Dive Brief:

• The U.S. economy will shrink 0.7% this quarter and sluggish consumer spending, tightening monetary policy and weakness in global growth will cause a “moderate contraction” next year that pushes unemployment above 5% from 3.5% in September, Fannie Mae economists predicted on Wednesday.
• The downturn will “be modest based in part on the relatively limited degree of labor market slack that we believe is necessary to alleviate above-target inflationary pressure,” Fannie Mae said. However, history suggests that a mix of rising interest rates and the strengthening dollar poses a risk of a financial crisis in coming quarters and a prolonged recession.
• Gross domestic product will fall 0.1% this year and 0.5% in 2023, Fannie Mae said, adding “we expect the [Federal Reserve] is willing to tolerate a modest recession in 2023 to ensure inflation trends have reversed before ending its tightening course.”

Dive Insight:

Despite signs of sagging economic growth, Fed policymakers in recent days have affirmed their commitment to keep raising the main interest rate to rein in demand and achieve a sustained slowing of inflation.

“The real issue is we need to do more,” Cleveland Fed President Loretta Mester told Bloomberg Television on Tuesday.

“We have not seen inflation move back down and we need to see that because leaving inflation where it is, if it continues, there’s a higher chance that it does become embedded in the economy, affecting pricing decisions of firms and getting into the psyche of households,” she said.

Already in 2022 the central bank has tried to curb the highest price pressures in nearly four decades by pushing up borrowing costs at the fastest pace since the 1980s.

The Fed’s fight against inflation has yielded mixed results.

The Producer Price Index (PPI) for final demand, a measure of what suppliers charge businesses, rose 0.4% in September compared with August in the first increase in three months, the Labor Department reported Wednesday. On an annual basis PPI increased 8.5% last month compared with 8.7% in August.

“The moderation in demand due to monetary policy tightening is only partly realized so far,” Fed Vice Chair Lael Brainard said Monday. “It will take time for the cumulative effect of tighter monetary policy to work through the economy and to bring inflation down.”

Fed officials have raised the federal funds rate 0.75 percentage point after three consecutive meetings and have indicated they may announce a similar increase at the end of a two-day meeting on Nov. 2.

Most Fed officials expect they will push up the benchmark interest rate an additional 1.25 percentage point by the end of this year, according to their projections released last month.

“We know that it’s time to continue on and persevere and bring the funds rate up,” Mester said, adding “we know that we’re going to have to keep it there for a time until we see inflation beginning to come back down” toward the Fed’s 2% target.

At the same time, policymakers at the Fed’s Sept. 20-21 gathering flagged the risks from an excessive pullback in stimulus, according to minutes of the meeting released Wednesday.

“Several participants noted that, particularly in the current highly uncertain global economic and financial environment, it would be important to calibrate the pace of further policy tightening with the aim of mitigating the risk of significant adverse effects on the economic outlook,” according to minutes from the meeting released Wednesday.

Like Fed officials and Fannie Mae economists, the International Monetary Fund warned about a risk of financial market instability as several central banks simultaneously withdraw accommodation.

“There is a risk of a disorderly tightening in financial conditions” if inflation persists longer than expected or the economic slowdown worsens, the IMF said Tuesday in its Global Financial Stability Report.

Still, central banks “should heed the lessons of the past” and prevent inflation from taking root in the economy, the IMF said.

The global economy will grow 3.2% this year and 2.7% in 2023, while the U.S. economy will expand 1.6% in 2022 and 1% next year, the IMF forecast.