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The economy’s unknown territory – POLITICO

HIKE AND HOPE — Chair Jerome Powell and his Federal Reserve colleagues did exactly as everyone expected they would this week: jack up interest rates by three-quarters of a point for the third time in a row and a total of 3 percent worth of hikes this year. What happens now is completely unknown. 

Want to know how unknown? Just look at the scattershot market reaction to the Fed’s official statement and Powell’s subsequent press conference. It’s all over the place. Both stocks and bonds suffered today as central banks around the world followed the Fed in tightening policy, raising the risk of a global slowdown.

While nobody knows what’s going to happen with the U.S. economy, one pretty decent guess is it winds up in recession sometime next year, just in time for the 2024 presidential campaign kickoff featuring incumbent President Joe Biden (or a replacement Democrat) and a GOP nominee whose name might be Donald J. Trump, a politician quite adept at leveraging grievance, economic or otherwise. One assumes Trump would relish running for another term amidst an economic slowdown.

Recession is not a lock. Don’t put any money on it (you may need that money later). What the Fed would like to see happen is for inflation to finally relent from its current annual rate of over 8 percent — the highest since the early 1980s — without economic growth turning consistently negative and unemployment rising sharply from its currently very low 3.7 percent (the basic definitions of recession).

But even a deflated-seeming Powell this week acknowledged that core inflation has not really dropped at all, despite all the rate hikes so far. Gas prices dropped from highs hit after Russia’s invasion of Ukraine, but that’s about it.

Powell tried to sound at least a little upbeat about the economy’s strong points, including continued robust job growth and household savings. And he noted that inflation “expectations,” or what people think inflation will be in the future, remain pretty favorable (this is important, but a story for another time).

But he pretty much dropped the idea that the Fed can beat down inflation closer to its target of around 2 percent without some potentially significant pain. “It would be nice if there was a way to wish it away,” Powell lamented. “But there isn’t.”

And he admitted neither he nor anyone else has any clue what impact the Fed’s rate hike will have beyond — God willing — bringing down inflation. “No one knows whether this process will lead to a recession or, if so, how significant that recession will be,” he said.

Many economists, including Democrats like former Treasury Secretary Larry Summers, argue that inflation will not get back anywhere near reasonable levels without unemployment rising to 6 percent or even higher. “It is looking increasingly likely that economic contraction, and a more meaningful move higher in the unemployment rate, is exactly what will be needed to bring down inflation,” Tiffany Wilding, economist at investment giant PIMCO, wrote in a client note this week.

Thus far, the Fed hikes have mainly hit the housing market, driving average 30-year fixed mortgage rates above 6 percent for the first time since 2008. Hiring, wages and job openings remain strong and the third quarter is likely to show at least modestly positive gross domestic product growth.

But as any Fed wonk will tell you, rate hikes operate with a big lag, meaning higher borrowing costs generally don’t start to tug down consumer and business spending (and thus the economy) for many months. Hikes also tend to drive up the value of the dollar, making our exports more expensive and giving companies less reason to bring cash back to the U.S. from overseas. All of which brings us back to the potential 2024 problem for Democrats from the presidential race on down.

Biden’s approval ratings got a little bump from the drop in gas prices. But they remain very bad, especially on the economy, where he averages just 39 percent. That’s a big problem for Democrats in the midterms. But it would be an even bigger one for the 2024 presidential race if the U.S. — and possibly the world — drops into a serious recession.

Trump’s future amidst all the sprawling investigations remains as unclear as the path of the economy. Perhaps he will be unable to run. But at the moment, the former president already polls fairly close to even with Biden in a hypothetical match-up. Imagine what Trump could do with joblessness hitting new highs and companies laying off millions of workers? Crowds at his rallies would indeed be “yuge.”

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