Earth to Federal Reserve: What are you waiting for?
This is the same headline I used in February 2022 in this article
Earth to Federal Reserve: What are you waiting for?,
when the Federal Reserve (Fed) was dithering about raising rates. It is just as applicable today as they dither about cutting rates.
Indeed, sometimes I wonder if the Fed is more concerned about coming up with catchy phrases: “transient inflation; “data dependent”; “higher for longer”; and now “data-dependent, not data point dependent” – than actually taking decisions.
“Date-dependent mean the Fed doesn’t have a clue”
This was a heading in an earlier Bloomberg article, which continued: But perhaps the bigger takeaway is that Chair Jerome Powell and his fellow policymakers really don’t have a clue what’s going to happen in the economy. They’re shooting in the dark. “They’re making it up as they go along.”
These comments may seem harsh but it expresses the frustration many feel about what I described in this recent article: The Federal Reserve’s Analysis Paralysis
The data is unreliable and subject to change
Mohamed El-Erian, whom I often quote, captured the current state of affairs when he observed: “I think the major issue is that the market has become overly data-dependent, just like our central banks have become overly data-dependent. So, we’re not looking beyond the next data release because we’re worried about what will the Fed do in September, what will the ECB (European) Central) Bank) do in September.”
Central bankers and markets should be aware of the risks associated with an overly data-dependent approach to monetary policymaking. In 2019, Powell himself highlighted the basic challenge: “We must sort out in real time, as best we can, what the profound changes underway in the economy mean for issues such as the functioning of labor markets, the pace of productivity growth, and the forces driving inflation.”
Yet economic data are often unreliable. Official statistics undergo multiple and often substantial revisions. For instance, the payroll numbers undergo subsequent revisions —sometimes large ones that give the lie to the initial perceptions.
Richard Fisher, a former Dallas Fed president, once offered an example of the dangers involved. Data pointing to excessively low levels of inflation had prompted the Fed to keep rates low in 2002 and 2003. Subsequent revisions, he acknowledged, showed that “inflation had actually been a half point higher than first thought. In retrospect, the real fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been.”
In a recent Financial Times article, Mohammed-El Erian asked a number of questions, amongst them:
Why did Fed forecasts get it so wrong, be it on inflation or unemployment — the so-called dual mandate — in recent years? And to what extent has this resulted in a longer-term shift to excessive data dependency in the formulation of the central bank’s policy?
Ongoing structural and secular changes in how the US and global economies function are more consequential for policy design than “noisy” short-term data. So, is it not now time to combine data dependency with a much greater injection of forward-looking strategic thinking?
Interest Rates should have been cut in July
One of my favourite hymns has the line, “slow to chide and quick to bless.” Translate that to the Fed, and it becomes “slow to raise or cut rates….” but I can’t think of anything they do quickly.
By not cutting rates in July, the Fed has dug itself a hole as its next meeting is not until September. At the July meeting Powell said, cryptically (no, not about cryptocurrency) “the economy is moving closer to the point at which it would be appropriate to reduce our policy rate, but we’re not quite at that point yet.”
Two days later, came the August jobs report, leading to this comment in the Wall Street Journal:
“For months, the U.S. economy appeared to be in a sweet spot, with inflation falling and the domestic economy humming along.
A slate of data this week abruptly punctured some of those hopes. Weakening employment, manufacturing and construction data triggered a selloff in stocks and other risky bets Thursday. The rout worsened Friday after the latest jobs report showed that the U.S. economy added 114,000 positions last month, well below what economists had expected, while the unemployment rate rose to the highest level in nearly three years.
The disappointing data has stoked worries that a soft landing might be elusive, and the economy could tip into a recession.”
And led to at plunge in world stock markets (Japan fell over 10% in one day) and drop in Treasury yields (which determine mortgage ratesw).
Did the Fed know on Wednesday what was coming in Friday’s report? And if they didn’t, why in the blue blazes (as my German master Mr. Kidd liked to say) did they schedule their meeting just before the monthly employment report?
Markets generally rallied last week, but was the volatility caused by the Fed’s (in)action really necessary?
The Fed continues to look in the rear-view mirror
Experienced drivers, while keeping an eye on the rear-view mirror, focus on the road ahead so that they can anticipate conditions.
But the “date-dependent but not data-point dependent” Fed seems to spend most of its time looking in the rearview mirror, which risks being surprised by what lies ahead.
Jackson Hole in the spotlight
The Federal Reserve Bank of Kansas City hosts dozens of central bankers, policymakers, academics and economists from around the world at its annual economic policy symposium in Jackson Hole, Wyoming, which will take place this year from August 22-24.
And the market will be parsing Powell’s words, expressions and intonations for hints about what the Fed may do in September, providing of course there has not been a new economic indicator which can justify inaction again.
I end by repeating the closing remarks from my July article.
Cui bono? (Who benefits?)
I come back to a basic point. “Higher interest rates do have benefits for some with savings and investments: Americans in the first quarter earned about $3.7 trillion from interest and dividends at a seasonally adjusted annual rate, up roughly $770 billion from 4 years earlier. Higher interest payments and higher corporate profits and dividends (attributed to inflation) benefit many”, according to the Commerce Department.
It is hard for me to see how, say, a 1% reduction in the Fed Funds Rate could, with any confidence, be forecast to have a negative impact on inflation. But it would at least provide some relief to those Bloomberg described recently as having “mostly exhausted the extra pile of cash they squirreled away during the pandemic “and are “relying on their credit cards and other sources of financing to support their spending.”
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