America’s unending economic blues

The Federal Reserve has raised interest rates on Wednesday by 75 basis points, taking the interest rate to between 1.5 and 1.75 per cent, which is still quite low.

But it is expected that interest rates could be as high as 3.4 per cent by the end of 2022 even as inflation is expected to hover round 5.2 in the year.

Fed Reserve Chairman Jerome Powell is fighting the unenviable battle of taming inflation without impacting growth.

Powell said, “We don’t seek to put people out of work, and that the Fed was “not trying to induce a recession.” Powell wants to bring down inflation to two per cent, and that seems a tall task.

He confessed that it was indeed a challenge. He said, “Our objective really is to bring inflation down to 2% while the labour market remains strong…What’s becoming more clear is that many factors we don’t control are going to play a very significant role in deciding whether that’s possible or not.”

It is expected that inflation could be brought down to 2.2 per cent by 2024. The economic situation in the world’s largest economy is challenging if not grim, with growth for the year expected to be 1.7 per cent, unemployment rising to 3.7 per cent by the end of the year and rising to 4.1 per cent in 2024.

The side-effects, or rather after-effects, of rise in interest rates is that dollar will become stronger, and this could seriously affect corporate profits, especially of companies doing business in non-dollar economies.

A strong dollar, the experts say, will eat into the profits of the American biggies like Microsoft. Though most corporate guidance for the year estimate profits in the range of 7 per cent, down from 8 per cent in January and April this year, it is felt that the outlook will really change once the second-quarter growth figures are announced.

Microsoft and retailer Target have already played down their earnings and profits. But the S&P 500 companies are still holding out to expectations in profits. The price-to-earnings ratio stood at 17.1 last Friday compared to 22.1 per cent projected in December.

Despite Powell’s intention to raise interest rates and not hurt growth, market experts believe that it cannot be done, that corporate profits will be hit.

Peter Tuz, president of Chase Investment Counsel, says, “Estimates are too high, and you’ll see them start to come down as the second quarter numbers come out as companies talk about what they’re seeing.”

The interesting paradox is that despite contrary indications, profit expectations or consumer spending are not showing any dip.

According to investor analysis of Blackrock, “We expect the energy crunch to hit growth, and higher labour costs to eat into profits. The problem: Consensus earnings estimates do not seem to reflect this.”

Similarly, consumption levels remain high despite the inflation. Steve DeSanctis, small- and mid- capitalisation equity strategist at Jeffries says that consumption pattern is shifting but there are no signs of slowdown.

Global experts have recognised that America is a declining power in terms of its political and military prestige, especially after its retreat from Afghanistan last August, and its inability to prop Ukraine comfortably against Russia.

Despite American economic sanctions, Russia seems to be holding on its own, and though Russia has not scored the decisive military victory in Ukraine, it is gaining ground.

So, for America to show signs of economic weakness could further affect its standing in the world. The consoling factor is that there is no other with as a large an economy as that of America, with China trailing at a distant second.

America is sure to come out of the inflation squall, but it is not certain whether it will retain its perch.