Has the Federal Reserve Gone Too Far?

The Fed raised the fed funds rate by 75 basis points (bps) on July 27. The Fed had said they were going to do it. We were hoping they would change their collective mind based on several factors:

1. 1. The St. Louis Fed’s breakeven inflation rate, which represents a measure of expected inflation derived from 5-Year Treasury Constant Maturity Securities, showed lessening inflation pressures.
   2. The PCE Price Index (excluding food and fuel), the Fed’s preferred inflation measure, shows inflation subsiding since a March high.
   3. Core CPI (this series also excludes food and fuel) inflation is declining.
   4. The Fed acknowledges there is little they can do about food and fuel prices given the Ukraine war.
   5. The housing market has established a high.
   6. GDP (adjusted for inflation) fell in the first and second quarters of 2022.
   7. The bond market, via longer-term yields, is signaling that the additional rate hike was not necessary.
   8. Federal government spending has slowed.
   9. Prices of some commodities (including oil at the moment) are exhibiting trend reversals.
   10. Global supply chain pressures are easing.

Regardless, the Fed went with the aggressive 75 bps rise. The question now is “Has the Fed gone too far?”

Short answer: It is too soon to know.

Despite concerns, we do not thus far have an inverse yield curve on the 90-day T-bill and the 10-year government bond. This is a key metric to watch for, and an inverse yield curve must be maintained for two consecutive months before it becomes a statistical certainty that a GDP recession is coming our way.

If a sustainable inverse yield curve develops, it will signal a business cycle recession is probable for late 2023 or, more likely, 2024 for the economy at large – sooner for those parts of the economy (such as housing) that lead and later for segments (such as nonresidential construction) that lag GDP.

Even if an inverse yield curve is sustained in the near term, it would not be an immediate problem for the general economy. Unfilled orders are not likely to be slashed; backlogs will keep many firms busy. The consumer will continue to consume through the rest of this year and likely all of 2023.

What to do:

• Stay tuned to ITR Economics for updates on the yield curve status
• Let us help you determine the potential impact of a sustained inversion upon your specific business so you can properly prepare to take action(s) to minimize the adversity and focus on the upside potential that always exists.