AnalysisWhy is the Fed trying to ruin the economy?

Southern California bosses have added 400,000 jobs in the past year.

Local wages, by one measure, are growing at a 5.6% annual pace. The region’s homes are selling at prices 10% higher than a year ago.

So, why is the Federal Reserve hellbent on quashing the good times and pushing the nation

toward a recession?

You see, the Fed’s job is to keep the economy humming while maintaining a relatively stable cost of living. The central bank sharply raised a key interest rate twice within six weeks because it failed badly at managing inflation.

The local consumer price index shows inflation running at a budget-busting pace: 9.4% in the Inland Empire and 8.6% in Los Angeles and Orange counties. Nationally, the CPI was rising at a 9.1% annual rate in June — a 40-year high.

Two years ago, the pandemic’s economic wallop prompted various parties, including the Fed, to rescue the briefly shattered economy. Yet “too much good stuff” in these various aid packages means it’s now payback time. Inflation is an economic evil with wealth-cutting effects that must be tamed.

Now restoring economic sanity shouldn’t just be the Fed’s chore, but the nation’s central bank is being forced to be the adult in the room. Throughout 2022, it cautioned anybody who would listen that its gift-giving phase was ending. Some government entities — not all — are still in handout mode.

To cool the economy, the Fed’s deploying its most powerful tool: shutting off the cheap money it previously promoted. And the economy is starting to stall.

“Too much demand because people went nuts coming out of the pandemic restrictions. Too little supply because of just-in-time inventory schedules trashed by the intermittent and unpredictable pandemic lockdowns around the world,” says economist Mark Schniepp of the California Economic Forecast. “This has created higher prices which ration goods to the highest bidders. So the Fed’s job is simple: Get demand for goods to decline.”

Closer to home, Southern California’s hiring pace has cooled to 14,000 a month so far this year from 55,000 in 2021’s second half. Home sales in the six-county region are down 20% in a year. And one poll found California’s view of the financial future taking its biggest drop in nearly 14 years.

Tempering inflation requires economic influencers to work toward a difficult-to-swallow goal. Of course, everybody wants higher profits or pay. Yet who’ll cut their price for the greater good?

Let’s consider a dozen hazards the economy must dodge to deftly reduce inflation without a major business collapse.

1. The fed itself

The last time the central bank pushed its key rate up to today’s 2.5% was December 2018 as it was trying to chill inflation from that cycle’s peak of 3%. Yes, just 3%!

So Fed chairman Jerome Powell must keep his rate-setting partners at the bank thinking along his same “tough love” logic for today’s steep inflation problem.

If inflation cools slowly, how high could rates go? Or if the economy begins to implode, will inflation become a secondary concern? Powell could face an internal battle.

2. The bond market

The Fed only controls certain interest rates with the rest decided by bond traders. And these folks seem to have a very split opinion.

Short-term rates set by Treasury bill trading, but heavily influenced by Fed actions, have risen to roughly 2.5% from 1.75% in the past month. Meanwhile, 10-year rates, a benchmark for mortgages, fell to under 3% from roughly 3.5%.

So will market rates go higher to fight inflation? Or fall to reflect the growing probability that pricier financing will create a recession?

3. Lenders

The Fed used its checkbook to boost a once-ailing economy with mortgage rates as low as 2.65% at 2021’s start, by Freddie Mac’s math.

Rates nearly hit 6% this spring before settling to 5.3% at last count. In the wake of the surge, mortgage making has been pummeled. Refinancing opportunities are gone and homebuying is stalled.

Will lenders, faced with shrinking business, take on more risks with borrowers to keep loans flowing? This works against the Fed’s cooling plans.

Plus, it creates other risks. Remember the loose lending that led to the housing bubble of the mid-2000s?

4. Savers

Gosh, some banks now offer 1-year CDs above 2%.

The old near-zero-rate policies nudged savers to spend and invest in the economy. Rate hikes are designed to get folks to stop shopping and park money in safe places.

Slowing the flow of speculative investments to assets such as stocks, crypto and real estate can cool the economy. Or kill it.

5. Washington, D.C.

Any verbal flak the Fed gets from the White House or Congress is not a real concern. But politically minded economic worries, or partisan necessities, might motivate some sort of additional federal stimulus action.

Putting more cash in taxpayers’ wallets, despite the political popularity, would undermine the Fed’s ability to restrain an overheated economy.

6. Governors ‘helping’

Uncle Sam isn’t the only government with cash. Governors from California to Florida are approving aid packages designed to help residents affected by the rising cost of living.

Gov. Gavin Newsom’s budget will send most Californians up to $1,050 as soon as October. His arch-rival Gov. Ron DeSantis provided many Florida families with $450 per child just in time for a statewide sales-tax “holiday” that ends Aug. 7.

There’s only one problem with this state-level generosity to taxpayers — it percolates an economy the Fed is hoping to slow.

7. The housing market

The Fed’s rising mortgage rates are quickly chilling the housing market.

House hunters nationwide quit looking amid high rates and lofty prices. June’s U.S. pending sales — deals in escrow — are down 20% in a year, slipping to the slowest pace since September 2011, just after the Great Recession ended.

Can the nation fix its inflation mess before a house-price collapse?

8. The energy game

The local CPI says gasoline is 50% pricier than a year ago, electricity is up 21% and heating fuels are 39% more expensive.

Yes, Econ 101 says higher prices beget more output that eventually lowers costs. But energy companies don’t seem to mind their current windfalls.

Plus, energy is a geopolitical chess piece. Further international turmoil could spur major oil-producing nations to turn off the spigots.

9. The pandemic

The coronavirus won’t go away, even if most people are tired of its impact on everyday life and commerce.

As tough as it is to admit, fears about new variants and long-term health impacts could help the Fed throttle the economy.

Conversely, health-related business issues might raise doubts about the timing of future rate hikes.

10. The stock market

Well before rate hikes were reality and recession talk common, share prices were slashed.

The worst first-half-year for stocks since 1970 cut values by 20%-plus, creating an “official” bear market. The Fed is probably thankful for that economic warning signal.

While that’s a win for the Fed — lowering speculation — further significant drops in stock values could create calls to ease rate hikes.

11. Bosses

Most CEOs spend too much time worrying about the company’s share prices, so a horrible 2022 on Wall Street no doubt revised C-suite thinking.

Many bosses will cut costs to boost profits. That penny-pinching could help moderate inflation, particularly surging wages.

Already, employers from online retail’s Amazon to technology’s Google to entertainment’s Netflix to auto seller Carvana to real estate’s Compass are in layoff mode.

12. The supply chain

How goods get made, shipped and distributed isn’t the Fed’s responsibility.

And yet the tangled supply chain wasn’t the only inflation contributor. An overstimulated economy meant the ports of Los Angeles and Long Beach handed record shipments — 16% more than pre-pandemic 2019.

If rising rates chill consumer demand, the world’s logistics systems could get some relief. But that may not get critical materials produced in time to satisfy factory shortages.

Prime example: Missing chips are still slowing the production of new vehicles, ballooning prices of new and used cars.

Bottom line

The timing is hard to predict, but it’s a good bet fixing inflation will not be painless.

It took three years to get 1980’s nearly 15% inflation rate to under 3%. In 1990, it took a year for inflation to go from 6% to 3%. And one year after inflation hit 5.5% in 2008, the nation was suffering 2% deflation.

All three of those chills to the cost of living came with recessions attached.

Want to rate 12 risks the Fed faces as it navigates this challenging inflation-correction chore? Go to my questionnaire at bit.ly/fedrisks!

Jonathan Lansner is the business columnist for the Southern California News Group. He can be reached at [email protected].