It sure looks like the Fed is hiking interest rates too fast

Four months after the US Federal Reserve started to hike interest rates, there are some clear signs the economy is slackening. Manufacturing hit its lowest level in two years in June, according to data from the Institute for Supply Management manufacturing index released Friday.

At the same time, the supply-chain crunch seems to be easing, with a growing number of factory managers saying suppliers are picking up the pace of deliveries.

That’s because high prices for everything from gasoline to food continue to eat away at Americans’ disposable income, cutting demand for products. The reopening of the economy has also meant consumers are spending more on services — and less on manufactured goods. The Fed’s interest rate increases, meanwhile, have raised the cost for financing equipment that manufacturers sell.

“​​Some industries are cutting headcount, including tech, retail, mortgage finance, and now manufacturing,” said Bill Adams, chief economist for Comerica Bank.

Does the slowdown in manufacturing point to a recession?

The Fed is in a tough spot because its main inflation-fighting tool is not designed to fight price increases primarily driven by supply shortages. As the central bank speeds up its interest rate increases, some economists fear it might be overdoing it.

The contraction in manufacturing, among other factors, may lead to another negative quarter of real GDP in the second quarter, Adams said. (While consumer spending accounts for most of US GDP, manufacturing regularly makes up more than 10%.) The Atlanta Fed’s GDP indicator, which attempts to track economic activity in real time, turned negative after Friday’s data release.

But unless the labor market craters, the current economic slump is unlikely to meet the definition of a recession, said Adams. “With labor demand still near a record high, workers who are losing jobs are able to find new ones much faster than in a typical downturn,” he added.

Where is inflation headed?

The slowdown in manufacturing activity is cooling off inflation in the sector, and as supply shortages ease, purchasing managers are also getting a break from higher prices.

Factory supply prices have dropped back to levels last seen in the spring of 2018, when inflation was running just below 3%, said Adams. But overall inflation is unlikely to go back to that rate anytime soon. Prices for food and gasoline will remain hot because of the war in Ukraine, and the cost of services will also increase as demand for them normalizes.

Still, with supply-side issues beginning to abate, the Fed should have some room to slow down the pace of its rate hikes. The central bank increased rates by 75 basis points last month and could do so again at its next meeting.

That may be too fast, according to former Fed macroeconomist Claudia Sahm. She doesn’t see the Fed changing tack soon, though. “Nothing but inflation coming down will change the Fed’s stance, sadly,” Sahm said.

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