Investment Institute
Macroeconomics

Will humble and nimble Fed policy avoid recession


Key points

  • Inflation is too high and looks set to remain so throughout 2022. The Federal Reserve has embarked on a swift policy tightening to quell domestic pressures

  • The US has achieved few soft landings. It will be difficult again this time given the significant structural uncertainties in the post-pandemic economy

  • The Fed’s own policy implementation faces additional uncertainties. The impact of policy depends on the tightening in financial conditions and this relationship is complex. Conditions have tightened beyond thresholds that have historically seen the Fed relent in previous tightening phases. Going forwards the Fed will be torn between slowing activity sufficiently to rein in inflation and the risk of tipping the economy into recession

  • The Fed’s balance sheet unwind – quantitative tightening (QT) – adds additional uncertainty. This is both through uncertainty over the impact of QT and large amounts of overnight reverse repo holdings

  • On balance, we think the US can still avoid recession over the next 12 months, but this likely depends on the Fed’s cycle ending before markets currently expect (at 3.25%) and conditions not tightening further on other developments.

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