Another 75 bp Hike by Fed

Update 624 — Another 75 bp Hike by Fed
Role of Consumer in Recession Risk Ahead

The Federal Reserve announced by unanimous vote an increase in its target interest rate by 75 basis points for the second month in a row this afternoon. Though expected, this and last month’s rate hikes— both the largest since 1994 — seek to slam the brakes on inflation with both feet. The Fed is apparently adamant about fighting inflation, to a point.

The Fed’s attempt to slow down inflation without triggering a recession depends in large measure on the consumer response to the rate hikes. So in today’s update, we examine the implications of the Fed policy and the possibility of soft landings for businesses large and small, investors, workers, and consumers.




As it sets forth monetary policy, the Fed right now is coping with mixed signals from the macro and microeconomy.  Among the leading and countervailing factors complicating its aggressive monetary tightening: 

  • Exogenous factors like the conflict in Ukraine 
  • A tight job market 
  • Mortgage rates rising faster than the prime rate
  • Consumer spending at a healthy rate 

The Fed has to consider these factors and more when assessing its policy path, but the confounding data highlights the lack of omniscience and omnipotence of the central bank. Stuck between high inflation and the risk of a recession, consumers are hoping the Fed can stick a soft landing, but plummeting consumer confidence suggests people are predicting a crash landing instead. 

Macro on the Mind

Ultimately, the Federal Reserve’s duty is to balance the labor market and prices. Known as its dual mandate, the Federal Reserve seeks the highest level of employment without causing inflation to accelerate. The main purpose of the Fed’s current policy path is to impact the trajectory of the macroeconomy and cool it down:

  • Labor Market: Many expected hawkish monetary policy to rapidly cool the job market, but there does not seem to be a significant effect yet. Job growth still sits at a three-month average of 372,000 jobs gained each month, a slowdown since the winter but no discernable slowdown since the rate hikes began. 
  • Inflation: The Consumer Price Index registered at a 40-year high of 9.1 percent year-over-year and 1.3 percent month-over-month in June. The Personal Consumption Expenditures Price Index – generally the price index the Fed relies on – stabilized at 6.3 percent year-over-year but accelerated to 0.6 percent month-over-month in June. 

The robustness of the job market does give the Fed more breathing room to continue raising rates, but there is little evidence the rate hikes are easing inflation. The stubbornly high inflation in the face of aggressive interest rate hikes raises questions about the efficacy of the Fed’s policy path. The Fed can not do much to tame inflation generated by supply-side factors, a considerable portion of inflation. Balancing perceptions of being tough on inflation while avoiding a labor market freefall is a daunting task for the central bank.

Unemployment Rate, CPI, and PCE since 2018

Source: FRED, BLS, BEA

Checking Consumer Confidence

Consumers are now afraid of a looming recession. A July 11 survey found that 70 percent of Americans believe a recession is on the horizon – 59 percent believe it will happen within the next six months. The Federal Reserve keeps a close eye on consumer sentiment as a leading indicator for economic downturns as consumers will face the impacts of a recession before economic data releases capture the full image. 

To keep track of consumer confidence, the Federal Reserve keenly watches the University of Michigan’s Survey of Consumers – broken into the Consumer Sentiment Index and Inflation Expectations – and consumer spending via the Census Bureau’s advance retail sales:

  • Consumer Sentiment Index: In June’s survey, the consumer sentiment index fell to 50, the lowest reading on record, reflecting the immense pain inflation is causing despite a historically strong labor market. July’s report showed the consumer sentiment index inching up to 51.1, signaling easing gas prices could be removing some of the financial pinch on households. Consumer sentiment has still fallen 37.1 percent since July 2021 when the economy was rapidly expanding and high inflation had not yet settled in. 
  • Inflation Expectations: In the June report, inflation expectations fell from 5.3 percent over the next year to 5.2 percent. While marginal, the decrease means consumers are not anticipating the current rate of inflation to become embedded into the economy. 
  • Advance Retail Sales: The Census Bureau reported advance retail sales grew by 1 percent from May 2022 to June 2022 and by 7.7 percent over the year, showing consumers are still shopping and engaging in the economy. The stability of inflation expectations and spending contradicts the signals given off by the consumer sentiment index. 

The pessimism is already hitting retailers. Multiple big box retailers are slashing costs and offering sales to dump inventory, a necessary cut in their profit margins to induce consumer spending in the wake of inflation. Some retailers have begun to issue profit warnings or announce layoffs, a troubling signal that the Fed must address.

Despite the state of consumer confidence, expectations for inflation slightly fell and consumer spending remains strong. The confounding consumer indicators make the Federal Reserve’s job that much more difficult. Sentiments and expectations for the economy are dismal, but consumers also do not expect inflation to get worse and are spending as if elevated inflation and an impending recession are nonexistent. 

Advance Retail Sales and Consumer Sentiment
Year-over-Year Changes since 2018

Source: FRED, Census Bureau, University of Michigan

Time to Reel in?

Following this 75 basis point interest rate hike, the Federal Reserve must make a critical decision: push forward with this aggressive monetary tightening or begin winding down the interest rate hikes to a slower pace of 50 basis point rate hikes. Multiple Fed officials have begun reintroducing 50 basis point rate hikes back into the conversation after last month’s abrupt change from 50 basis points to 75 basis points. 

The next series of economic data releases before the next FOMC meeting on September 26 and 27 could convince the Federal Reserve to slow down its pace as well: 

  • Jobs Report (Aug. 5 and Sep. 2): The jobs report over the next two months will provide much-needed information about the state of the labor market. We will begin to fully understand how much of an impact the two 75 basis point interest rate hikes have had on the labor market. We will also receive weekly unemployment insurance data that will be a real-time indicator of the health of the labor market.
  • CPI (Aug. 10 and Sep. 13): It would not be a surprise at this point for inflation to come down considerably in the next two CPI reports. With gas prices plummeting over the last month, CPI could significantly dip for July and August. These drops could help convince the Fed it is time to reel in the rate hikes. 
  • PCE (Jul. 29 and Aug. 30): The next PCE report comes this Friday, hopefully heralding the fall in inflation before the July CPI numbers come out in August. The next two reports will likely show similar trajectories, but since PCE provides comprehensive coverage of the economy, the Fed will focus on PCE to determine its next interest rate hike and future policy path. 
  • University Michigan Survey of Consumers (Jul. 29, Aug. 12, Aug. 26, and Sep. 16): Before the next Fed meeting, we will get final data for July, preliminary and final data for August, and preliminary data for September for both consumer sentiment and inflation expectations. These releases will help give the Fed crucial insight into how consumers are responding to tightening credit and potentially a reduction in inflation. 
  • Advance Retail Sales (Aug. 17 and Sep. 15): The Fed will use advance retail sales as a signal for a recession. If consumer spending begins to drop, particularly by a significant amount, the Fed will be forced to slam the brakes if not reverse course and cut interest rates. But if consumer spending remains strong, the central bank will not be immediately concerned. 
  • Gross Domestic Product (Jul. 28 and Aug. 25): The upcoming Q2 GDP report has been the talk of the town following the 1.6 percent decline in GDP in Q1 as a potential indicator of recession. However, due to volatility among inventories in the last report and the long period of time the data is subject to revisions, the Fed is discounting the GDP report as a real-time indicator of economic contraction. 

The Federal Reserve has the weight of the economy on its shoulders. That burden is not eased by the confusing economy before it as multiple signals compete with each other to dominate the narrative. The job market continues its steady expansion while inflation chips away at people’s wallets. Consumers are hurting from inflation, but consumer spending remains robust in spite of the pessimism. 

A third 75 basis point hike could prove to be too much and tip the country into a recession, so the Fed should move to a 50 basis point rate hike path and eventually move down to 25 basis point rate hikes by the end of the year before ending monetary tightening sometime early next year. The Fed must consider slowing down its interest rate hike path after today in order to preserve the impressive recovery it and Congress worked so hard to attain, but it cannot fully let go of its effort to tame inflation. Consumers will continue watching with bated breath as their wallets feel the crunch and their jobs hang in the balance.