The Fed says this is going to hurt, but it matters who feels the pain

1 big thing: This is gonna hurt

2. A busy day for central banks

We're back after a very eventful Fed day. Today, we look at who will experience the economic pain the Fed stands ready to inflict in its war on inflation, and why it matters.

Plus, a rundown of the busy day for monetary policymakers across Europe.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 695 words, a 2½-minute read. 

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Axios Macro

Pound plunges after new British government releases budget

1 big thing: Britain is the newest emerging market

2. 💷 Currency transition

So much for a quiet Friday. Global markets are reeling after the U.K. government unveiled a larger-than-expected fiscal package — a gamble to jolt economic growth. Below, we'll explain why investors are treating Britain more like an emerging market.

Plus, staying across the pond, a look at the country's looming currency transition. 💷 🇬🇧

Situational awareness: Our colleague Hans Nichols scoops that the Biden administration may seek to oust World Bank president David Malpass after he appeared reluctant to say he believes in climate change at an event last week.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 799 words, a 3-minute read.

1 big thing — First look: Trump country wins in the Biden economy

Illustration of two different colored briefcases on a grid

2. The latest in Fedspeak

A bumpy week on global markets continues, with bonds and currencies experiencing another volatile day. Below, we look at the latest chatter from Federal Reserve officials for signs of how much the U.S. central bank is sweating a global recession risk.

But first, a look at some new research on how the jobs recovery is playing out in Trump country vs. Biden country.

Today's newsletter, edited by Javier E. David and copy edited by Katie Lewis, is 693 words, a 2½-minute read.

1 big thing: Why Japan is a global outlier

2. The rundown for FOMC day

Welcome to Fed day! At 2pm EDT, we'll find out whether the Fed delivers another large 0.75 percentage point interest rate hike — or surprises markets with a full percentage point move. 

Neil will be in the room as chair Jerome Powell takes questions from reporters; more on what to expect below. Follow our breaking coverage at Axios.com, and we'll be back tomorrow with a full analysis. 

In today's edition, a look at the country that's been a global outlier in the fight against inflation: Japan.

Today's newsletter, edited by Kate Marino and copy edited by Katie Lewis, is 624 words, a 2-minute read. 

The world economy has an ominous August 2007 kind of feeling

1 big thing: That August 2007 feeling

Animated illustration of a downward trending market trend line that plateaus and then stops, at the edge of the line is the Earth, teetering on the edge.

U.K. tax cut proposals reverberate across markets

2. UK woes reverberate across markets

It's been an eventful Monday so far, to say the least. In today's edition of Macro, we'll tell you why events unfolding around the globe — including in the U.K. — are reminiscent of the earliest days of the global financial crisis.

🚨 Situational awareness: In a newly issued statement, the Bank of England says it is closely monitoring developments in financial markets as fallout from Britain's tax-cutting proposals continues. More below. 🇬🇧

Today's newsletter, edited by Javier E. David and copy edited by Katie Lewis, is 750 words, a 3-minute read.

The newly formed British government rolled out its fiscal plans Friday morning — and the reaction from global financial markets is beyond stunning.

Why it matters: Essentially, the markets are treating the U.K. the way they do emerging markets, which are viewed as not having the same reliable, disciplined institutions setting economic policy as the richest nations.

Beyond the unique crises facing Britain right now, we're in an upside-down world compared to that which prevailed during the 2009-2019 period. Policymakers worldwide will want to be on notice that deficits may matter again, even in rich countries.

Driving the news: The government helmed by Prime Minister Liz Truss announced a budget including extensive tax cuts, along with assistance for Britons facing soaring energy bills this winter.

The package was bigger than analysts expected, amounting to about 1.4% of U.K. GDP, according to JPMorgan. For comparison, the additional spending next year included in the Biden administration's signature climate and health care package is expected to be more like 0.14% of U.S. GDP.

The prospect of higher deficits led to soaring rates on U.K. bonds, with the five-year yield rising by nearly half a percentage point, to 4.02%. It was the biggest single-day move on record, according to Bloomberg.

That coincided with the pound plunging on currency markets to $1.09 as of 11:55am EDT, its lowest against the dollar since 1985.

Between the lines: Normally, when leaders of an advanced country like Britain tilt toward more expansionary fiscal policy, the effect is higher interest rates but also a surging currency, as investors seek to take advantage of surging growth and those higher rates.

That, for example, is what happened after former president Donald Trump's surprise victory in the 2016 election. The sense that the U.S. would cut taxes — leading to larger deficits — under his leadership fueled a 6% rally in the dollar index over the ensuing weeks.

That pattern we're seeing in Britain — of higher rates and a weaker currency — is what you expect to see in countries where investors lack confidence in the governance institutions to prevent deficits from spiraling out of control and fear the value of their bonds will be inflated away, or worse.

This will step up pressure on the Bank of England to raise rates even more than had been planned, as the fiscal stimulus and weaker pound will tend to worsen inflation. That, however, also makes a recession more likely.

Meanwhile: Decisions by the new government to fire the top civil servant at the British Treasury and to release this fiscal plan without the traditional process of review from an independent fiscal agency are also contributing to a sense that economic policymaking has gone awry in the world's sixth-largest economy.

What they're saying: The U.K. government "is driving ahead with extraordinary, even reckless ambition" in its fiscal policy, wrote Krishna Guha and Peter Williams of Evercore ISI in a client note.

"[I]t is running a very high stakes experiment as to where binding market fiscal constraints lie for a developed economy with its own central bank, large domestic financial system and domestic currency debt."

Flashback: Around 2010, there was a lot of discussion of "bond market vigilantes," the supposed role that financial markets play in punishing any country that displayed insufficient fiscal rectitude.

It became a sort of punchline, and in hindsight wasn't the right lens to apply to a country like the United States at that time of insufficient output and too-low inflation. But now we're seeing what bond vigilanteism really looks like in Britain.

It's a reminder that the economic conditions of that era really were the opposite of those in this era. The problem then was insufficient global demand; now it's one of insufficient global supply.

The bottom line: The era in which policymakers had a free lunch when considering policies to stimulate their economy is over, as bond and currency markets are telling the British government loud and clear.

The markets are treating the U.K. the way they do emerging markets.

Prime Minister Liz Truss. Photo: Chris J. Ratcliffe/Bloomberg via Getty Images

United Kingdom

Economy & Business

August 2007 was, on the surface, a fine month for the U.S. and global economy. Unemployment was low. The stock market had a few bumpy days, but nothing too dramatic.

Why it matters: Many consider it to be the beginning of what we now call the global financial crisis. And there are some ominous parallels with what the world is experiencing right now.

To be clear, we're not predicting a new crisis as severe as the one that rocked the world in 2008. Rather, we're arguing that major (and accelerating) underlying shifts are underway and likely to reverberate for years.

How significant the pain will be is hard to predict. It could vary significantly across countries and industries. It's plausible that the economic damage in most sectors of the U.S. economy will be mild.

In this parallel, the tumult in Britain — where the currency and government bond prices are plunging — is the equivalent of when French bank BNP Paribas experienced funding problems due to mortgage losses.

The bank required a liquidity lifeline from the European Central Bank on Aug. 9, 2007, which many date as the beginning of the global financial crisis.

As it was then, the U.S. economy remains strong, and the financial disruptions across the Atlantic seem remote. But in that episode, they were in fact early manifestations of profound adjustments that were only beginning, and would eventually affect economies worldwide.

State of play: For a decade-plus after the 2008 crisis, the world was stuck in a low-interest rate, low-inflation, low-growth rut.

Central banks searched for novel ways to loosen monetary policy to stimulate demand, including negative interest rates and quantitative easing.

They concluded that the "neutral rate" of interest had become much lower, due to seismic forces like demographics and globalization.

The widespread view — reflected in bond prices and officials' comments — was that after the pandemic's disruptions passed, this low-rate normal would return. Until recently, at least.

What's happened in the last few months — and with dizzying speed in the last several days — is that markets are adjusting to the possibility that the era of extremely low rates and liquidity is over, and the 2020s will be very different from the 2010s.

Consider that at the start of the year, a 30-year U.S. Treasury bond yielded 1.92%. That's up to 3.62% as of 10:45am EDT this morning.

The effects of that repricing are only beginning to ripple through the economy. It's most visible now in housing, but could eventually affect everything from the sustainability of large budget deficits to the viability of any business relying on lots of leverage.

Flashback: Donald Kohn, who played a key role in fighting the global financial crisis as the No. 2 official at the Fed, had some prescient comments last year.

"It's possible that [the natural rate of interest] is higher than backward-looking models now suggest," he said at the 2021 Jackson Hole symposium, noting loose fiscal policy and pent-up savings.

"But the transition to a higher rate environment could be pretty bumpy given that a lot of asset values and assessments of debt sustainability are built on very low interest rates for very long."

What they're saying:  In a note out this morning, Joseph Brusuelas, chief economist at RSM, said that dollar funding markets have shown some of the strains they have in crises past (though not as severe.).

He writes that it is likely economies that have been "characterized by insufficient aggregate demand and low inflation over the past two decades, will now be characterized by insufficient aggregate supply, negative supply shocks, geopolitical tensions and higher inflation," which require different monetary and fiscal policies.

"Fixed income markets are signaling a shift in perceptions of financial stability and raising a caution flag for investors," he added.

The bottom line: We're in the early days of seeing how a world of tighter money will play out across sovereign nations, real estate, the corporate sector and more.

Things are fine for now, but warning signs abound as rates soar.

World economy

August 2007 was, on the surface, a fine month for the U.S. and global economy. Unemployment was low. The stock market had a few bumpy days, but nothing too dramatic.Why it matters: Many consider it to be the beginning of what we now call the global financial crisis. And there are some ominous parallels with what the world is experiencing right now.

The Federal Reserve enacted its third consecutive 0.75 percentage point interest rate hike Wednesday and released new forecasts that show the central bank envisions higher unemployment and yet higher rates in the coming months in its campaign to bring down inflation.

Why it matters: Altogether, the signal of more rate increases ahead paired with pessimistic projections for the labor market, is a clear signal of the Fed's commitment to putting a lid on soaring prices — even if it the broader economy takes a hit as a result.

What they're saying: "We have got to get inflation behind us. I wish there were a painless way to do that. There isn't," Federal Reserve chair Jerome Powell told reporters at a press conference.

Driving the news: Following a two-day meeting, the Fed's policy committee increased its target for short-term interest rates to the 3 to 3.25% range, and said in a statement that it "anticipates that ongoing increases in the target range will be appropriate."

In new forecasts, the median official of the central bank now expects their rate target to reach 4.4% by the end of this year, a full percentage point higher than they had projected at their June meeting. That would move that benchmark rate to its highest level since 2007.

They anticipate at least one additional rate increase next year, with the median official now expecting a 4.6% rate target at the end of 2023, up from 3.8% in June.

Flashback: There had been signs earlier this summer that inflationary pressures could have been fading, which would have given the Fed some flexibility to slow its pace of rate hikes.

But the August Consumer Price Index numbers showed scorching 8.3% inflation over the last year, and an acceleration in various measures of core inflation that exclude the most volatile prices.

Now, Powell is aiming to convey a whatever-it-takes determination to bring inflation down, even at the cost of significant economic pain. 

The new projections, showing higher rates, higher unemployment, and weaker GDP growth, are elements of that strategy, aiming to signal the central bank's resolve.

As Powell started to take questions from reporters on Wednesday, he opened with a stern warning — possibly directed to financial markets: "My main message has not changed at all since Jackson Hole," Powell said, referring to his blunt speech last month that signaled the Fed would not relent on interest rate hikes to bring inflation down. 

By the numbers: In new forecasts, the median Fed official envisioned the unemployment rate rising to 4.4% late next year and staying there through 2024, a projected increase that Powell characterized as a "relatively modest" by historical standards. They previously envisioned the jobless rate peaking at 3.9%.

They also downgraded GDP growth forecasts to 0.2% over the course of 2023 from 1.7% in June. They see GDP growth of  1.2% next year.

The officials expect inflation as measured by their preferred gauge will move down from a projected 5.4% this year to their 2% target in 2025.

Already, the Fed's tightening campaign has driven home mortgage rates above 6%, causing home sale activity to slow dramatically, and walloped many financial markets.

Editor's note: This story has been updated with additional reporting.

Fed raises rates 0.75 percentage points, signals more to come

New forecasts show the central bank envisions a weaker economy in the coming years.

The Federal Reserve's headquarters building in Washington. Photo: Kevin Dietsch/Getty Images

Federal Reserve

The Federal Reserve enacted its <a class="gtmContentClick" data-vars-link-text="third consecutive" data-vars-click-url="https://www.axios.com/2022/07/27/fed-raises-interest-rates" data-vars-content-id="8165a4af-2fad-4202-97de-8d7e577e3450" data-vars-headline="Fed raises rates 0.75 percentage points, signals more to come" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/2022/07/27/fed-raises-interest-rates" target="_self">third consecutive</a> 0.75 percentage point interest rate hike Wednesday and released new forecasts that show the central bank envisions higher unemployment and yet higher rates in the coming months in its campaign to bring down inflation.Why it matters: Altogether, the signal of more rate increases ahead paired with pessimistic projections for the labor market, is a clear signal of the Fed&#x27;s commitment to putting a lid on soaring prices — even if it the broader economy takes a hit as a result.

The places where Donald Trump won in the 2020 election are collectively seeing stronger labor markets in the Biden economy, according to a new report from the Economic Innovation Group.

Why it matters: Beyond the political irony, the last couple of years have seen a boom in the counties that make stuff, where the manufacturing, energy and agriculture sectors are a disproportionate share of their economies. And in a reversal of the 2010s, the status quo has been less kind to big-city knowledge economies.

That divide increasingly represents politics as well as economics, with the goods-producing areas voting red and the services-producing areas voting blue.

Details: As of the first quarter of 2022, counties that voted for Trump were 0.3% below their pre-pandemic employment levels, according to the report that analyzed government data. For Biden counties, that gap was 1.8%.

Between the lines: To understand why blue state labor markets are bouncing back more slowly, look to the economic makeup of the geographies. 

In many ways, the forces that explained why these areas thrived in the years leading up to the pandemic are now weighing on recovery.

Counties Biden won include nearly all the country's key business districts that were once a consistent bustling center of economic activity. 

Why these areas have fewer jobs now can be at least partially explained by the rise of remote work, a phenomenon that's rippled through these economies.

Some local businesses have seen demand plummet. For them, fewer office-goers mean fewer customers.

Meanwhile, Trump counties employ a bigger share of workers in the goods-producing sector. For decades, that took a backseat to services — that is, until the pandemic ushered in a historic rotation of consumer spending.  

Roughly 25% of those in areas that Trump won in 2020 are employed in the goods sector, the report finds, compared to Biden counties, where the share is 14%. 

Goods-producing businesses went on a hiring spree to keep up with the pandemic-induced demand. The services sector saw demand bounce back, but not until fear of the virus ebbed and the economy began to reopen.

What they're saying: "It seems that the pandemic has been a force for convergence across the U.S. economy: modestly lifting up many formerly-struggling and right-leaning areas while weighing down formerly-dominant and left-leaning ones," the EIG's Kenan Fikri writes in the report.

Of note: The authors find that six states with high-profile elections this cycle that may decide control of the Senate (Arizona, Florida, Georgia, Nevada, North Carolina and Wisconsin) feature above-average economic performance. All but Wisconsin have surpassed pre-pandemic employment.

Trump country labor markets faring better in the Biden economy, report finds

Counties that voted for Trump were 0.3% below their pre-pandemic employment levels. For Biden counties, that gap was 1.8%.

Economy

Jobs

The places where <a class="gtmContentClick" data-vars-link-text="Donald Trump" data-vars-click-url="https://www.axios.com/politics-policy/donald-trump" data-vars-content-id="86147abf-9848-4d73-be8e-e5bdab9731f5" data-vars-headline="Trump country labor markets faring better in the Biden economy, report finds" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/politics-policy/donald-trump" target="_self">Donald Trump</a> won in the 2020 election are collectively seeing stronger labor markets in the Biden economy, according to a new <a class="gtmContentClick" data-vars-link-text="report" data-vars-click-url="https://eig.org/economic-map-2022" data-vars-content-id="86147abf-9848-4d73-be8e-e5bdab9731f5" data-vars-headline="Trump country labor markets faring better in the Biden economy, report finds" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://eig.org/economic-map-2022" target="_blank">report</a> from the Economic Innovation Group.Why it matters: Beyond the political irony, the last couple of years have seen a boom in the counties that make stuff, where the manufacturing, energy and agriculture sectors are a disproportionate share of their economies. And in a reversal of the 2010s, the status quo has been less kind to big-city knowledge economies.

The overriding message out of the Federal Reserve's communications on Wednesday was a simple one: Its leaders believe that some meaningful economic pain is necessary to bring inflation down, and they are willing to impose it.

Why it matters: The Fed is now forecasting a meaningful rise in unemployment over the next year as it pushes interest rates to their highest levels since 2007 — which implies that it will not only tolerate a recession or near-recession, but see it as evidence of success.

It is a contrast with just three months ago, when the policymakers clung to a more optimistic story in which inflation resolves itself with a mere bumpy patch for the economy.

"We have got to get inflation behind us," chair Jerome Powell said in his news conference on Wednesday. "I wish there were a painless way to do that. There isn't."

The big picture: What matters most for both the economic and political outlook is who will feel that pain, and how. Already, some on the left are assailing the Fed for throwing workers under the bus in its inflation-fighting campaign.

Perhaps most prominently, Sen. Elizabeth Warren (D-Mass.) tweeted yesterday that she's "been warning that Chair Powell's Fed would throw millions of Americans out of work — and I fear he's already on the path to doing so."

If yesterday's projections prove accurate — meaning a 4.4% unemployment rate late next year, up from a low of 3.5% in July — that would imply another 1.5 million Americans unemployed.

Hypothetically, unemployment could rise that much due to a mere soft patch in the economy. But in practice, historical examples of that playing out are scarce. Unemployment only rises that much in recessions.

There's no doubt that in this scenario, moderately higher unemployment is, in fact, a goal of the Fed, with all the moral and political consequences that implies. But it goes too far to say workers bear the entire brunt of the war on inflation.

Tighter money from the Fed has its first-order effects through financial markets, as witnessed in the S&P 500's 21% collapse this year.

Indeed, if you believe, as many people do, that the era of zero interest rates and quantitative easing made the rich richer and increased inequality, then the era of rate hikes and quantitative tightening ought to have the reverse effect.

There are many channels through which the Fed tightening can help bring down demand and inflation without people losing their jobs. For example: 

An affluent investor decides they can't afford a vacation home because of stock market losses. 

Or a business accepts lower profit margins because it believes it can't raise prices in a slump.

Reality check: But just because those channels exist doesn't mean job losses won't be the most salient in how people experience the economy.

The bottom line: The 1.5 million people who may lose their jobs in the Fed's scenario will experience a lot more pain than the tens of millions who experience a moderately lower balance in their investment portfolio.

Higher unemployment could be on the way, the central bank suggests.

Fed chair Jerome Powell at yesterday's news conference. Photo: Drew Angerer/Getty Images

The overriding message out of the <a class="gtmContentClick" data-vars-link-text="Federal Reserve&#x27;s communications" data-vars-click-url="https://www.axios.com/2022/09/21/fed-raises-rates-075-percentage-points-signals-more-to-come" data-vars-content-id="a9c3d44e-52ac-4f06-a4ea-eb95973342b8" data-vars-headline="The Fed says this is going to hurt, but it matters who feels the pain" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/2022/09/21/fed-raises-rates-075-percentage-points-signals-more-to-come" target="_self">Federal Reserve&#x27;s communications</a> on Wednesday was a simple one: Its leaders believe that some meaningful economic pain is necessary to bring inflation down, and they are willing to impose it.Why it matters: The Fed is now forecasting a meaningful rise in unemployment over the next year as it <a class="gtmContentClick" data-vars-link-text="pushes interest rates" data-vars-click-url="https://www.axios.com/2022/09/21/fed-raises-rates-075-percentage-points-signals-more-to-come" data-vars-content-id="a9c3d44e-52ac-4f06-a4ea-eb95973342b8" data-vars-headline="The Fed says this is going to hurt, but it matters who feels the pain" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/2022/09/21/fed-raises-rates-075-percentage-points-signals-more-to-come" target="_self">pushes interest rates</a> to their highest levels since 2007 — which implies that it will not only tolerate a recession or near-recession, but see it as evidence of success.

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Trump country labor markets faring better in the Biden economy, report finds

The world economy has an ominous August 2007 kind of feeling

Pound plunges after new British government releases budget

The Fed says this is going to hurt, but it matters who feels the pain

Fed raises rates 0.75 percentage points, signals more to come

Newsletter editions

📊 Trump country economics

🌎 August '07 vibes

🇬🇧 UK omnishambles

😖 Powell pain

🇯🇵 Global outlier