Federal Reserve Chair Jerome Powell testified before Congress Wednesday and will continue to do so today. He has been grilled on topics ranging from interest rates to inflation, as well as what he thinks the Fed can do to get the US dollar back under control. He’s faced some criticism from economists who think he’s increasing interest rates too quickly, and others who say he waited too long to reverse the Fed’s free-spending policies in 2020 and 2021.
The main takeaway from Powell’s testimony before Congress is that the Fed is up against a wall with inflation. It’s not an option for the central bank to do nothing about the cratering dollar. However, taking dramatic measures could send the economy into a recession, creating a tough dilemma for Powell. He has responded by aggressively hiking interest rates in an attempt to wrench the dollar back to a reasonable level, irrespective of the potential for a recession.
The Fed’s strategy has some economists worried about the potential for retail bankruptcies and stagflation. It’s unclear whether these moves will have any impact on the economy, though–despite months of higher interest rates, inflation continues to roar at full strength. Will things get better soon, or is the market in store for a bad year?
Powell Testifies Before Congress
Powell’s testimony before Congress hammered home something that investors and economists already knew: the Fed isn’t acting, it’s reacting. The 75 basis-point interest rate hike last week was something the market expected and priced in. That’s a far cry from the previous such hike, initiated by Alan Greenspan in 1994, which came out of the blue and stopped inflation before it could take root.
Some economists now think that Powell could be repeating the mistakes of past Fed chairs by capitulating to politicians and the markets. “Remember that until early January, the Fed was arguing for a moderate path of rate hikes that would top 2% in 2024 while the bond markets priced in a much faster pace to 2% at the end of 2022,” writes MarketWatch contributor Joachim Klement. “At its January policy meeting, the Fed suddenly changed tack and raised its guidance in line with what markets had priced in.”
“I estimate that about two-thirds of current inflation is due directly or indirectly to supply shocks in the energy and food markets that cannot and should not be fought with higher interest rates,” Klement continues. “Instead, the right policy action would be the one taken by Alan Greenspan in 1990: Look at underlying core inflation and the demand dynamics, not the headline inflation.”
Stocks Rise on Powell’s Comments
Despite some economists’ reservations about Powell’s policies, the stock market has reacted positively to his testimony. The S&P 500, Nasdaq, and Dow Jones indexes all rose slightly Thursday morning to erase some losses from Wednesday. This is good news for investors after the S&P 500 lost its highest amount of value since March 2020 last week.
During his testimony, Powell noted that the Fed is strongly committed to fighting inflation, but admitted that a recession was a possible outcome of the central bank’s strategy. “The Fed is behind — they’ve been behind for a while,” explains Ryan Belanger of Claro Advisors. “They’ve got their work cut out for them […] the soft landing speak is somewhat of a myth.”
Some economists are now saying that a recession is the only way out of this runaway inflation. The Fed can hike interest rates all it wants, but that might not address the underlying supply issues in the economy that are driving this monetary nightmare. A recession could disrupt demand long enough to allow prices to stabilize even though this outcome would be painful for US workers.
Bankruptcies Loom for the Retail Sector
Recessions are hard on everyone, but retailers feel the squeeze more profoundly than other businesses. Large retailers like Walmart and Target operate on slim margins that require a high volume of sales transactions to stay profitable. When the economy slows down, these retailers typically have the cash reserves to weather the storm. Some smaller retailers, however, don’t have this luxury.
Earlier this month, long-running makeup company Revlon filed for bankruptcy. While this move shocked some investors, many economists said it was a matter of “when,” not “if,” given the current instability in the market. “Retail is in flux,” says B. Riley Securities co-head of investment banking Perry Mandarino. “And within the next five years, the landscape will be much different than it is today.”
High energy prices, bottlenecked supply, pent-up demand, and inherent stubbornness on the part of Powell will likely all coalesce into a recession before the end of the year. The only question now is which companies will be able to survive the coming problems and which will be able to find success in an uncertain era.