Federal Reserve chair Jerome Powell’s formula to avoid a hard US recession: Robert Gottliebsen

The US may go into a technical recession but it will be mild and not damage the basic fabric of the economy, under Federal Reserve chair Jerome Powell’s watch. Picture: Win McNamee/Getty Images/AFP

The US share market hears these comforting words from US Federal Reserve chairman Jerome Powell with all fingers crossed: “The aim is to slow growth down so that supply has a chance to catch up. It is a necessary adjustment that needs to happen”.

Everyone knows that the risk is that merely “slowing” the US economy so that supply has a chance to catch up could see inflationary forces like wages and salaries, China price hikes, energy, food etc creating an inflationary spiral requiring either draconian action or simply living with much higher inflation and interest rates.

Some members of the US Federal Reserve have made it very clear that they believe tough interest rate action is now required but bond prices are rising and yields falling so, for the moment, the markets are embracing the Powell stance.

And there is no doubt the US economy is slowing noticeably with housing and retail sales both in decline. Consumers are spending less. And with China now opening it’s ports goods are flowing and the cost of shipping has declined.

Under the Powell formula, the US may go into a technical recession but it will be mild and not damage the basic fabric of the economy.

Powell made his remarks in the presence of the head of both the European and UK Central Banks who are watching inflation raging in some European countries. Yet increasingly the sentiments spreading around Europe are that draconian action is not politically possible so a path must be found to live with higher inflation.

Anyone who has studied history knows that if “living with inflation’” allows it to reach double figures and beyond then it can be just as politically dangerous as draconian action.

Spanish inflation is already in double figures and confidence in the value of Italian bonds has been falling.

There is no doubt that whether it be Russian energy or Chinese manufactured goods western countries became hooked on the delights of low costs good from totalitarian regimes which kept a lid on global inflation. But in China costs are rising and during the next year there will be significant price increases.

The combination of Russia’s invasion of Ukraine and the Chinese threat to Taiwan is causing corporate and government strategy revisions which means that the boom in globalisation that delivered low inflation is not about to be repeated.

In Australia, Reserve Bank Governor Philip Lowe still believes that he can lower the inflation rate back into the two to three per cent range.

But Ian Macfarlane who was either Reserve Bank governor or deputy governor for 14 years between 1992 and 2006 — an era prior to massive globalisation — has seen it all and is alerting the nation that Australia may need to adapt to underlying inflation of around four per cent.

The Macfarlane scenario means a very different business and savings environment. For example those banks that went on lending sprees in the last two years will have to nurse homeowners through much higher mortgage rates and negative equity in homes. The number of new mortgages will fall.

But for the nation the good news will be that the days of banks being virtual building societies will be over and they will need to relearn business banking which will become more important. National productivity will improve.

Meanwhile, the focus of the world will be on Powell to see first whether he can take the Federal Reserve with him in and second, whether a US slow down can avoid rampant inflation. So, fingers crossed.