The FED Is Struggling To Slow Down The Economy: Is This The Beginning Of The End?

Have you ever wondered why the Federal Reserve’s efforts to balance our economy sometimes don’t seem to do the trick? You’re not alone. In this blog post, we’ll dive into what’s going on with the FED and see if we should be preparing for any economic roller coasters. But first, let’s take a quick rundown on how the FED functions by answering 3 simple questions.

How is the FED regulating the US economy?

What’s the FED, and why do we need it?

You’ve probably heard about the Federal Reserve, or as most call it, the FED. Think of it as the main controller for U.S. banking. Their big job? Monitoring the amount of U.S. cash floating around. And while they don’t physically print money (that’s the Bureau of Engraving and Printing’s job), the Fed decides how much money circulates. Essentially, they have the significant responsibility of setting policies that can increase or decrease billions of dollars almost overnight. Quite a role, right?

What exactly does the FED do?

You might be wondering, “What’s on the FED’s daily to-do list?” Well, it’s got two main goals: keep prices stable and get jobs for as many people as possible. The first part is about controlling inflation, while the second one targets the unemployment rate.

To break it down, the Fed has four big tasks:

• Monetary policies. They regulate monetary and credit conditions in the U.S. to help with job growth, stable prices, and keeping interest rates at a sweet spot (currently, the goal is 2%).
• Regulatory functions. The Fed keeps an eye on financial institutions, ensuring the American banking sector is solid and that your money is safe.
• System safety. They’re like the guardians of our financial galaxy, making sure the whole system stays strong.
• Financial help. Beyond just monitoring, the Fed plays a role in running the national payment system and helping out other financial institutions, the U.S. government, and even some foreign entities. 

What tools does the FED have to influence the economy?

Before we understand why the FED’s tools used to cool down the economy don’t work, we need to learn what those are:

1. Interest rates adjustments. The FED+’s primary tool is adjusting interest rates. When they lower these rates, borrowing becomes cheaper, and saving seems less appealing. This encourages people and businesses to spend more. When the FED raises the rates, the opposite happens: less spending and more saving. So, in simple terms, lower rates can boost the economy.
2. Buying and selling in the open market. The FED buys and sells Treasury bonds. When they buy bonds, they’re essentially pouring money into the economy, which can reduce interest rates. On the flip side, selling bonds pulls money out, leading to potential rate increases.
3. Setting rules for banks. The FED decides how much money banks should keep on hand based on their deposits. In the economy, it is referred to as the reserve ratio. By changing it, the FED affects how much banks can lend. For instance, with a 5% reserve rule on a $500 deposit, a bank would keep $25 and lend out the rest. Adjust that percentage, and you’ll see how the lending landscape changes.
4. Power of words. Don’t underestimate the weight of the FED’s words. A mere hint or statement from them can send ripples through the markets. Say the FED drops hints about rising interest rates because they’re worried about the economy getting too heated. Investors might start selling bonds, expecting those rate hikes. As a result, the FED can sway the economy without even lifting a finger.

So, there you have it. The FED has a toolkit full of strategies to keep the economy on track. Whether it’s nudging interest rates, diving into the open market, setting bank rules, or just announcing something, the FED is always working behind the scenes.

Why is everyone worried about the current US economy?

You know that feeling when you’re trying to find the right balance? Like adjusting the water in the shower so it’s neither too hot nor too cold? That’s kind of what the FED is dealing with when it comes to interest rates. Raise them too much, and we might end up with something called a “hard landing” – think of it like accidentally dropping your phone on concrete. If they get the balance just right, we get a “soft landing” – where it feels like putting your phone down gently on a pillow.

According to some insiders over at Forbes, a lot of people are keeping their fingers crossed, hoping that the US economy will take that gentle path, cooling off without any major bumps. But (there is always a but), there are a few clouds in the sky. Inflation is getting better lately, but what about those interest rates? They’re at their peak in the last 20 years. And when we look at employment stats and how interest rates are playing out, it feels like we’re on thin ice.

What are the latest expectations from the FED’s crystal ball? The New York FED estimates there’s a 56% chance we could see a recession next year. It’s a bit of an improvement from the 66% probability announced in August. Still, what is the biggest issue?

Is inflation the major problem?

Ever noticed how the same amount of money doesn’t get you as much as it used to? Maybe a cup of coffee was $3 last year, and now it’s $3.10? That’s inflation in action – the more money there is in the economy, the lower its buying power, meaning our dollars’ worth goes down.

And the consequences go further than the price increase, as inflation impacts pretty much everything – from consumer spending and real estate prices to business investments. When companies start reviewing their costs and spending, they can change how they operate and the number of people they hire. 

So, how do we keep an eye on inflation? Here comes the CPI, short for the Consumer Price Index. It’s like the thermometer for inflation. This index watches price changes in things we use daily, like food, rent, clothes, and even your Netflix subscription. And guess what? It gathers info from 23,000 businesses and 80,000 products to give us an idea of inflation. If CPI jumps 3% in a year, it means we’ve got a 3% inflation rate.

Now, the latest stats show the US inflation rate sitting at 3.7% as of September 2023, which is a significant drop from 9.1% recorded in June 2022. Over the past 30 years, it’s been chilling around 2.31%. What is the FED’s take on this? Their target inflation rate is at 2%.

Source: Statista

But what’s the link between jobs and inflation? Well, it might sound weird, but they’re like opposite ends of a scale. More jobs and stable paychecks mean more shopping. More shopping means companies produce more, but their costs go up, leading to higher prices and, you guessed it, higher inflation. This is why some say a tiny bit of unemployment can actually be good for keeping inflation under control.

Source: Investopedia

Let’s look at the job scene now. The US is celebrating a low 3.8% unemployment rate – a huge drop from the 14.7% we saw during COVID times. The FED has a say here, too. They can tweak interest rates to cool things down if needed. This can keep inflation get close to that 2% sweet spot. Still, what if they play their cards wrong? Skyrocketing interest rates could slow things down, and that’s not great news for businesses or job seekers. Tighter budgets could mean fewer jobs and maybe even more layoffs.

So, there’s a lot in play. Yet, knowing how it all connects helps us make sense of those headlines, doesn’t it?

Top 3 reasons why the FED’s cool-down plan doesn’t work

So, you might have heard that the FED has been putting in the effort to slow the economy down a bit. But let’s be real, it’s not going quite well. Here’s a quick rundown of what’s been spoiling their plans:

1. That stubborn inflation. While the FED has been working its magic trying to bring down prices, they’re still playing catch up to hit that 2% dream. Just to give you an idea, there’s this indicator called the core personal consumption expenditure (PCE) price index that doesn’t count food and energy prices (because they’re volatile and less predictable). It is important because it is the FED’s preferred inflation measure. The issue is that even with the volatile products out of the picture, in August 2023, the core PCE price index was still up by 3.9% from last year on an annual basis. That’s one of the indicators suggesting that we’re dealing with so-called sticky inflation. So, there is still some work to do there for the FED.

Source: Trading Economics

2. Sky-high interest rates. 2023 was a wild year in terms of interest rates. The Central Bank raised them not once, not twice, but four times! That pushed the federal funds target to 5.5% – a level we haven’t seen in 22 years. And here’s the catch: that’s not the greatest news for businesses or our wallets.

Source: FRED

3. The job market rollercoaster. Generally, the US job scene has been on a good ride. But there’s been a significant layoff trend since the beginning of 2022. Some big names decided to cut back their teams, especially in the tech sector. According to Crunchbase, almost 1,300 American tech businesses laid off over 177,000 workers in the last two years. And if big companies are making moves like that, it makes you wonder what’s next, right? The interesting thing is that all these layoffs haven’t influenced the low unemployment rate so far, meaning that people found new jobs fast enough.

Source: layoffs.fyi

What’s up next for the US economy?

So, what might happen next in the US economy? To answer this question, there are a few factors we should consider:

1. Looking back. Historically, achieving a ‘soft landing’ for the economy hasn’t been easy. When the FED tried to control inflation before, it sometimes resulted in a recession. This trend has been around since the 1950s.
2. Powell’s take on this. That’s what FED Chairman Jerome Powell had to say about this in September: “To begin, a soft landing is a primary objective, and I did not say otherwise. I mean, that’s, that’s what we’ve been trying to achieve for all this time.” But given the past, it’s quite the challenge.
3. Twisted yield curve. In simpler terms, it’s when short-term interest rates go above long-term rates. In the past, when this happened, there was often a recession within the next 18 months. Remember 2019? This curve flipped, and shortly after, we faced the COVID-19 recession. It’s kind of a warning sign for the economy.

Source: US Wealthy Management

And this is how it looked in 2018:

Source: CNBC

Still, before you start panicking, remember that it’s not so bad after all. Right now, the US job scene is looking good, inflation is generally decreasing, and Wall Street says the FED won’t raise interest rates again this year. Plus, if history has taught us anything, it’s that the American economy recovers after any type of crisis.