The Fed's obsession with 2% inflation could cost Americans their jobs
- Inflation is falling, and fast.
- But the Federal Reserve wants the rate to drop to just 2%.
The Federal Reserve is entering the home stretch of its war against soaring prices – but now might be the time its interest-rate hikes finally cause economic pain.
Data released this week showed inflation rising 3% in June, down from 4% the previous month and way below the four-decade highs the rate had hit in the middle of 2022.
Under Ben Bernanke's leadership in 2012, the Fed brought itself in line with most of the world's other major central banks by setting itself an explicit target to keep inflation at around 2%.
That meant that, to hit its goals, it's chosen to aggressively raise borrowing costs over the past 16 months in a bid to stop the price of food, gas, and housing from surging.
Some economists fear that to lop a final percentage point off the inflation rate, the Fed will end up wrecking the jobs market.
That's because when interest rates rise, spending falls – meaning that businesses take lower profits and become more likely to lay people off in a bid to cut costs.
In 2023, that's not yet happened – with jobs numbers rising over the past six months and unemployment holding steady at under 4%, even though inflation has rapidly cooled.
That's close to a dream scenario for the Fed – but now it has a decision to make:
- Option 1: it carries on tightening, crushes inflation – but risks costing hundreds of thousands or even millions of Americans their jobs.
- Option 2: it decides that 3% inflation is "good enough", doesn't raise interest rates again – and risks another flare-up in prices in a few months' time.
But policymakers have tended to signal that they favor the first choice, while traders expect the central bank to bring in one more rate hike and then not loosen monetary policy until May 2024, per CME Group's Fedwatch tool.
But BlackRock bond guru Rick Rieder is one of several top Wall Street names who've called for the Fed to pick option #2 – pat itself on the back for getting inflation to fall to 3% so quickly, and take further rate hikes off the table so not to crush the jobs market.
"This whole idea of there's a magic to 2% doesn't make any sense to me," he told Bloomberg's "Odd Lots" podcast this week.
"It's not worth it," the asset manager's CIO for fixed income added. "Why would you take millions of people out of work because you need to go from 2.7% to 2%?"
If Americans start losing their jobs, expect a lot more questioning of the hallowed 2% target.