Fed Abandons Forward Guidance, Opening The Door To Speculation On Its Next Move

• Avoiding another 75-basis-point hike in September looks tough
• Policymakers say focus should be on inflation, not recession
• Central banks, including the Fed, made mistakes that have led to inflation

Now that the Federal Reserve has followed through on expectations it would raise its policy rate by three-quarters of a percentage point and has abandoned forward guidance to free policymakers to decide monetary policy on a meeting-by-meeting basis, speculation is rampant about what the Fed will do next.

At his press conference following last week’s meeting of the Federal Open Market Committee, Fed Chair Jerome Powell hinted that the panel might slow down the pace of rate hikes as demand responds to monetary tightening.

But analysts say the latest data, along with growing unease among big retailers regarding consumer demand, means the Fed will have to have some compelling numbers on a slowing economy and inflation to avoid another 75 basis point increase at the September 20-21 meeting of the FOMC.

The data has not been encouraging. On Thursday, the Commerce Department confirmed that the economy contracted in the second quarter at an annualized 0.9% rate after declining at a 1.6% rate in the first quarter. We now have to call two successive quarters of decline a “technical” recession, because administration officials are not willing to use the R-word.

This roused the ire of bank expert Karen Petrou in her latest memorandum:

“It’s hard to think of a greater disconnect between economic policy and economic reality than when public officials assure Americans everything will be fine even as households with employed individuals are cutting back essential purchases, going even more deeply into debt, and hearing more and more about shorter hours and even layoffs.”

Another prominent Fed critic, economist Nouriel Roubini, weighed in last week with a gloomy forecast. “There are many reasons why we are going to have a severe recession and a severe debt and financial crisis,” he said on Bloomberg TV.

“The idea that this is going to be short and shallow is totally delusional.”

The release last week of the personal consumption expenditure index of inflation provided more discouraging data as it showed prices up 6.8% on the year in June, compared to 6.3% in May. Even the core PCE index, which Fed policymakers consider a better gauge of underlying inflation because it excludes food and energy prices, rose 4.8% after 4.7% in the previous month.

Two prominent Fed doves played down talk of recession following the FOMC meeting, but both acknowledged inflation is too high and the Fed has to make it come down.

“There are a lot of people hurting,” Atlanta Fed chief Raphael Bostic said in an NPR interview Friday.

“And because of that, we really need to address the high levels of inflation and get this economy back into a more stable and sustainable situation.”

Neel Kashkari, head of the Minneapolis Fed, said his focus is on inflation, not recession. “We’re going to do everything we can to avoid a recession, but we are committed to bringing inflation down, and we are going to do what we need to do,” Kashkari said on CBS’s Face the Nation.

“We are a long way away from achieving an economy that is back at 2% inflation. And that’s where we need to get to.”

Graeme Wheeler, who was governor of New Zealand’s central bank from 2012 to 2017, co-authored a paper published last week under the title “How Central Bank Mistakes After 2019 Led to Inflation.”

Wheeler and his co-author, economist Bryce Wilkinson, ticked off those mistakes: central banks were too confident about their monetary policy framework, too confident about their models, too confident they could control output and employment, lost their focus on price stability and took on too many other obligations, including conflicting “dual mandates” and the distraction of extraneous political objectives like climate change.

The Fed made every one of those mistakes and is now trying to catch up on inflation. It might be too late to do so without Roubini’s severe recession.