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MainStreet Macro: Makin’ it look easy

May 09, 2022 | read time icon 3 min

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The truly great always make it look easy, don’t they?  Be it Meryl Streep or Michael Jordan – no matter how hard, no matter what the feat – they make it look so easy.

The Fed is trying to do something now that’s really hard: Rein in inflation without choking growth. Last week, the central bank announced its intention to raise short-term interest rates by a half percentage point. 

Markets at first seemed satisfied with the Fed’s approach, but their initial rally was short-lived. After the central bank’s announcement that it would raise rates, the S&P 500 fell 3.6 percent on Thursday. It was the second biggest decline since June 2020, when the economy was entering the throes of the pandemic.

Fed policymakers will try to make their job look easy as they attempt to bolster confidence on Main Street and Wall Street. But as last week’s stock market slide shows, making it look easy is going to be quite difficult. 

Here are three things to keep in mind as the Fed tries to pull off one of the trickiest maneuvers in modern monetary history.

It’s complicated

The Fed’s game plan involves three moves. One we already know – raise rates.

The second is to reduce the swollen bond portfolio that the central bank accumulated over the last two years as it worked to pump up the economy. This huge portfolio did what it was supposed to do. Now it could be putting upward pressure on inflation.

The Fed’s third move is to keep an eye on the job recovery and wages. Policymakers want the economy to continue to add jobs at a solid clip every month, but rapid wage growth could fuel inflation.

Last month, the Fed was rewarded with a win. The economy added 428,000 jobs in April and year-over-year growth in average hourly earnings slowed to 5.5 percent, down from 5.6 percent in March.

The stakes are high

Whenever central bankers start raising interest rates, there’s always a specter of recession. As the saying goes, economic expansions don’t die of old age, they’re clobbered to death by the Fed. Policymakers this time aren’t messing around. They’ve brought in their best defensive line to tackle the overheated economy and sack inflation.

Except – the economy wasn’t overheating last quarter. Gross domestic product actually shrank by 1.4 percent.

That leads us to a second concern: Stagflation, where the economy slows but inflation remains high. The good news is April’s solid job gains should head off stagflation worries for now.

What’s next

As the Fed executes its inflation playbook, Main Street can expect some short-term pain for long-term gain.

Short-term pain will come in the form of market jitters. We know about higher interest rates, that’s a given. Expect continued stock volatility as markets repeatedly recalibrate their take on the Fed’s ability to wind down inflation.

But Wall Street is just a sliver of the economy. Main Street is the economy. And Main Street is more likely to be hurt by rapidly rising prices than by the Fed slowly moving interest rates up from the rock-bottom levels they’re at now.

Monetary policy is never like a slam dunk or even a layup. You have to wait a long time – six to nine months – to know if you’ve scored, because monetary policy moves are slow to take root in the economy. If the Fed’s plan works, we’re likely to see substantively lower inflation later this year, though it still could be higher than what Main Street is used to.

My Take

If you have to choose, higher interest rates and lower inflation is the way to go. And even if the Fed can deliver expertly on its complex moves, the economy will have to nurse some sore muscles for a while.