Under My Thumb

Fed meetings usually focus on the change in current interest rates, but this week the focus was on 2024. Current rates were left unchanged, but the Fed doubled down on the ‘higher (rates) for longer’ theme. Chair Powell repeated at least a dozen times that the Fed will “proceed carefully” from here, not wanting to ease policy to early and invite a repeat inflationary episode; and not wanting to press to hard on the economic brakes and throw the U.S. into a recession. In short, he wants to keep his thumb on the economy and limit growth, but not so hard that he crushes it. We wish him luck. The odds are very good that he will need it.

Central Bankers never have the desire to force recessions, yet at times they must (think Paul Volker in the early 1980’s) and at other times, they simply miscalculate the economic equation a little and the economy tips into a recession. It is an extraordinarily difficult balancing act between doing too much and doing too little, which is why the Fed fails to meet its desired goal most of the time. This time is arguably more difficult than usual because of the many economic anomalies created by the pandemic.

Markets have been disbelievers in ‘higher for longer’ for a long time, consistently projecting rate cuts in 2024, which would imply a weaker economy. That appears to be changing as the market anticipation for rate cuts next year weakens. This process started a few weeks ago, but has picked up steam this week as Treasury bond rates hit new highs and bond prices hit new lows. We perceive an undercurrent of growing inflationary fears. De-globalization; and higher wages (union strikes), are all structurally inflationary. Higher oil prices are often transitory, but are currently adding to inflation concerns. On top of those factors, the economy is performing much better than most expected, which also makes the expectation of lower rates more difficult.

For the Fed, this is the hard part. Rapidly raising rates from zero in response to rapid inflation was the easy part. Now the problem is keeping their thumb on inflation without choking off the economy. Historically, an extended period of tight monetary policy has almost always concluded in economic contraction. The much anticipated ‘soft landing’ for the economy remains plausible, but as Chair Powell conceded, the outcome was also subject to things outside of the Fed’s control.

What the Fed really needs now is a recovery in productivity, which allows the economy to grow without igniting inflation, but productivity growth has been sluggish post-pandemic and the Fed can’t really influence productivity. We know we sound like a broken record, but a recession remains more probable. When is a much more difficult question.

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By: thinkhouse