Rising Inflation: Is a Recession Inevitable?

The Federal Reserve (the Fed) is taking several steps to fight rapidly rising inflation. It recently increased the Fed Funds rate by 0.5%, making the rate currently 1.0% after starting the year at 0.25%. This 0.5% increase was the largest made in a single meeting of the Fed’s Open Market Committees since May 2000, signifying the Fed’s willingness to tackle inflation head on.

In addition to raising the Fed Funds rate, the Fed is taking the fight against inflation even further as it announced that starting next month it will allow up to $ 47.5 billion in investment holdings to roll off its balance sheet. In three months, the Fed’s plan is to raise the amount of assets rolling off its balance sheet to $95 billion per month. Here’s an overview of how the Fed has tackled inflation in the past, their economic impact and if a recession will be inevitable.

Historical perspective

While the recent increases in the Fed Funds rate may seem to be unusual, travelling back in time to the late 1970s provides some much-needed perspective. In April 1977, the rate stood at 5.0%. By April 1980, it had risen to a level over 17%. In January 1981, it hit its peak of 20%. It then declined but increased back to the 20% threshold in May 1981.

During the recent COVID-19 pandemic, the rate was reduced to essentially zero as monetary policy officials took dramatic steps to help the economy recover from the impact of the lockdown that was implemented in response to the pandemic.

Economic impact

The measures recently taken by the Fed are specifically designed to reduce the level of inflation currently present in the U.S. economy. For the last twelve months ending in March, the nation’s Consumer Price Index measure of inflation rose 8.5%. This increase represented the fastest annual pace since 1981 and was led by higher fuel prices and food costs in part due to the Russian invasion of Ukraine. On a year-to-date basis, the price of oil has increased over 40% and a bushel of corn has risen over 30%.

By raising its funds rate, the Fed is attempting to slow economic momentum by increasing borrowing costs. This ripples through the economy as lenders will increase the rates they apply to loans in response to the Fed’s actions thereby making it more expensive to borrow money. Additionally, the decrease in the Fed’s balance sheet will increase the supply of bonds available in the marketplace and this increased supply may lead bond investors to require higher yields to entice them to purchase additional bonds.  This will also potentially contribute to an overall higher level of interest rates.

Is recession inevitable?

A commonly held belief is that when the Fed raises interest rates via its various policy tools a recession follows. This is not necessarily the case. There are periods of rate increases that began in 1963, 1994 and 2015 that did not result in a recession. And when recession did occur, its inception after the Fed’s first rate hike was highly variable. In fact, when reviewing recessions going back to 1946, the average time from the first increase to the start of recession was 25 months.

As the Fed continues to implement its efforts to squelch inflation, markets are likely to remain volatile. It is during these periods that investors should confirm their goals and objectives and remain disciplined in their pursuit of those goals. Resisting temptation to time markets or succumb to panicked trading are key components in exercising the discipline needed to help enhance the ability to achieve investment success.

The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns.

This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.