The Federal Reserve issued a Federal Open Market Committee (FOMC) statement that will increase the target range for the federal funds rate to 2.25-2.5 percent. The FOMC statement indicates that it seeks to achieve maximum employment and inflation at a 2-percent rate over the long term.
In furtherance of this goal, the Federal Reserve increased the primary credit rate to 2.5 percent (a .75 percent increase). This marks the second .75-percent increase in the last two months in an effort to tame inflation that has gripped the economy in early 2022.
The interest rate increase was promptly followed by the Bureau of Economic Analysis’ (BEA) announcement that there was a GDP decline in the second quarter of 2022. This decline marks the second consecutive declining quarter, which many economists technically consider a recession. The GDP decline is attributable, in part, to decreases in private inventory, residential fixed and other investments. In particular, the private inventory investment decline was led by a decrease in the retail space related to general merchandise stores as well as auto dealers. These declines were partially offset by increases in exports and personal consumption expenditures. However, if inflation continues to increase and real disposable personal income and personal savings continue to decrease, we may see declines in personal consumption.
Despite the overall economic decline, inflation is at historical highs. The price index for gross domestic purchases increased 8.2 percent in the second quarter of 2022 after an 8-percent increase in the first quarter of the same year. Even if the particularly high costs of food and energy are excluded, gross domestic purchases are still up by 6.6 percent and 6.9 percent for the second and first quarters of 2022, respectively.
Many have been able to weather the inflation storm based on savings accumulated over the last couple of years, but with record-high prices and dwindling savings, they may start to feel the financial pressure. Retail and similar or related industries may be particularly impacted as investment goes down and consumers tighten their purse strings due to having less disposable income.
Interest rate increases are intended to combat inflation by raising the cost of borrowing, thereby encouraging businesses and people to borrow less and, therefore, spend less. In theory, this should reduce demand and slow down price increases. However, despite prior rate increases, inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, continued logistics challenges and broader price pressures.
There is concern that the rate adjustments may push the U.S. into a recession or deeper into a recession, depending on how you choose to define “recession”. However, Federal Reserve Chairman Jerome Powell stated that the Federal Reserve is likely to continue increasing interest rates in an effort to curb inflation that is running at a 40-year high. Powell noted that the Federal Reserve is not trying to create or contribute to a recession, but that some economic slowdown is necessary. In fact, some commentators suggest that we may see rate decreases in 2023 once inflation is adequately slowed.
HOW TO RESPOND
With the current economic uncertainty and a looming recession, it is important to prepare your business to deal with any fallout. Businesses should review existing capital management, talent, client, vendor, operations and other positions and policies to ensure they are in the strongest possible position and have sufficient flexibility to adapt to future disruption. Going into the second half of 2022, working capital and, in particular, cash management will likely be of the utmost importance.
If you have any questions or want to discuss how your business can respond to the interest rate increase and other economic changes, please contact our GHJ Advisory Team.