A recession would force the Fed to slow rate hikes, but a cut would come when inflation falls, unemployment jumps

The Federal Reserve has been sending a clear message – it wants to bring down inflation, accepting and even willing to see economic pain. So far, officials have been talking about ¨below average growth,¨but not an outright downturn. In the US, a body called the NBER determines when there are recessions. It depends on a mix of factors such as a decline in GDP, rising unemployment and other factors.

The Fed has two mandates: price stability (aka low inflation) and full employment. It is easy to focus on inflation when the unemployment rate is at 3.7% and the US continues creating many new jobs – 315K in August, above the pre-pandemic average of 200K.

At some point, the Fed will have a hard choice between pushing inflation down and pushing inflation up. We don’t think they will have this dilemma until there are at least two consecutive months of job losses. One month would be brushed off as a one-time event.

For now, We don’t see the Fed raising rates by only 50 bps. What it could do is raise rates by 75 bps as expected, but signal that signs of a slowdown mean the next steps will be more cautious.

We think it has a low probability after the recent super-strong Core CPI report – and despite a small drop in inflation expectations. We think they could consider such a “pivot” in November. By then, they will have new inflation figures and also GDP estimates for Q3.

For now, even if Powell mentions the possibility of a recession, it will be in the context of his tough message – something along the lines of “We will have to continue hiking rates into a recession, because we need to crush inflation.”

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