Why the Fed Won’t Stop Raising Rates — Shun Nakahara’s Today’s Word updated August 3
The dramatic drop in consumption is already countdown
The reason the Fed and Chairman Powell will not stop raising rates is that consumer prices keep rising and employment remains strong. Inflation staying high due to wage growth—that, in essence, is the Fed’s nightmare. However, this path is effectively blocked because prices have risen so much that real wages of workers continue to decline. It would be more appropriate to tolerate some wage growth to improve real incomes. But the Fed will not tolerate that, so I believe the economy is heading toward a dramatic decline in consumption. If this comes to pass, GDP which has already contracted for two quarters may continue to contract for three to four quarters, forcing authorities to rush to stimulate the economy—that is my main scenario.
Ironically, the path to inflation cooling that Chairman Powell spoke of at Jackson Hole last summer is now becoming feasible. In Jackson Hole in 2021, Powell said, “The rapid reopening of the economy led to a rapid rise in inflation,” but “the likelihood is high that inflation will prove to be temporary, and inflation concerns will ease.” He added, “Mistimed tightening will unnecessarily delay employment and other economic activity, and push inflation below the desirable level,” and further, “There remains considerable slack in the labor market, and the pandemic is ongoing, so such mistakes would be especially harmful. Prolonged unemployment could inflict lasting damage on workers and the economy’s productive capacity.” Even looking back now, that view in the summer of 2021 was a major mistake, but in 2022, actually implementing this content might avert a rapid economic decline.
GDP growth has been repeatedly reduced due to the Fed’s own monetary tightening, and economic activity in 2022 is shrinking rapidly.
Both the rise in consumer prices and the expansion of employment are the most lagging indicators. As long as policymakers focus on these, the Fed will again be decisively late. Real income continues to fall, consumers defend their living standards, mortgage applications are rejected, and purchases of major durable goods are foregone. June personal consumption expenditures (PCE) rose by only 0.1% from the previous month on a inflation-adjusted basis. Meanwhile, the PCE index, which the Fed uses as the standard for its inflation target, rose 1.0% from the previous month (consensus was 0.9%). Year over year, it rose 6.8%. The advanced release of gross domestic product (GDP) for the second quarter (April–June) showed a 0.9% annualized decline from the previous quarter. With two consecutive quarters of contraction, purchasing power is deteriorating under the influence of rising inflation. Personal income is rising, but the pace cannot keep up with rapidly rising prices, and many consumers have little left to spend after essential payments for gasoline, food, and rent. The savings rate fell to 5.1%, the lowest since 2009. A recent Census Bureau survey found that 4 in 10 Americans say they are struggling or having great difficulty making ends meet. That share is the highest since the question first appeared on the survey in August 2020.
Given these extremely tough conditions for U.S. consumers, at some point a “dramatic drop in personal consumption well beyond expectations” should occur. When that happens, even the relentlessly cautious Fed and policymakers will be forced to undertake large-scale economic stimulus. Initially, I expected this period to arrive around spring–summer 2023, but with this pace, a decisive consumption decline could be observed in fall–winter of this year.
That will be the moment when all conditions for stock purchases are met.
