Opinion | The Economy Is Already Cooling, So Why Is the Fed Dousing It With Cold Water?


The economy is in “strong shape,” the Federal Reserve chair, Jerome Powell, said last week at a forum of central bankers in Portugal. In addition to jobs, he cited strong household and business finances, saying that the United States is “well positioned to withstand tighter monetary policy.”

More and more, though, the strength of the job market is looking like the shiny coating on a machine that is rusting on the inside. Consider just a few key indicators:

— Economic output shrank in the first quarter at an annual rate of 1.6 percent. And while the dip was originally portrayed as a fluke, it doesn’t look that way anymore. The Federal Reserve Bank of Atlanta estimates that gross domestic product shrank at an annual rate of 2.1 percent in the second quarter, which ended June 30.

— Incomes aren’t rising rapidly enough to keep up with prices, so consumers are losing spending power. That’s critical because personal consumption accounts for a majority of economic output. Adjusted for inflation, disposable personal income fell 0.1 percent in May and personal consumption expenditures fell 0.4 percent.

— The University of Michigan’s index of consumer sentiment fell to 50 in June, the lowest ever recorded.

— Prices of many commodities are falling, a sign that industrial buyers are cutting back in anticipation of weak demand for their products. Since the start of the year, futures prices have fallen 23 percent for copper, 13 percent for platinum and 41 percent for lumber. Prices of oil and wheat are still higher than at the start of the year, but that’s in large part because of shortages caused by Russia’s invasion of Ukraine, not because of strong demand. That said, even those commodities are off their highs of the year.

— Investors, who are sensitive to the risk of an economic downturn, are running scared. The stock market had its worst first half since 1970. The dollar’s value against other major currencies, which rises when people seek a safe haven from risk, is at a 20-year high. And investors have started demanding extra yield for the risk of holding junk bonds, which are more likely to default in a recession.

Despite all this, the Federal Open Market Committee is still expected to raise the target range for the federal funds rate, the short-term rate it controls, by another three-quarters of a percentage point at its next meeting, scheduled for July 26- 27. That would bring the cumulative increase since the start of the year to two percentage points, an increase so rapid that it’s reverberating throughout the financial system. The US financial stress index of the Office of Financial Research has risen to its highest since the pandemic recession.

While Americans hate inflation, there’s also mounting worry about its opposite, deflation, which is a broad-based decline in prices and incomes that’s usually a symptom of economic weakness and rising joblessness. (Still a distant threat, I’d say.) Deflation makes debt more onerous because you owe the same amount of money but have less income to pay it off.

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