The Jumbled Recipe for a Safe Landing
Drawing a sharp contrast from the jubilant market sentiment throughout the past winter, intense tension and a psychological tug-of-war between the Federal Reserve, the central banking system of the United States, and the stock market seem to decorate this year’s holiday season. In response to the 40-year high inflation, the Fed has tenaciously raised the federal funds rate, the cost for one commercial bank to borrow capital from the other commercial bank, at a historically aggressive pace. Stretching from its recent fast rate hikes, the Fed pushed the federal funds rate to the 4.25 percent to 4.5 percent range through another half-a percentage point increase following its December Federal Open Market Committee(FOMC) meeting. Though the Fed downsized the volume of its rate hike from 0.75 percentage points to 0.5 percentage points this time, it still placed the federal funds rate at its 15-year high while displaying no signs of lowering them until 2024. Amid countless criticisms and warnings directed at the efficacy of the Fed’s rate hikes in cooling down inflation, the central bank does not seem to falter in employing the appallingly rapid interest rate controls in restoring inflation to its ideal two percent range. Today, I am citing the already-tumbling economic indicators and the Fed’s actions before and after the traumatizing 2001 Dotcom Bubble to title the Fed’s current rate hikes useless and a mere propelling force for the looming global recession.
In the face of persistent inflation, the Fed has one plain objective in mind: tame the current inflation back to the two percent range. Ever since 2012, the Fed has pursued maintaining the two percent inflation through assessments of the conditions of the employment market and the Personal Consumption Expenditure(PCE) Index. In essence, the Fed’s two percent inflation translates to a two percent reading in the PCE Index. The two percent inflation was easily visible prior to the outbreak of Covid-19–certainly not anymore. Since the beginning of 2022, the Fed’s most trusted inflation gauge consistently remained above 6 percent.
The only weapon the Fed is able to employ to ease inflation is the manipulation of the federal funds rate. The federal funds rate determines the volume of money supplied to the public by setting the cost for one bank to borrow capital from another bank. While the federal funds rate control may have the capability to cap liquidity input flowing into the economy, it does not have the ability to mend the damaged global supply chain, the primary cause of the undying inflation. Take the accelerated expansion of inflation following the 2022 Russian Invasion of Ukraine and the People’s Republic of China’s issuance of draconian coronavirus protocols designed in achieving the country’s ambitious zero-Covid vision. These two contentious events gave birth to three chronic and groundbreaking shifts in the global economic system that have stoked and rendered the current inflation irreversible to its past two percent range.
The first is deglobalization. Attracted to the low labor and production costs, the two most crucial ingredients for high-profit-yielding manufacturers, the United States has planted numerous production lines across China to produce maximum profit. Notably, the world-leading tech giants Apple Inc. and Tesla, Inc. have displayed a high dependency on China for their mass production as they concentrated their frontline factories in the cities of Zhengzhou and Shanghai. But this trend has vanished. Battered by the stringent lockdowns and shutdowns, global producers lost their reason to rely on China for their mass production sites. Moving away from the former global factory powerhouse, American companies have begun to relocate their production lines back into the States. The no-compromise zero-Covid policies have erased the once irresistibly cost-effective facet of China, expediting the global economy toward the end of globalization. Unfortunately, the waning dependency on China for mass production indicates the rise in the cost of manufacturing since goods are cheaper to make in China than are in the United States or other European nations. In return, price tags for global goods inevitably will remain at a level that cannot feasibly lower the current inflation to the Fed’s ideal two percent.
The second, more obvious issue springing from the lingering war and China’s strict coronavirus control is the disruption in the global supply chain. Upon the onset of the war in March 2022, food and energy prices were sent into the stratosphere. Natural gas prices doubled in less than half a year and showed no sign of retreating as Russian President Vladimir Putin launched an energy war by halting the operation of Europe’s primary gas suppliers Nordstream I and Nordstream II. Russia’s export ban on Ukraine, the largest breadbasket in the world that produces over 90 percent of globally consumed wheat, elevated food prices to levels that let the Consumer Price Index(CPI), one of the most commonly referred inflation barometers, take a quantum leap upward. While both the energy and food prices have steamed off and loosened strain on consumers, the declaration to the end of the war and China’s step away from the zero-Covid mindset, which in fact has already occurred as its leader Xi Jinping stressed economic growth over covid controls, will undoubtedly cool them down much more.
Alongside deglobalization and the broken supply chain, high wages coupled with quick retirement have condoned the current inflation to grow into a monster that engulfed the growth of the global economy. The story begins with the unforgettable bullish periods in the stock and the cryptocurrency market amid the ungraspable spread of the coronavirus. As people settled in their homes to work, a great number of workers turned their attention to high-risk assets like stocks and cryptocurrencies. The exhilarating two-year rally produced sizable returns and convinced more than three million workers that their former workforce is not the only avenue to make a living and that they have an alternative route for fast retirement: investment in the highly volatile asset market. Soon enough, the employment market lacked sufficient workers and pulled out the “high wage” card to attract people. While such a tactic has proved ineffective, employers are tenaciously keeping the wages high, hoping to form contracts with new employees that will replace the retired ones. However, with high wages, inflation only grows in size because bolstered income indicates stable spending, and consistent consumption leads to high prices.
Citing these three pro-inflation forces, the market does not trust that the Fed’s abominably abrupt rate hikes will tamp down inflation. Rather, investors believe the Fed’s current measures against inflation will merely trigger an economic recession. Countless economic indicators reflect the market’s apprehensive anticipation of a recession. Most notably, the manufacturing Purchase Managers Index(PMI) for November 2022 recorded 49.0 percent, its lowest mark since May 2020. A reading of 50 percent or more on the manufacturing PMI released by the Institute for Supply Management(ISM) represents economic expansion and contraction for one below the 50 percent line. The most recent 49.0 percent is markedly below the standard 50 percent and can serve as a herald for a recession. Furthermore, the United States Conference Board Leading Economic Index(LEI), a gauge for investors’ consensus on the outlook of the global economy declined 0.8 percent in October compared to the previous month to 114.9. In a bigger picture, the index lost 3.2 percent during the six months interval from April 2022 to October 2022. Though these numbers are not true representations of the development of a recession, they show the market’s dominant sentiment toward the outlook of the global economy. The current numbers clearly demonstrate that the market is expecting an imminent recession to take shape within the course of the next six months to a year.
On top of the three drivers that rendered the current inflation impossible to go back to its normal two percent, overlaps between the economic conditions surrounding the scarring 2001 Dotcom Bubble and those in the present are fomenting pure dread within the market. Current circumstances alike, the Fed, under Alan Greenspan’s conduct, sweepingly ratcheted up the federal funds rate six times within less than 11 months from 5.0 percent to 6.5 percent in an attempt to deflate the bubble in technology stocks. The tech-heavy Nasdaq Composite Index was off the leash as companies in the index such as Linux and Foundry Networks gained preposterous 697.5 percent and 525 percent respectively on the day they were publicized to the market. However, the Fed’s hawkish interest rate controls could not prevent the bubble from bursting. The most injured Nasdaq Index relentlessly slid from its top at nearly 4,000 points in June of 2000 to 1498 points in September of 2001, an astonishing 62.5 percent loss. Taken aback by the plummeting market and the September 11 attacks that paralyzed the defensive and economic integrity of the United States, Greenspan rushed into pushing the benchmark interest rate down to one percent. The problem was that the radical move did no good in quelling the market that was devastated by the crashing earnings of the tech companies. In other words, the Fed was too late in the rescue. Rendering the Fed’s interest rate cap incompetent, the market staggered at its low for the next five years until 2006. Though the motives behind the federal funds rate control around 2001 slightly differ from those of now, the market has commonly expressed concerns about the Fed’s treatment of precarious economic conditions in both tumultuous eras. Coming back to the present, the Fed’s ignorantly resilient belief in “transitory” inflation successfully dented the market’s trust in the Fed’s ability to make timely decisions in fighting off the current inflation. Further hurting the market is the Fed’s blinded pursuit of killing inflation through fast rate hikes. As the market views an economic recession to be inevitable and imminent, it wants the Fed to ease its interest rate increases so that the global economy avoids reaching the point of no return as it did 20 years prior.
On the other side is the Fed with its unwavering object in grappling down the inflation to its safe two percent. Aware of the imprudent blunder committed earlier in this perilous era by downgrading inflation as a transitory one, the Fed has has been desperate in rehabilitating its damaged status. To achieve this, the only way out was to contain inflation through its only applicable counterforce: sharp raises of the federal funds rate. But, I am highly doubtful that the Fed is not aware of the dire ramifications of its rapid rate hikes. I believe this momentous economic stage caused rifts in the Fed in devising the best response that can both quash the powerful inflation and repair its dampened image as the central bank of the United States. Let’s see how the Fed maneuvers in this decisive period.
Works Cited
Nikolic, Luka. “A Tale of Two Bubbles: How the Fed Crashed the Tech and the Housing Markets.” FEE Stories, 10 Aug. 2019,
fee.org/articles/a-tale-of-two-bubbles-how-the-fed-crashed-the-tech-and-the-housing-markets/.
“The Disunited States of America | SEP 3rd 2022.” The Economist, The Economist Newspaper, 3 Sept. 2022,
www.economist.com/weeklyedition/2022-09-03.
Timiraos, Nick. “Fed Raises Rate by 0.5 Percentage Point, Signals More Increases Likely.” The Wall Street Journal, Dow Jones & Company, 15 Dec. 2022,
www.wsj.com/articles/fed-raises-rate-by-0-5-percentage-point-signals-more-increases-likely-11671044561.
“United States ISM Purchasing Managers Index (Pmi)November 2022 Data.” United States ISM Purchasing Managers Index (PMI) — November 2022 Data,
tradingeconomics.com/united-states/business-confidence.
“US Leading Indicators — The Conference Board.” The Conference Board, 18 Nov. 2022,
www.conference-board.org/topics/us-leading-indicators.
