If you grew up in the upper Midwest, you may have encountered a smorgasbord at your friend’s grandmother’s house. It could be a wonderful feast of unlimited Swedish meatballs, fried sausages, and desserts—or a scary encounter with grandma’s herring salad and pickled eel. Last week’s GDP release was like the bread and butter of the smorgasbord. US economic growth reached 2.6 percent—exceeding estimates of 2.3 percent—for the third quarter, helping to dispel rumors that the US is currently in a recession. Underlying data points for the advance showed positive trends in a narrowing trade deficit, resilient consumer spending, capital expenditures from corporations, and higher government spending.
But, much like grandma’s herring salad and pickled eels, there were also data points on the table to make your stomach clench. Many of the positive factors for growth are likely transitory and will likely diminish in coming quarters. In particular, the decline in trade deficit is running headlong into a very strong dollar, which makes exports more expensive for foreign buyers and creates a headwind for US exporters. The greenback has strengthened by over 16 percent so far this year—a noteworthy move in terms of foreign exchange—versus a basket of major world currencies. The Federal Reserve’s aggressive rate hike regimen is the primary contributor, or, rather, the disparity between US and foreign interest rates that has emerged as a result. Other central banks around the globe have started their own tightening programs, raising rates in an attempt to catch up to the Fed.
Interest rates seem to fit somewhere between the cheese plate and the fermented fish—not good, but not bad, either. Today, as expected, officials raised the fed funds rate by 0.75 percent to a range of 3.75 percent to 4.0 percent—the highest level since 2008 and the most aggressive tightening pace since the 80s. While the rate hike fit right within expectations, Fed Chair Jerome Powell left the door open for a potential pivot. The central bank may be getting ready to slow its pace and noted it would take cumulative tightening and policy lags into account. Hikes, along with the unwinding of the Fed’s enormous balance sheet, have led to volatility in the financial markets and shifts in liquidity. The Treasury Department and the Federal Reserve both have tools they can use to mitigate worsening liquidity. But, like the high wire they are walking now in trying to restrain inflation, the eye of the needle is a difficult target to hit.