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May 5, 2022
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Something extraordinary is happening in the US economy

The beast called “economic recession” is ready to pounce on America

The main financial news on May 4 is the decision of the US Federal Reserve System to raise the key rate. The key rate is the percentage at which the Central Bank lends money to commercial banks. The higher it is, the higher the deposit rates, but the more expensive the loans. When the rate is lowered, the opposite is true. The key rate determines the “weather” in the financial and, to some extent, commodity markets.

So, the key rate of the US Federal Reserve was raised to a value of 0.75-1.0%. It is noteworthy that the Federal Reserve usually changes the rate, raising or lowering it by one “step”, equal to 25 basis points (0.25%). And now the key rate has been raised by two “steps” at once, i.e. by 50 basis points. Prior to that, it was at the level of 0.25-0.5%. Such a two-stage jump last took place 22 years ago. This is a clear sign that something extraordinary is happening in the US economy. It is also noteworthy that this is the second consecutive increase in the key rate. At the previous meeting FOMC On March 16, there was the first increase in the rate by 0.25% (before that, since the beginning of the announcement of the “pandemic” in the US, the key rate had been at zero). The last time the US Central Bank increased the rate following the results of two meetings in a row was in 2006.

The Federal Reserve linked its decision to the difficult economic situation in the United States, linking it to Russia’s special operation in Ukraine and the epidemiological situation in China. A US Central Bank press release said:The invasion causes enormous human and economic hardship. The implications for the US economy are highly uncertain. The invasion and related developments are putting additional upward pressure on inflation and are likely to put pressure on economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is very attentive to inflation risks“.

After the March meeting, which raised the key rate by one “step”, the chairman of the Fed Jerome Powell began to psychologically prepare market participants for the subsequent possible radical steps of the Federal Reserve. He repeatedly said that America’s economy is threatened by two big troubles: inflation and recession. Inflation is already evident (according to the results of March – 8.5%), while a recession (economic downturn) still exists as a possibility. To fight a recession, it is necessary to pursue a super-soft monetary policy, and to fight inflation, this policy must be tightened. In the second case, it is necessary to raise the key rate and compress the money supply. The Federal Reserve understands that it is impossible to fight two “beasts” at the same time, and chooses to fight inflation. In March, annual inflation in the United States exceeded 8% for the first time in 40 years (since January 1982).

On March 21, the head of the Fed said that the regulator is ready for a tougher increase in the key rate to reduce inflation, if necessary. “We will take the necessary steps to ensure a return to price stability. In particular, if we conclude that it is appropriate to act more aggressively by raising the stake by more than 25 basis points in a meeting or meetings [Комитета по операциям на открытом рынке]we will do it” Powell said.

Let me remind you that during the financial crisis of 2007-2009. The Fed began to rapidly ease monetary policy. First, it reduced the key rate (bringing it to zero). Secondly, it rapidly increased the money supply (thrown money into the economy through the purchase of treasury and mortgage securities); this buildup is called “quantitative easing” (quantitative easing – quantitative easing). This liberal policy continued until the fourth quarter of 2014. By this time, the assets of the US Federal Reserve exceeded 4.2 trillion. dollars (for comparison: on the eve of the financial crisis in 2007, they were equal to 0.8 trillion dollars).

After that, the Federal Reserve tried to slowly tighten the screws, but it turned out badly. We were afraid of a recession. The greatest success was achieved in 2017-2019, when the Fed’s assets were reduced by 10-15% compared to the record values ​​of 2014, and the key rate slightly exceeded the 2% mark (the maximum value of 2.5% was held since December 2018 to August 2019). Even before the start of the “pandemic” in the second half of 2019, “quantitative tightening” was stopped, and the key rate was lowered to 1.75%. And already during the “pandemic” it was lowered to 0-0.25%.

After about two and a half years, we see a new attempt at “quantitative tightening.” The Fed unveiled plans to reduce balance sheet assets. Today, their value is very close to 9 trillion. dollars (which is more than an order of magnitude higher than the value of the Fed’s assets on the eve of the financial crisis of 2007-2009). Starting June 1, the Fed will sell $30 billion in Treasuries and mortgage-backed securities by $17.5 billion monthly. From September 1, sales will double, i.e., monthly sales of Treasuries will amount to 60 billion, and mortgage securities $35 billion. This is even more “cool” than in the period 2017-2019.

At a press conference after the decision to raise the key rate Jerome Powell said that the US Central Bank will do everything possible to bring inflation down to 2% per annum. Many were rather tense by his words that the US Federal Reserve is not yet considering raising the key rate by 75 basis points (this has not happened at all in the foreseeable history). But the discussion on a possible subsequent rate hike by 50 basis points at the next meetings FOMC he called quite appropriate.

Among senior Fed officials, it is customary to conduct surveys of their expectations for a key rate in the future. According to the latest polls, the average expected value of the rate at the end of this year is 1.9%; at the end of the next – 2.8%.

What are the possible consequences of the May 4 Fed rate hike? Of course, some decrease in inflation is expected. Maybe up to 6 or even 5 percent. US stock markets cheered up. Post news index Dow Jones rose by 1.10%, the index S&P 500 by 0.96%, index NASDAQ Composite by 0.67%.

In the good old (for America) times, an increase in the key rate would have meant a strengthening of the dollar. However, now we see the opposite picture. dollar index USDX (an index showing the ratio of the US dollar to a basket of six other major currencies: the euro, yen, pound sterling, Canadian dollar, Swedish krona and Swiss franc) fell markedly following the Fed meeting. Also, 15 out of 23 emerging market currencies appreciated against the dollar (Developing markets), and among them – the Russian ruble. An increase in gold prices has been recorded (it is expected that in the very near future they will overcome the psychological bar of $2,000 per ounce).

The looming thundercloud of economic recession is becoming more and more visible. And consequently, distrust towards the US dollar and financial instruments of American origin is growing. AT Goldman Sachs after the decision on the key rate, they estimated the probability of a recession in the United States in the next two years at about 35%, in the next 12 months – at about 15%. However, Goldman Sachs incorporates an element of optimism into their assessments.

It makes sense to listen to more independent experts. For example, Lawrence Summers (Lawrence Summers), a former US Treasury Secretary, called a recession the most likely scenario for the US economy in April. “The chances of a hard landing in the next two years are now clearly over 50%, perhaps two-thirds or even higher.”– Summers said on April 14 in an interview with the agency bloomberg. April Poll Wall Street Magazine among American economists and entrepreneurs showed that they estimate the probability of a recession in the United States in the next 12 months at 28% against 13% a year earlier. I think that after the Fed’s decision on the key rate on May 4, the mentioned experts would have made adjustments to their estimates, increasing the likelihood of an economic downturn. And of the two “beasts” that the Federal Reserve fears the most, an economic recession is, of course, more terrifying than inflation. And the “beast” called “economic recession” is ready to pounce on America.

Photo: REUTERS/Kevin Lamarque

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