Two Central Banks One Optimistic One Very Pessimistic

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The most recent decisions by the Federal Reserve and the Bank of England to raise their respective policy rates could not present a more divergent outlook for investors.

Yesterday, the Federal Reserve adopted a strategy it has never successfully undertaken in the past. Chairman Powell remains optimistic that the Fed can reduce inflation from the current rate of 6 percent by 4 percentage points with no impact on economic performance. The Fed must count on a number of external factors 0verseas to break in its favor in order to achieve such a desired outcome. Nonetheless, Powell claims that there is “a path by which we would be able to have demand moderate in the labor market without causing a recession”.

Recognizing that this is a great challenge, he maintains his confidence that the Fed can achieve “a soft landing”. He continues to stress that households and corporations’ balances sheets are in good shape. 

Such fine-tuning has always been part of the Fed’s unshaken belief in the efficacy of its monetary policy decisions. Many critics, including this writer, do not share that confidence, since the Fed has a history of overstimulating the economy, only to have to make a mid-course correction to contend with an economic downturn.  

The first quarter of US GDP actually shrunk, a sign that the recession may have already started. Worker productivity declined by an unprecedented 7.5% and unit labor costs soared to 11.6% in the quarter. Yet Powell attributes these “unexpected” negative results to technical factors, such as higher inventories and slower export growth. Yet, both developments are the beginning signs of a slowdown. One wonders just how honest the Fed remains in the face of economic developments that do not fit their narrative.

The BoE is a study in complete contrast. Not mincing words, the BoE warned today that the UK economy is headed for a recession as higher energy prices are expected to push inflation to 10%. The bank stated that it was “unable to prevent” households from becoming worse off as the bank pursues its goal of bringing inflation down to 2%. The BoE stated outrightly that it will not be able to manage a soft landing while it is struggling with reducing the inflation rate. More to the point, this dismal prediction anticipates the UK to enter a recession by year’s end, as energy prices continue to soar and discretionary consumption cuts back in response to declining real wages. The BoE forecasts a significant increase in the unemployment rate from 3.8% to 5.5% by 2025.