Fed likely needs to limit GDP growth to 1% to curb inflation: Moody’s

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Diving Brief:

  • JThe Federal Reserve could slow economic growth to 1% or less over the next two years as it delivers on its commitment to curb inflation from a four-decade high through aggressive stimulus cuts, Moody’s said. Analytics on the eve of a meeting of decision makers. .
  • “To calm inflation, the Fed will probably need the GDP [gross domestic product] growth closer to 1% or even lower in each of the next two years,” said Ryan Sweet, senior director of economic research at Moody’s. in a research report. “A number of indices we are tracking have shown that financial conditions have tightened, but the Fed will need more if growth is to slow enough to bring inflation under control.”
  • GDP growth in the first quarter fell to an annualized rate of 1.4%, from 6.9% in the fourth quarter, mainly due to the reduction in inventories, a weakening of fiscal stimulus aimed at offset the damage from the pandemic and an increase in imports as congestion at U.S. ports began to ease. .

Overview of the dive:

For several months, CFOs faced a series of external challenges that forced adjustments to risk management and their plans for pricing, salaries, capital allocation and other components of earnings. .

The business landscape in the United States has changed repeatedly amid soaring inflation, rising borrowing costs, tight supply chains, high wage pressures, a labor market tense and the threat of a disruptive new variant of the coronavirus – to name just a few of the CFO’s planning challenges.

Moody’s description of the threat to expansion from Fed tightening suggests that CFOs may need to update their list of risks with “stagflation,” or weak growth and high inflation.

The consumer price index rose 8.5% year over year in March, while The Fed’s favorite inflation measure — the basic personal consumption expenditure price index — rose 5.2%, according to the Labor Department.

Additionally, the employment cost index in the first quarter gained 1.4% for a 4.5% year-over-year increase. Persistently rising labor costs reinforce fears that consumer expectations of long-term low inflation are fading, prompting demands for higher wages and triggering a self-perpetuating upward spiral in prices and wages.

Fitch Ratings warned of stagflation and rising credit risks as “the Russian-Ukrainian war upends the macroeconomic outlook”.

“The outlook for monetary tightening has increased significantly, as has the potential for stagflation,” Fitch said.

Fed Chairman Jerome Powell and other policymakers expressed confidence that economic growth will remain stable. They reported that at the end of a two-day meeting on Wednesday, they planned to announce a half-point hike in the federal funds rate and a plan to begin reducing the $9 trillion balance sheet of the central bank.

At the Federal Open Market Committee’s March meeting, “many members of the committee felt that it would be appropriate for there to be one or more 50 basis point increases” in the prime interest rate, Powell said. April 21.

“We are really committed to using our tools to get inflation back to 2%,” he said, referring to the Fed’s prime rate for long-term price gains.

In anticipation of policy tightening, the interest rate on the 10-year Treasury note – a benchmark for borrowing costs – rose above 3% on Monday for the first time since 2018, twice the yield at the end of last year.

The inflation news hasn’t been all bad. For example, the increase in the number of workers compensation have gradually declined, according to Ian Shepherdson, chief economist at Pantheon Macroeconomics.

“It is fair to say, in our view, that the end of enhanced/extended unemployment benefits, the reopening of schools and childcare centers and the disappearance of the fear of COVID – thanks to vaccination and the less severe omicron variant – have slowed the pace of wage gains from last summer’s peak,” Shepherdson said.

“On a quarterly basis, there’s now a decent bet that wage gains have stabilized,” he said. “But they’re still rising at too fast a pace for the Fed,” bolstering the odds that policymakers will announce a second consecutive half-point hike in the main interest rate after a two-day meeting ending June 15.

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