While the world is focused on the situation between Russia and Ukraine, the global economy is already rapidly slowing. Further uncertainty because of geopolitics and war could easily tip the global economy into a recession. For the Federal Reserve, the Russia and Ukraine conflict couldn’t come at a worse time, as the central bank is about to embark on its first tightening cycle since 2004.
Many pundits are calling for the Fed to back off its tentative plan to raise the federal funds rate or even commit to a slower pace of rate hikes as any tightening could shock the U.S. economy. Even though Fed Chairman Jerome Powell would probably prefer to keep monetary policy loose, inflation is running rampant.
Many consumers are blaming the Fed for creating runaway inflation because of its overuse of quantitative easing and zero-interest-rate policy, as many Americans are not seeing their wages rise as fast as consumer prices are rising. The Fed’s credibility is once again on trial, as it’s supposed to be using monetary policy to achieve both maximum employment and price stability.
With the unemployment rate at 3.8 percent, a historically low number, and job openings at almost 11 million, the labor market is showing signs of strength. The strength of the labor market is further validated in the weekly unemployment claims data that has been in the low 200,000 per week, which is a sign of a tight labor market.
Those who are unfortunate to hit the unemployment line can quickly find work. Total claims remain stable at around 2 million per week, validating that those out of work can find another job. Even the labor force participation rate is slowing, moving higher as long-term unemployed are returning to the workforce.
From the Fed’s perspective, a tight labor market should lead to a further increase in wages that should propel inflation even higher. The inflation issue is no longer an employment-related issue but one of supply and demand. The Fed believes demand is outpacing supply.
Due to the unprecedented shutdown of the global economy, supply chains ground to a halt as the world confronted a global pandemic. After repeated rounds of fiscal stimulus, shelves and warehouses were emptied as consumers eagerly spent their government handouts. Without factories and supply chains open, the supply of available goods quickly disappeared.
While supply chains are now showing signs of easing, many experts suggest it won’t be until this summer before supply chains are back to pre-pandemic operations. Despite a lack of fiscal stimulus, consumers aren’t showing any signs of slowing their spending as personal spending and consumption continue to increase based on the January data.
Even though neither Russia nor Ukraine are big trading partners with the United States, the conflict could further disrupt global supply chains and manufacturing, which could push inflation even higher. For the Fed, there’s only one solution, which is to constrict demand until supply chains normalize. The only tool the Fed has remaining, as quantitative easing will soon end, is to start raising the federal funds rate.
