High inflation growth and projected increases in interest rates can lead to an unwarranted economic recession. US investors expect the Federal Reserve to raise interest rates by at least 1% by the end of this month as high inflation suggests that possibility. Inflation rose 9.1 percent in June, the highest since November 1981, according to data released by the Bureau of Labor Statistics on Wednesday.
Federal Reserve officials will no doubt do something about it, and the most likely response is to raise interest rates at or near the previous 75 basis point hike. As CNBC reports, Fed funds futures rose 81 basis points in July, an indication that markets expect the Fed to raise interest rates by at least 0.81% on July 27.
While 81 basis points is the most worrying, market sentiment and expectations in this regard continue to improve as federal funds futures appreciate 93 basis points from July’s gains, according to the BMO. The increase in Fed funds futures can be attributed to comments from Atlanta Fed President Raphael Bostick, who said Wednesday afternoon that the June CPI report was very worrying and everything was “in play.”
Many traders are looking for clues like this from senior Fed officials ahead of the much-anticipated July meeting. At least one of them is expected to make a relaxed statement that would at least ease tensions around the region.
High inflation and aggressive interest rates can trigger a recession
High inflation growth and projected increases in interest rates can lead to an unwarranted economic recession.
When there are persistent increases in interest rates and no expected outcome of those increases, i.e. benign inflation, the risk of a recession becomes very high. This is a very difficult position for the Fed, as inflation must not be allowed to rise and the most appropriate monetary policy tools to contain it can also create this much bigger dilemma.
“Higher inflation means the Fed will have to act more aggressively.” A more aggressive Fed action means a higher recession risk, and a greater likelihood of a recession lowering interest rates,” said Andrew Brenner, head of international debt at National Alliance Securities.
Fed officials will think long and hard about this before their meeting. Although the situation in the United States looks bleak, other developed economic regions face a similar dilemma.
The Bank of Canada recently raised interest rates by 100 basis points, 25 more than the 75 basis points expected. The European Union also raised inflation expectations for this year to 8.3% as the ongoing dispute between Russia and Ukraine continues to fuel the rise in commodity prices.