The Federal Reserve’s focus on inflation must co-exist with the recent sell-off in equity markets. This has led to a lot of discussion about the possibility of a recession. Some pundits have even begun referring to the current climate as a “bear market” or a “corrective period.” Despite these fears, we have yet to see any evidence of an imminent recession. The Fed is currently focusing on inflation and not recession fears because they know that there are four key risks from continuing to raise interest rates: A slowing economy, deflation, financial instability and stagflation. We can think of the Federal Reserve as having two main goals: Keep unemployment low and make sure prices (inflation) don’t continue higher. The risk of recession is one of many factors they consider when making decisions about raising interest rates. The Fed must consider all four factors when deciding to continue to raise interest rates.
Inflation is the Federal Reserve Primary Concern
Discussion among pundits and investors revolves around the question of whether the stock market has “corrected” or entered a “bear market.” From the perspective of the Federal Reserve, the real risk is not a decline in the stock market, but a decline in the price of goods and services. The Fed considers a stock market correction as needed after a long period of strong performance to remain healthy. The Fed’s preferred measure of inflation: The core Personal Consumption Expenditure (PCE) price index. The core PCE price index measures inflation by removing the most volatile components of the consumer price index, like food and gas. In the Fed’s view, if the core PCE price index begins to decrease, it may be a sign of the economy growing too slowly.
The Labor Market
The unemployment rate has fallen to 3.5%. The Federal Reserve preferred measure of the labor market is the Labor Market Conditions Index (LMCI). The LMCI measures employment growth and whether workers are switching jobs. When the LMCI is falling, it suggests that the labor market is not as tight as it may seem. The Current Employment Situation Survey, which measures the unemployment rate, is almost as reliable as the LMCI.
FOMC: Interest Rates are Stable and Does Not Signal Recession
One of the most common myths about the stock market is that a rising interest rate is a sign of a recession. In fact, the current level of interest rates is not an indication of how strong or weak the economy is. It does not signal that a recession is imminent, nor does it predict what will happen to the economy in the future. The Federal Reserve has been raising interest rates because it expects inflation to rise in the future. The Fed’s preferred measure of inflation, the core PCE price index, is 4.8%. If the Fed does not raise interest rates, they risk allowing inflation to rise even higher.
Recession Fears Don’t Change the Timeline for Interest Rates
The Federal Reserve is expected to raise interest rates to tame inflation. They may lower rates during times of recession, but not at the expense of out-of-control inflation. Inflation control is the priority. The Fed tries to be transparent and projects long-term plans for interest rates. This is called the Fed’s “dot plot,” and it shows how each member of the Federal Open Market Committee (FOMC) anticipates interest rates will change over the next several years.
Think of the Federal Reserve as having two main goals: Keep unemployment low and make sure prices (in this case, inflation) don’t go too low or too high. The risk of recession is one of many factors they consider when making decisions about raising interest rates. Despite what pundits and investors are saying, the current sell-off in equity markets does not signal an imminent recession. The Fed is focusing on inflation and not recession fears because they know the four major risks: A slowing economy, deflation, financial instability and stagflation. Mark Waggoner – 8/11/2022 FEL-PM-220811
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