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 Market Mysteries of the week

   Does the Fed want a recession? 

Answer:

The Federal Reserve has made clear that it's willing to constrain the economy as much as it takes to bring inflation down. That could mean higher unemployment.

Who's the Fed?

The Fed, aka the Federal Reserve, aka the Central Bank, controls our whole money system.

It is responsible for stimulating the economy when it's struggling and moderating it when it overheats

.

The Fed stimulates with two primary forms of "steroids."

It lowers baseline interest rates

, affecting everything from savings accounts to credit cards, mortgages, and corporate loans. If it's cheaper to borrow and less attractive to hold money in savings, people and corporations are incentivized to spend and invest, stimulating the economy.

The Fed also "prints money."

It pumps new money into the system to keep the pipes flowing so the banks can cover all the new loans and spending. While it doesn't physically print dollar bills, it will buy assets like treasury bonds or mortgage bonds with money it essentially speaks into existence.

After stimulating the economy for nearly two years,

the Fed is now focused on rolling back the supportive policy because it's seeing signs of overheating

. The biggest sign is high inflation. Inflation is the Fed's economic temperature gauge. If prices are rising too quickly, that means there's too much lending and spending for the given available resources. Due to supply disruptions, labor shortages, and other pandemic-related reasons, consumer demand has recovered faster than companies can produce and deliver.

Too much demand for the same or less stuff has caused prices to soar.

How bad is inflation?

Inflation is the rate at which things get more expensive. Prices rarely go down. It's normal for things to get more expensive. You'll never be able to buy a Coke for a quarter again, but that's ok. Low inflation (~1-2% per year) is a natural part of a functioning economy.

High inflation, like we're seeing now with prices of essential goods going up nearly 8-10% in a year, is a problem.

It's unmanageable for consumers and businesses. Basically everything consumers spend money on is

8.3% more expensive

than it was a year ago.

What's the Fed doing to stop it?

It's trying to slow the economy.

Unemployment and inflation are the two biggest considerations for the Fed's policy decisions. The Fed wants to help the economy achieve full employment without letting inflation get too high.

The Fed may have done too good of a job stimulating the jobs market.

Unemployment is as low as it can get

. We've

recovered all of the jobs lost during the pandemic

.

We're in a labor shortage

.

There are two available jobs for every unemployed worker

. The remaining unemployed workers are considered the natural floor for employment, as there are always people moving from job to job.

The economy is running so hot that we don't have enough people and resources to keep it functioning

. So now, the Fed is focused on slowing things down.

It has stopped pumping new money into the system

, even starting to decrease the overall money supply,

and raised interest rates significantly

. The Fed has hiked interest rates faster and more significantly than ever before, trying to deter corporations and consumers from borrowing and spending.

The booming real estate market has already experienced the cooling effect of higher rates.

The pandemic created a perfect storm of catalysts fueling housing demand. Mortgage rates were extremely low. Consumers had higher savings and wanted more space. Housing supply, though, couldn't rise to meet it. Home construction takes time. Materials and workers were disrupted by the pandemic.

Exploding demand met limited supply and sent real estate prices soaring

.

The median home price rose nearly 30% in two years.

As the Fed started shifting away from stimulus mode,

interest rates climbed.

Mortgage rates more than doubled

.

Home affordability deteriorated, and home buyer demand stalled.

With less demand, inflation in the real estate market has cooled significantly.

Prices have started declining

.

The Fed is hoping to have this effect across the broader economy.

Will there be a recession?

First off,

we might already be in a recession

. Historically, recessions have been defined as two quarters of negative US economic production. We experienced that in the first two quarters of the year and might see

a third quarter of decline

.

Economists, politicians, investors, and various talking heads have debated whether this is a recession because it's an unprecedented economic scenario.

It's hard to call it a recession when everyone has a job, wages are rising, and consumer spending is still strong

.

The Fed might push us [deeper?] into a recession

. With the economy running so hot that companies can't find enough workers to deliver their services, the Fed will try to slow economic demand. Higher rates mean less spending and lower sales. As corporate revenue slows, executives will look to cut expenses - the biggest being labor costs.

Policymakers expect to constrain economic activity until corporations need fewer workers than they currently have and start laying people off.

Many corporations have

started trimming their workforce

to cut costs, but broadly,

layoff rates are still low

. The Fed wants to see more people out of work to know for sure that the economy has calmed down. Hopefully, inflation will cool off before the Fed needs to take it that far.

The risk of higher unemployment isn't great, but don't extrapolate that to economic collapse.

Recession is an ugly word, resurfacing images of 2008 and 2020, but it's a natural part of the economic cycle. The last two recessions were also combined with global financial collapse. Few are expecting that. The market falls because investors hate uncertainty. Despite the market decline, Wall Street Analysts are still projecting American corporations will

grow profits by 8% this year and 8% next year

.

They're not expecting mass bankruptcies and defaults.

It's hard to know what will happen.

We've never shut the global economy off, then turned it back on, and pumped it full of steroids like this ever before. Major economies are still dealing with covid disruptions.

Supply chains are better

but not fully recovered yet. The US has only been out of pandemic restrictions for months.

China's economy

is a major unknown, and continued covid lockdowns could make a global recovery difficult. The war in Ukraine adds more uncertainty to global trade and energy supply.

It's likely to be a bumpy road ahead as we return to more normal conditions, whatever that means.

💙 The Share Scoops Team

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