US recession risk remains as Fed seeks to tame inflation

The Federal Reserve raised interest rates by another 75 basis points (bps) at its July meeting, but indicated that the pace could slow from here.

In prepared comments, chair Jerome Powell said “the labour market is extremely tight and inflation much too high”.

However, he also said that as policy tightens further, it will be appropriate to slow the pace of increases to assess how the cumulative policy adjustment is affecting the economy and inflation.

Later, in his press conference, Powell noted that policy is now neutral, a view shared by other members of the committee. There will be plenty of new information coming in on the state of the US economy before the next meeting on 21 September, but these comments suggest the Fed is more likely to move by 50 bps rather than 75 next time.

In our view, evidence of a slower economy is likely to continue to accumulate via a weaker housing market and consumer. This should feed through to a slower labour market as firms respond to weaker sales.

The challenge will be how quickly or otherwise inflation declines. Lower commodity prices and easing bottlenecks suggest we will see lower inflation in the goods sector; however, headline CPI rates could remain sticky as service sector inflation will take time to turn.

As a consequence, the risks are still skewed towards the Fed having to generate a recession to bring inflation under control.