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Why Today’s Fed Reveal Is A Big Deal: It’s Not Enough

 
 

Today the Federal Reserve’s FOMC met to determine the next steps to take in order to curb rising inflation.

One of the most important meetings in the world is happened today: The Federal Reserve’s FOMC meeting. The Fed met to decide how to manage the outsized inflation that we’ve been experiencing.

The Fed has three main tools to manage this: providing forward guidance, raising rates, and the balance sheet (i.e., quantitative tightening), and they need to influence two things: the Labor Market, and Inflation. They primarily manage these things through financial conditions — when they nudge around the federal funds rate, that impacts mortgages, auto loans, credit cards, etc., but it also impacts the performance of assets like stocks and crypto. T

he big question for today was how much do they want to impact all that? They normally raised by 25 basis points (0.25%), but Powell recently provided guidance towards 50 basis points. However, Nick Timiraos from the WSJ, the “Fed Whisperer”, came out with an article Monday that said 75 basis points was on the table. That proved to be prophetic as 50 basis points likely wouldn’t have been seen as enough by the market, whereas 75 basis points is being seen as neutral.

The big question is can they raise that much without causing recession? We’re already seeing stress in credit markets, but as the price of gas, utilities, and food continue to pick up, the Fed has to do something. Today’s announcement is a start, but will it be enough?

Meanwhile, the stock market officially entered into a bear market yesterday.

It’s been showing warning signs about this for a while, and was set off by the Consumer Price Index (CPI) print on Friday, where everybody was expecting inflation to come in relatively high, but there were hopes that inflation had peaked. Turns out that inflation has definitely not peaked, and it showed up in energy prices, food prices, and shelter prices. The Federal Reserve, who is in charge of managing inflation, will use their meeting this week to decide on how they’re going to manage inflation. While there was a lot of talk now about how much they were going to raise rates by — ultimately, it’s all about controlling the narrative. The Fed has to prove that they’re willing to do whatever it takes in order to manage inflation, and so raising by 75 basis points, it’s “good” from the perspective of narrative + controlling inflation, but it’s “bad” from the perspective of economic growth.

After all, raising rates likely won’t fix the problems that we have right now. We have underinvestment in energy, and we have a housing crisis, among many other issues. The Fed raising rates is not going to fix any of that; instead what the Fed is trying to do is normalize demand. They can’t really do anything about supply issues (printing money doesn’t make ships go faster), but what they can do is make people stop buying things. However, the Fed’s monetary policy is likely to be only a short-term fix, and what we really need is fiscal policy to step it up with regards to energy production, but with midterms coming up, that’s unlikely to happen.

This is interesting, too. because until a few weeks ago, it was widely expected that we would see 50 basis point hikes in June and July, followed by a 25 basis point hike in September. This has changed, as the market is now expecting 75 basis points in July, along with 50 basis points in September. With the baseline rate before today at 0.75%, these potential hikes would give us a baseline rate of 2.75% by the end of September. This is much quicker than the pace we expected early in 2022.

In the June meeting this week we are also getting the Summary of Economic Projections, which will tell us more about what the Federal Reserve thinks about the future of the economy, and what their plans are for rate hikes for the rest of the year.

But now, let’s address why today’s rate announcement, while certainly leaning hawkish vs. the previous hikes in March and May, is not nearly enough to curb our inflation problem. 


How does Money Printer Go Brrr: Part 1 — Bonds or Bondage? | by  Thoughtmosphere | Medium
Example of what happened in the economy the last 2 years

The Problem

The problem we are facing is a multi-leveled challenge.

The baseline level is we printed too much money in an attempt to keep the economy from crashing during Covid. The only reason we can say this is because hindsight is 20/20.

Layer 2 is the supply chain issues we saw due to the initial Covid shutdowns. This greatly delayed many areas of production, giving us the increase in many commodities, leading to many massive price increases.

The 3rd layer was the first wave of Delta, causing even shutdowns and more delays in the supply chain.

The 4th layer comes after we thought we were out of the clear of Delta, and that is Omicron. This caused another layer of delays and even more supply chain issues. The 5th layer are the continued Chinese shutdowns, once again adding more strain to the supply chain. The icing on the cake is the Russia and Ukraine War, causing a massive spike in oil, wheat, and many other commodities, and fears that we will have a worldwide famine this fall.

And in comes Jerome Powell, Chair of the Federal Reserve, and the Federal Open Market Committee. All they can do to solve this issue is raise interest rates and tighten the money supply. Quite literally the whole world is watching and waiting to see what they are going to do, and their words have massive impacts on all markets.

Paul A. Volcker, Fed Chairman Who Waged War on Inflation, Is Dead at 92 -  The New York Times

Paul Volcker, former Federal Reserve Chairman.

The (Potential) Solution

The man pictured above is Paul Volcker, former Federal Reserve Chair, the same job as current Fed chair Jerome Powell. Paul Volcker was the Fed Chair from 1979-1987. In 1979 when Paul Volcker took office as Fed Chair, the inflation rate was 13.3%, even after a long decade of massive inflation. To get this down, Paul Volcker believed it was necessary to raise interest rates above the rate of inflation in order to bring the rate of inflation down.

So he did.

In October 1979, Paul Volcker and the Federal Reserve raised interest rates to almost 20% in an effort to bring down inflation. This worked, but at a cost. This massive rate increase in the year to come did bring down inflation, but with it pushed the economy into a severe recession, with massive job loss, no liquidity in markets, and what proved to be a painful recession. Unemployment peaked at 10.8%, but inflation finally fell to 3.7% in the early 80’s.

The potential solution here would be to do something similar to what Paul Volcker did in 1979, shock markets and raise interest rates much higher than expected. Of course in today’s economy, 20% is not feasible, but we need the same measure. It is becoming increasingly obvious that inflation will not go away on its own, and at some point we must ask ourselves if it is worth suffering years of high inflation, or a short term recession to bring down inflation.

In my opinion, whether we have years of inflation or not, the end result of a nasty recession is inevitable. Because of this, I believe it would be appropriate for the Federal Reserve to raise rates 100 basis points at the next three meetings, much higher than market expectations, bringing us to 3.75% at the end of September, in order to help bring down inflation. After September, we will have FOMC meetings in November and December, giving us the opportunity to hit 5% by end of year.

Regardless, I believe whether it’s one of these upcoming meetings or one later in the year, we are going to see serious and legitimate action from the Federal Reserve in an attempt to bring down inflation.

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