Fed's meeting in September amid disputes over the possibility of raising interest rates by 75 basis points for the third time in a row or sufficing with an increase of 50 points.

Powell acknowledged that controlling inflation would be at the expense of American households and companies but said it was a price worth paying.

"While higher interest rates, slower growth, and weak labor market conditions will lead to lower inflation, they will cause some pain for households and businesses. These are unfortunate costs of lowering inflation, but failure to restore price stability will mean more pain," he added

"Of course, inflation is getting everyone's attention right now, which highlights certain risks today: the longer the current wave of high inflation continues, the greater the chance of rising inflation expectations being entrenched," he said.

Powell noted that the inflation of 40 years ago offers the current Fed 3 lessons, namely that central banks like the Fed are responsible for managing inflation, that expectations are critical, and that we must stick to them until the job is done.

Powell explained that the Fed's failure to act aggressively in the 1970s caused the persistent high inflation expectations that led to a sharp rise in interest rates in the early 1980s.

 

Negative Repercussions

Immediately after the end of the pessimistic speech delivered by Jerome Powell, Wall Street indices fell by about 3% and ended Friday's trading, August 26, 2022, with the worst performance in months, according to what was published by the CBS News network.

The stock market losses since August 28, 2022, have exceeded about $3 billion to complete the wave of losses after it ended last week with a severe defeat.

The S&P 500 fell 3.4%, its lowest since mid-June, the Nasdaq, which includes major tech companies, fell more than 4%, and the Dow Jones fell 3%.

It is noteworthy that US stocks recorded their strongest monthly rise last July since November 2020, which prompted investors to bet that the difficult period is over.

Given the above, the wealth of the richest people in America fell by $78 billion, with Elon Musk losing $5.5 billion of his fortune and Jeff Bezos losing $6.8 billion, which is the largest loss in their wealth according to the Bloomberg Billionaires Index.

While Bill Gates' fortune fell by $2.2 billion, Warren Buffett's fortune decreased by $2.7 billion, and Sergey Brin's fortune fell to less than $100 billion.

Larry Page lost $5 billion, Steve Ballmer lost $3.5 billion, and Larry Ellison's fortune decreased by $2.4 billion.

The wealth of billionaires this year witnessed significant losses, as the world's 500 richest people lost $ 1.4 trillion in the first half of 2022, the largest decline recorded in six months for the world's richest people.

 

Contraction or Recession?

According to a report by the US Department of Commerce, the US economy contracted again during the second quarter.

Gross Domestic Product (GDP), a broad measure of economic activity, contracted by 0.6% on an annual basis during the second quarter of 2022, the second reading, after the first reading, showed a contraction of 0.9%.

The US economy, which is facing consecutive hikes in interest rates, contracted by 1.6% on an annual basis during the first quarter of this year.

Although the preliminary estimate released by the Bureau of Economic Analysis on August 25, 2022, represented a sharp decline from the 6.7% growth experienced by the economy in the second quarter of 2021, the White House was adamant that the world's largest economy remains essentially healthy despite its exposure to the highest inflation level in decades and a series of supply shocks.

Even the administration took the extraordinary step of publishing an emphatic explanation that two consecutive quarters of economic contraction do not in and of themselves constitute a recession.

The White House blogged last July, saying that in addition to GDP, data on the labor market, personal and business spending, production, and income are all included in the official resolution of a recession.

The figures and recent actions come at a turbulent time for the US economy, although economists disagree on the likelihood of a full recession or stagflation.

US markets change their expectations almost daily regarding the next rate hike expected on September 21.

A few days ago, 62.5% of investors had expected an increase of 75 basis points, according to CME Group's calculations on futures contracts.

Gregory Volokin, portfolio manager at MisChart Financial Services, said that the Fed will try, despite everything, to take into account investors, adding: "We must not forget that we are very close to the presidential midterm elections in November, and it fears that it will be accused of fomenting an economic contraction."

"The Fed is in a somewhat sensitive position. What is required is to overcome inflation, but the road is long," Volokin said.

Two closely watched metrics, the Consumer Price Index and the PCE Price Index, showed that prices did not change much in July, largely due to a sharp drop in energy costs.

Meanwhile, other areas of the economy are slowing down, housing, in particular, declining rapidly, and economists predict that the massive increase in employment over the past year and a half is likely to subside.

In the same context, Joseph Stiglitz, a Nobel Prize winner and renowned economist, said during a meeting in Germany in August 2022 that "raising interest rates does not solve the problems related to the supply side, but it may make matters worse because the right thing to do now is to invest more in solving supply-side constraints."

He added that "basic economic models indicate that raising interest rates can lead to more inflation."

Meanwhile, Raphael Bostic, a member of the Fed, confirmed that "the good thing about the issue is that the economy is responding to tighter monetary policy and higher interest rates, but there is still a long way to go, and we still have a lot to say before we can say we have managed to control inflation."

Bank of America Corp's analysts believe that "a strong US dollar is necessary to help the Fed control inflation and reach the target."

It is noteworthy that the Fed raised interest rates for the first time in about 4 years last March by 0.25%, and by 0.5% at the May meeting, then by 0.75% in June, the highest rate since 1994, and the fourth time in July by 0.75%.

With steady increases in interest rates, and Powell's speech about his insistence on strict monetary policy, observers are asking: Has the world leader (the United States) lost its way in the inflation journey or is the view of economists not insightful enough?