Insana: ‘Be careful what you wish for’ as Fed steps up aggression on monetary policy

US Federal Reserve Chairman Jerome Powell speaks during a press conference in Washington, DC on May 4, 2022.

jim watson | AFP | Getty Images

We have reached the “be careful what you wish for” moment for Federal Reserve policy.

After months of scathing criticism from former Treasury officials, Wall Street economists and others for seemingly lagging the inflation curve, the Fed now faces mounting complaints – from those same people – that his more aggressive inflation-fighting plans will boost the US economy. in recession.

With a sharp drop in U.S. real estate activity, a downward revision to second-quarter gross domestic product estimates, and a rapid accumulation of business inventories, it’s clear the economy is slowing much more noticeably than it does. the so-called experts had foreseen it. This is starting to cause the kind of market-related strains that have, in the past, brought Fed tightening cycles to an end.

Consumers shoot in their horns

Mortgage applications have plunged. The mortgage refinance business is dead in the water. Pending home sales, as well as new and existing home sales, have all fallen in recent months.

With a 30-year fixed-rate mortgage now at around 6%, a $450,000 home purchased with a 3% mortgage last year has almost the same monthly payment as a $320,000 home purchased at the current rate. . Talk about sticker shock!

Consumers seem to be pulling in their horns. They have exhausted excess savings accumulated during the pandemic, turning to credit card purchases instead of cash.

For some, this indicates that the alleged $2.5 trillion in excess savings has evaporated.

Indeed, after peaking at nearly 34% at the height of the pandemic – thanks to generous measures to mitigate the economic impact of sheltering-in-place and working from home – the personal savings rate fell to 4.4%, about where it was before the pandemic.

There, of course, there was also the obvious impact on the financial markets.

The Nasdaq Composite is down more than 30% from its all-time high. The S&P 500 has lost more than 20% of its record. Think here of a negative wealth effect.

Speculative “meme” stocks plunged. The much-loved technology has dropped. US Treasuries posted the worst half-year performance in bond market history. Credit spreads widened and crypto crashed.

The spread between high-yield debt and comparable Treasuries has exploded, increasing the risk of default among debtors who are below investment grade.

Ford says auto loan delinquencies are rising, while 60% of corporate CEOs predict a recession is now likely within the next 12 to 18 months.

It looks like it won’t take that long, judging by the current market-based recessionary indicators.

Indeed, more aggressive action by the Fed to stifle inflation, which stems more from supply-side disruptions than from demand-side imbalances, will lead to economic hardship.

Overseas policies

Fed policy, which essentially influences interest rate policies around the world, is also causing tensions outside our borders.

The European Central Bank has held an emergency meeting to discuss ways to support Europe’s most indebted countries – including Italy, Spain and Portugal – even as it raises rates to fight the coronavirus crisis. ‘inflation.

Good luck with running these policies concurrently.

Global monetary policies are asynchronous: China and Japan are easing, while the US, EU, Britain and Switzerland are tightening.

This may well lead to additional global tensions, as the unintended consequences of “zero coordination policies” will bring some markets to breaking point.

We witnessed this in 1994 during the Mexican peso crisis, during which there was massive tension over the peso-dollar peg. This led the US Treasury and the International Monetary Fund to bail out Mexico when its currency crashed.

Orange County, California, through horrible bond bets in its own treasury, declared bankruptcy in 1994. This led the Fed to change course and begin cutting interest rates to stop the damage caused at home and abroad.

Similarly, the 1997 Asian currency crisis, the Russian debt crisis, and the related collapse in long-term capital management also forced the Fed to stop raising rates and start easing them again.

It is often said that the Fed will raise rates “until something breaks”.

Something is about to break somewhere. Looking back, those who called on the Fed to be aggressive will also say they anticipated the consequences of a tough tightening cycle.

I hope someone calls them out for such duplicity.

– Ron Insana is a CNBC contributor and a senior adviser at Schroders.

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