Federal Reserve tries to rewrite history

Two comments from Federal Reserve Chair Powell struck me while I was listening to his Press Conference on Wednesday:

On the “speed” of the Fed’s move to increase rates:

“When inflation changed direction, really, in October. We’ve moved quickly since then. I think people would agree. But before then, inflation was coming down month by month. And we kind of thought we had the story. Probably had the story right. But then I think in October, you started to see a range of data that said no. This is a much stronger economy and much higher inflation than we’ve been thinking.”

Moved quickly?

The first, tentative 0.25% increase in the Fed Funds Rate (FFR) was on March 16, 2022 – several months after the Fed concluded that inflation was not, in fact, transitory.  Indeed, during the period from last October to March this year it was still purchasing Treasuries and Mortgage-Backed Securities, thereby continuing to inject liquidity into the economy. And only recently has it ended its policy of reinvesting maturing bonds.

Between May and July the FFR has been increased by a further 2%, but the Fed did not “move quickly”. It moved quickly when it slashed rates in March 2020, but it has been way behind the curve in removing some of the excess liquidity its actions created.

“Does anybody think that (raising rates three months earlier) would have made a big difference?
Well yes, actually, several economists do. In the famous words of William McChesney Martin “the Federal Reserve is in the position of the chaperone who ordered the punch bowl removed just when the party was really warming up.”

As with so many other aspects of life – eg home prices – the basic equation of supply and demand applies with the economy. We know all about the supply chain problems since the pandemic. And there is nothing the Fed can do about those. But it can impact demand and should have started much sooner to restrain demand. But it kept pumping cash into the system long after the end of the emergency to which Quantatative Easing (QE) was part of the cure.
I don’t want to keep harking back to articles I wrote long ago (they are here), but I do know that I started to argue for a reversal of QE just about a year ago, some months after I had raised concerns that inflation may prove to be more embedded than the Fed believed (hoped?).

What now?
As Jon Farrow said on Bloomberg Surveillance on Friday morning, “the Fed says it is data-dependent, but we don’t know which data they are looking at or how they will react when they see it.”
So this week the stock market has decided that by the time the Fed meets again in September the economy will have slowed so much that the Fed will be able to ease off on its interest rate increases. Hence the big rally as “risk on” returns, betting that we will actually have a soft landing for the economy based upon the continuing strength of the labor market.
Or maybe it was just a strong, bear market rally from an oversold position where “everybody” was negative.
I guess we’ll find out when we get the data – just don’t ask the Fed which data.

And read these recent articles:

Economic commentary
Recession? Yes, no, maybe……
Has Inflation Peaked?
Have Mortgage Rates peaked?
Are we already in a Recession?
Federal Reserve in Fantasyland: Implications for Housing Market
How far Behind the Curve is the Federal Reserve?
Will the Federal Reserve show chutzpah today?
Why are Mortgage Rates so high?

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  • Andrew Oliver, M.B.E., M.B.A.
    Real Estate Advisor
    m: 617.834.8205
    800 Laurel Oak Drive, Suite 400, Naples, FL 34108
    Licensed in Massachusetts

If you – or somebody you know – are considering buying or selling a home and have questions about the market and/or current home prices, please contact me on 617.834.8205 or Andrew.Oliver@Compass.com.