Fed Walks Inflation/Recession Tightrope in Effort to Cool Economy

This is Not Your Father’s Inflation; Supply-Side Issues Wreak Price Havoc

The Fed moved aggressively at its May meeting by increasing the federal funds rate 50 basis points to a target of 0.75% to 1%. The Fed said that it expects to make a similar increase at both its June meeting and possibly in July as well.

The Fed’s actions have one goal: reducing runaway inflation, which was 8.3% in April and last seen at this level in the 1980s. But the cause of the current inflation is quite different from the last go-round, according to Kiran Kini, CoBank senior vice president and treasurer. He says current economic conditions have created a precarious tightrope walk for the Fed, which is trying to reduce inflation to its target of two percentage points while not pushing the economy into recession.

“This is not your typical inflation, said Kini. “Inflation normally occurs in an overheated economy where demand for goods is very strong. That certainly is the case now, but this time around the primary issues are on the supply side. 

“There is a shortage of goods across many categories, which initially began with the factory and office closures as well as transportation bottlenecks during the onset of the pandemic. More recently, the resurgence of COVID in China has led to significant new shutdowns in the country, which again slowed exports. The war in Ukraine has also added to inflationary pressures by raising the prices of commodities.”

According to Kini, the Fed has fewer tools with which to address supply-side inflationary issues. 

“The Fed can’t print computer chips and they can’t produce wheat,” he continued. “The only thing they can do is try to reduce demand with higher interest rates to offset the supply shock. But being too aggressive risks triggering a recession.

“A strong labor market makes it even more challenging because strong demand for labor has resulted in higher wages, which supports consumer demand for goods. But the Fed is continuing to tighten financial conditions, which is leading to the equity market volatility we’re seeing now.”

Kini does not believe a recession is imminent because of otherwise strong economic fundamentals. But if the Fed continues its current path—with the possibility of eight more rate hikes—the risk of a recession in 2023 would increase dramatically.

Secondary Loan Market: Lightly Used, Low-Mileage Leveraged Loans for Sale

Over the past two years, CoBank’s Capital Markets group has steadily expanded its activity in the secondary loan market and has centralized this function under Paul Trefry, head of loan trading and asset sourcing. Trefry and his team have begun establishing relationships with a selected group of institutional investors—collateralized loan obligation funds, mutual funds, hedge funds, pensions, insurance companies and endowments—that are interested in leveraged loan investment opportunities in the agricultural and rural infrastructure marketplace. 

Currently, the Capital Markets group represents CoBank and the Farm Credit System in purchasing certain loans for their portfolios, especially in areas—such as telecommunications—where CoBank has unique authority among Farm Credit banks to operate.

“We are serving in an execution capacity for CoBank relationship managers and portfolio management personnel who determine whether we should sell loans or portions of loans to reduce the bank’s risk exposure,” said Trefry. “But we’re also representing CoBank and many entities in the Farm Credit System in purchasing loans that have the potential to improve our respective loan portfolios. In 2021, we purchased about $1 billion in loans, which was split 50/50 between CoBank and Farm Credit participants.”

According to Clarence Plummer, senior vice president, Capital Markets, his team’s goal is to continue to improve CoBank and the Farm Credit System’s ability to lead large leveraged loan deals for its customers where a trading function is a necessity.