Recession fears rise as Fed eyes another interest rate hike (2024)
Investors are increasingly worried that the Federal Reserve will steer the US economy into a major recession – even as policymakers meet Tuesday to consider voting on a seventh straight interest rate hike.
The Fed is widely expected to enact a half-percentage point interest rate hike at the meeting’s conclusion on Wednesday. Fed Chair Jerome Powell has signaled ongoing rate increases are necessary to ensure inflation returns to normal – though the hikes will occur at a slower pace than the supercharged clip seen throughout the year.
The central bank’s critics say another rate hike, even of the smaller variety, would effectively dash remaining hopes for an economic “soft landing” amid signs of a cooling labor market and slowing growth.
“The Fed’s efforts have already pushed the U.S. economy into recession,” said DanielleDiMartinoBooth, CEO and chief strategist of Quill Intelligence. “The challenge they now face, as sticky housing inflation keeps broader inflation pressures high, is making sure that their rate hikes don’t cause a global financial crisis.”
Members of the Federal Open Market Committee will make their decision on the heels of the latest Consumer Price Index data from November, which is set for release on Tuesday and could have a major impact on the central bank’s course.
Investors are pricing in a 75% probability that the Fed will hike interest rates by half a percentage point, or 50 basis points. A half-point hike would mark a slowdown for the central bank, which has hiked by three-quarters of a point at four straight meetings through November — to reach its current level of 4%
Powell and Treasury Secretary Janet Yellen, who were perennially optimistic about “a soft landing” throughout the year, have begun to acknowledge the heightened risk of a slowdown. In a Sunday interview with “60 Minutes,” Yellen admitted to seeing a “risk of a recession,” though one wasn’t “necessary to bring inflation down.”
Concerns about the Fed’s plan has prompted volatility in the stock markets. Stocks indexes had a good day Monday — with the Dow gaining more than 450 points — but were coming off their their worst weeks since September. The broad-based S&P 500 closed at 3,990 on Monday, down from nearly 4,800 at the start of the year.
The uncertain economic outlook has only added anxiety among investors, who will be watching Powell closely for clear signs of the Fed’s long-term strategy.
“The real focus in Wednesday’s FOMC developments won’t necessarily be the magnitude of the rate hike itself, but which Jerome Powell shows up at the podium during the press conference – a kind, gentle and scripted dove prepared to pivot, or a hawkish Powell who isn’t afraid to jolt markets,” Booth said.
Among the Fed’s most prominent naysayers is billionaire Elon Musk, who recently warned that an economic recession “will be greatly amplified” if policymakers hike rates this week.
Elsewhere, JPMorgan Chase CEO Jamie Dimon shared a similar view during a recent appearance on CNBC. The bank boss warned that the Fed’s ongoing slate of interest rate hikes “well might derail the economy and cause this mild to hard recession people are talking about.”
While inflation has showed signs of moderation in recent months, the Fed’s hikes have hammered other parts of the economy – especially the US housing market, where prices and sales volume have plunged as mortgage rates skyrocketed.
Signs of disagreement have begun to emerge among the Fed’s governors. Doves such Philadelphia Fed PresidentPatrick Harker have urged a more methodical approach to gauge how hikes have already impacted the economy.
Meanwhile, more hawkish members, such as Kansas City Fed PresidentEsther George, warn economic pain is necessary to ensure inflation falls back to its acceptable target range.
“I don’t know how you bring this level of inflation down without having some real slowing—and maybe we even have contraction in the economy to get there, George told the Wall Street Journal last month.
In a late November speech, Powell further spooked investors by indicating the Fed could hike its benchmark rate“somewhat higher than thought”when policymakers last provided a forecast in September.
“It is likely that restoring price stability will require holding policy at a restrictive level for some time. History cautions strongly against prematurely loosening policy,” Powell said at the time.
At the time, Fed officials saw the rate hitting a peak of 4.6%. However, the market now expects rates hike to end when the range hits 5% to 5.25%, according to CME Group data.
Whenever the Federal Reserve lifts rates to battle high inflation, the risk of a recession increases, and the US economy has typically fallen into an economic downturn under the weight of rising borrowing costs.
For example, higher interest rates may hurt growth stocks more than value stocks. The high valuation of growth stocks tends to be based on expectations of future profits, but rising rates can decrease the value of those expected profits, taking growth stock prices with them.
In general, during a recession, interest rates tend to decrease. This is primarily because central banks and financial institutions take measures to stimulate the economy. By lowering interest rates, they aim to encourage borrowing and spending, which can help revive economic activity.
As interest rates rise, the interest income from loans typically increases faster than the interest paid on deposits, leading to wider profit margins. Additionally, higher interest rates can boost the earnings of insurance companies and investment firms, as they often hold large portfolios of interest-sensitive assets.
The New York Stock exchange (NYSE) at Wall Street, Jan. 31, 2024, in New York. A forward-looking measure of the U.S. economy continued to decline in January but importantly it is no longer signaling a recession in 2024, reflecting an economy outperforming expectations.
While interest rates usually fall early in a recession, credit requirements are often stricter, making it challenging for some borrowers to qualify for the best interest rates and loans. Consider the worst-case scenario: You lose your job and interest rates rise as the recession starts to abate.
Over time, higher costs and less business could mean lower revenues and earnings for public firms, potentially impacting their growth rate and their stock values.
Higher interest rates can make borrowing money more expensive for consumers and businesses, while also potentially making it harder to get approved for loans. On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits.
The average length between the initial rate hike and the start of a bear market is 3.5 years, and it's been 4.1 years between the initial hike and the start of a recession. However, that does not mean there is no risk of volatility.
Your money is safe in a bank, even during an economic decline like a recession. Up to $250,000 per depositor, per account ownership category, is protected by the FDIC or NCUA at a federally insured financial institution.
During an economic downturn, it's crucial to control your spending. Try to avoid taking on new debt you don't need, like a house or car. Look critically at smaller expenses, too — there's no reason to keep paying for things you don't use.
Cash: Offers liquidity, allowing you to cover expenses or seize investment opportunities. Property: Can provide rental income and potential long-term appreciation, but selling might be difficult during an economic downturn.
Unsurprisingly, bond buyers, lenders, and savers all benefit from higher rates in the early days. Bond yields, in particular, typically move higher even before the Fed raises rates, and bond investors can earn more without taking on additional default risk since the economy is still going strong.
When interest rates are higher, banks make more money by taking advantage of the greater spread between the interest they pay to their customers and the profits they earn by investing. A bank can earn a full percentage point more than it pays in interest simply by lending out the money at short-term interest rates.
Higher rates tend to lead to a more efficient allocation of capital across the economy, steering resources to growing enterprises that can put it to more productive use. Provide more income to savers, retirees in particular, who rely on fixed income.
Recessions are the result of shocks to aggregate supply or aggregate demand in the economy or both. A supply shock occurs when something reduces the economy's ability to produce output at a given price level.
How does increasing interest rates reduce inflation? Increasing the bank rate is like a lever for slowing down inflation. By raising it, people should, in theory, start to save more and borrow less, which will push down demand for goods and services and lead to lower prices.
A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.
When inflation is too high, the Federal Reserve typically raises interest rates to slow the economy and bring inflation down. When inflation is too low, the Federal Reserve typically lowers interest rates to stimulate the economy and move inflation higher. Want to keep reading? Learn the basics of inflation.
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