US growth falters; but Powell still keen on rate hikes

Weakening of US growth and rate hikes

by 5paisa Research Team Last Updated: Dec 10, 2022 - 06:03 pm 23.6k Views
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The US economy is slowing and it is slowing at an alarming pace. In the December 2021 quarter, the US economy had grown by an impressive 6.9%. However, with the Fed embarking on a rate tightening cycle, GDP growth contracted by -1.6% in the March quarter. This is the third estimate of the March quarter growth and it is 10 bps lower than the second estimate of GDP growth for the March 2022 quarter. However, Jerome Powell has hinted that there would be no let-up in the pace and the urgency of rate hikes going ahead.

That is something we would know in the July meet, towards the end of the month. For now, the Fed has already hiked rates by 150 bps over the last 3 meetings and has stuck to its stand of the interest rates touching 3.5% by the end of December 2022. In the June policy, the Fed had talked about front-ending the rate hikes as inflation did not seem to come under control. Now, despite the fact, that the impact on the GDP is serious and obvious, the Fed chair has underlined that negative growth would not change their stance on rates.

The dilemma of the Fed is best summed up by for Fed New York president, Bill Dudley. Bill is a long time veteran of monetary policy. He was among the first to warn that the Fed was committing a grave error by waiting for too long to commence the rate hike process. He felt that aggressive rate hikes should have come when US inflation was 5% and not when it was 8% and rising. However, now, even Dudley is of the view that if Jerome Powell decides to push through with aggressive rate hikes, then recession could come as early as 2023. 

The Fed itself has had tough choices. The American economy made a rapid recovery from the coronavirus crash and that is largely thanks to generous liquidity measures of the Fed. Now the Fed is trying something at the next level wherein it would try to soft land the economy. That means; the Fed would make the impact more business friendly, so that a temporary slowdown does not become a permanent slowdown. The hope is that by raising interest rates, it can cool off inflation, keep unemployment low and yet avoid a recession.

However, people like Dudley are more pessimistic. Their forecast is that aggressive rate hikes made by the Fed will drive demand sharply lower. That is already evident in sectors like FMCG, banking and consumer durables. Things will get worse when weaker revenues will lead companies to lay off workers, and the economy will slide into a downturn. Dudley believes that a recession in the US over the next 12 to 18 months was almost inevitable now. The issue is the US economy may still have momentum, but fundamentals are awry.

Over the last few years, the Fed maintained its goals of 2% inflation and maximum employment. However, now, jobs are a function of skills and training and while most of the low hanging fruits are already plucked, the business model going ahead will be a lot tougher. From a risk mitigative perspective, Fed is of the view that it was better to act now, whatever the cost in terms of jobs and growth. Powell wants to ensure that he does not repeat the mistakes of the late 1960s and the 1970s.

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