Is the Federal Reserve Setting Us Up for Recession?

In order to normalize monetary policy, the Fed stopped quantitative easing (QE), which was being used to stimulate the economy. Monetary policymakers will resist the belief that concluding the bond-buying program was a tightening of policy even though real interest rates rose at the suggestion that QE has a short half-life. The new normal for economic growth is low short-term rates while inflation expectations have decreased. With the end of the QE era, the yield curve flattened, equities started moving sideways, and the dollar rose as did GDP and employment.

Fears of inflation and extensive wage acceleration remain premature as the economy has settled into mediocre equilibrium. The Fed expects that interest rates will need to rise to tame inflationary pressures and that the economy will evolve to raise short-term rates. Financial markets participants however, view the Fed as persistently lower than anticipated. It seems that a soft landing is already occurring in financial markets and that additional tightening will risk tipping the economy back into recession. It is debatable how far the FOMC will push their aggressive view of the appropriate path for the equilibrium rate. The story told by the accidental release of staff forecasts is that the Fed is stuck in between. The main concern now is that rate increases seem inevitable, which could mean a recession is in the works.   

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