[R's Horror] Uncontrollable Inflation, Harsh Tightening... Powell's 'Hobson's Choice'

[Asia Economy New York=Special Correspondent Joselgina] As inflation soars, the path for the United States to avoid a recession is becoming increasingly narrow. For the central bank, the Federal Reserve (Fed), it seems to be approaching a ‘Hobson’s choice’ with virtually no alternatives. In the market, there are growing calls for even more ‘harsh’ tightening measures to curb inflation, which is at its highest level in over 40 years.

◇ "To curb inflation, a recession must be induced"

Concerns about a recession intensified ahead of the June Federal Open Market Committee (FOMC) meeting on the 14th-15th (local time) following the release of inflation data. The U.S. Consumer Price Index (CPI) for May recorded its largest increase since 1981 (8.6%), fueling expectations that the Fed’s tightening pace could accelerate.

Bloomberg reported, "Soaring inflation is putting pressure on the Fed to take more action," adding that "Fed Chair Jerome Powell faces a grim calculation of having to push the economy into a recession to control inflation."

On Wall Street, the previously expected ‘peak inflation theory’ was dashed by the May CPI release, leading to widespread views that the Fed’s future response will inevitably take on a more aggressive stance.

David Einhorn, founder of hedge fund Greenlight Capital, likened the Fed’s approach to inflation at a conference to "shoveling an ice-covered driveway with an ice cream scoop," pointing out that the current interest rate hike path is insufficient to control inflation. Moody’s Analytics warned in a report at the end of last month that "if the Fed does not act aggressively enough, stagflation could occur next year," and predicted that the Fed might face a Hobson’s choice. Hobson’s choice refers to a situation where there is no real alternative.

At this month’s FOMC, there is a high possibility of a so-called ‘big step’ rate hike of 0.5 percentage points. This increase is in line with previous forecasts in terms of magnitude.

However, the key issue is the hint of tightening after July. The market is closely watching whether Chair Powell will signal a big step in July during the press conference or leave open the possibility of a ‘giant step’ by raising rates by 0.75 percentage points at once. Attention is also focused on the interest rate path and changes in long-term rates shown in the accompanying dot plot. The current median for 2022 is 1.9%, and the long-term rate is 2.4%.

Ultimately, if the Fed chooses bold tightening to curb inflation, many expect that a recession and rising unemployment will be inevitable, similar to the era of Paul Volcker in the 1980s. Unlike the Fed, which has emphasized a ‘soft landing’ so far, Wall Street investment banks such as Goldman Sachs and Deutsche Bank have already expressed concerns that a recession cannot be avoided.

A survey jointly conducted by the University of Chicago Booth School of Business’s IGM and others showed that nearly 70% of economists predicted a U.S. recession next year. Among them, 40% believed that even if the Fed raises the current benchmark interest rate of 1% to 2.8%, controlling inflation would remain difficult.

◇ Intensifying recession debate

Larry Summers, Harvard University professor and former Treasury Secretary under the Bill Clinton administration, appeared on CNN that day to warn that the U.S. will face a recession within the next 1-2 years. Summers has been an advocate for more aggressive monetary tightening to curb soaring inflation. He also criticized the Fed for being "overly optimistic" about inflation. Bruce Kasman of JPMorgan Chase similarly diagnosed that "if the Fed prioritizes inflation stabilization, it will ultimately be difficult to avoid a recession."

There is also analysis that signs of economic downturn are already being confirmed one by one in the U.S. economy. CNN reported that the Fed’s rate hikes, simultaneous sharp declines in stock and bond markets, inversion of short- and long-term Treasury yields, the Ukraine crisis, and other global risks indicate signs of economic slowdown in the U.S.

On the other hand, former Fed Chair Ben Bernanke sees room for the Fed to avoid a recession in the fight against inflation. Citing strong employment data and other factors, he stated that if supply-side pressures improve, a soft landing as the Fed suggests could be possible.

This content was produced with the assistance of AI translation services.