Federal Reserve Chairman Jerome Powell took questions from reporters during a news conference following a meeting of the Federal Open Market Committee at the William McChesney Martin Jr. Federal Reserve Board Building. on July 31, 2024 in Washington, DC.
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In the eyes of the market, the Federal Reserve finds itself ready to face a recession or it will repeat the mistakes of the past – when it was too late to see the coming storm.
How Chairman Jerome Powell and his colleagues at the central bank react will go a long way in determining how investors negotiate the turbulent climate. Wall Street has been running wild in recent days, with Tuesday’s relief rally adding to some of the damage since recession fears intensified last week.
“In sum, there is no recession today, but one is inevitable at the end of the year if the Fed fails to act,” Steven Blitz, chief US economist at TS Lombard, said in a note to clients. “But it will, starting with (half a percentage point) cut in September telegraph at the end of August.”
Blitz’s comments represent a widespread sentiment on Wall Street — there is no feeling that a recession is inevitable unless, of course, the Fed fails to act. Then the possibility ramps up.
Disappointing economic data recently raised concerns that the Fed missed an opportunity at last week’s meeting to, if not cut rates outright, send a clearer signal that easing is on the way. It helps to recall the not-so-distant past when Fed officials dismissed the 2021 inflation spike as “transitory” and pressed into a series of harsh rate hikes.
Now, with a weak jobs report from July in hand and growing worries about a slowdown, the investment community wants the Fed to take strong action before the opportunity is missed.
Traders are pricing in the strong possibility of a September cut of half a point, followed by aggressive easing that could reduce the Fed’s short-term lending rate by 2.25 percentage points by the end of next year, as judged by the 30-day fed funds futures contract. . The Fed currently targets a key rate of between 5.25%-5.5%.
“The unfortunate fact is that few data confirm whether the current rise in the unemployment rate is a sign – the US economy is at best risk of falling into recession and the worst is already there,” wrote Citigroup economist Andrew Hollenhorst. “The data in the coming months will confirm the continued decline, keeping the cut (half a point) in September and the possibility of an intermeeting cut on the table.”
Emergency cuts are not possible
With the economy still creating jobs and the stock market average close to a record high, despite the recent sell-off, the emergency cut between now and September 17-18 open market committee seems a longshot to say the least.
The fact that they’re even talking about it, though, shows the depth of recession fears. In the past month, the Fed has implemented just nine such cuts, and all have been amid extreme pressure, according to Bank of America.
“If the question is, ‘Should the Fed consider cutting intermeeting now?’, we think history says, ‘no, not even close,'” said BofA economist Michael Gapen.
There is no catalyst for intermeeting cuts, the Fed is still expected to reduce rates almost as quickly as it will increase from March 2022-July 2023. It could start the process this month, when Powell delivers the main policy speech expected during the annual Fed. retreat in Jackson Hole, Wyoming. Powell is expected to signal how easing will unfold.
Joseph LaVorgna, chief U.S. economist at SMBC Nikko Securities, expects the Fed to cut rates by a full 3 percentage points by the end of 2025, more aggressively than the current market outlook.
“Go big or go home. The Fed has clearly said that rates are too high. Why would they be slow in removing the tightness?” said. “They will be quick in cutting if there is no other reason than the rate is not at the right level. Why wait?”
However, LaVorgna is not convinced that the Fed is in a life-or-death battle against recession. However, he noted that “normalizing” the inverted yield curve, or getting longer-dated securities to yield more than their shorter counterparts, would be an integral factor in preventing economic contraction.
Over the weekend, Goldman Sachs drew attention when it raised its recession forecast, but only 25% from 15%. That said, the bank noted that one reason it doesn’t believe a recession is imminent is that the Fed has plenty of room to cut — 5.25 percentage points if necessary, not including the capacity to restart its bond-buying program known as quantitative easing.
However, a shock in the data, such as Friday’s surprise in the nonfarm payrolls number, could trigger a recession quickly.
“The Fed is now behind the economic curve as it will be behind the inflation curve in 2021-2022,” economist and strategist David Rosenberg, founder of Rosenberg Research, wrote Tuesday. He added that the higher expectations for cuts “smacks of a true recession scenario because the Fed has rarely done this without an official economic downturn – being one, already being one, or limping out of one.”
