The Federal Reserve’s Analysis Paralysis

In November 2023, I wrote: “The question now is whether the Federal Reserve, having been extremely slow to start raising rates and reversing Quantitative Easing, will be similarly late in easing (rates). The Fed claims to be data dependent, but data tells us what happened in the past – and the Fed’s actions impact the future.”
The answer to that question is “yes” – and here we are, 8 months later, and the Fed is still “data dependent”, although this year’s mantra has become “higher for longer.”

2022
While nearly everybody outside the Fed now accepts that it kept interest rates “too low for too long”, I published the following articles:

Earth to Federal Reserve: What are you waiting for?
As the debate amongst economists continues as to whether the Federal Reserve will raise interest rates 3 times, 5 times or 7 times this year, the Federal Reserve continues to do….nothing.
Federal Reserve:

Federal Reserve: “Make me responsible…. but not yet”
With apologies to St. Augustine the gist from the release this week of the minutes of the last meeting of the Federal Reserve Open Market Committee (FOMC) was that, yes, inflation is worse than we expected, and yes, we need to raise interest rates and, yes, we need to sell some of our huge portfolio of Treasuries and Mortgage-Backed Securities, and we will …soon…I promise.

How far Behind the Curve is the Federal Reserve?
I continue to fail to understand why the Fed felt able to cut its Fed Funds rate by 1.5% in less than two weeks, but has been tip-toeing when it comes to raising rates again

Federal Reserve in Fantasyland
The Federal Reserve remains way behind the market.
For my part, were it not so serious I would have allowed myself a louder chuckle as I heard Chair Powell say that the Fed would be “data-dependent” – and then forecast that inflation – using the Fed’s preferred measurement – would be 5.2% this year, 2.6% in 2023 and 2.2% in 2024. Based upon what “data” exactly?

2024
In March the Fed “held onto their outlook for three cuts in borrowing costs this year, (but) Powell said the timing of those reductions still depends on officials becoming more secure that inflation will continue to decline towards the Fed’s 2% target even as the economy continues to outperform expectations.”
In April this year, Tony Dwyer at Canaccord Genuity wrote: “Think about Jerome Powell at the end of the dovish pivot at the end of December last year — market’s looking for seven rate cuts,” Dwyer said. “Now he’s saying maybe none. So, we are looking at somebody who keeps telling us information that changes within three months, aggressively. So, to make the assumption that we know what Jerome Powell and the Fed is going to do three months from now, I don’t think makes a lot of sense.”
On July 5, Reuters reported that: “Federal Reserve policymakers got more evidence of U.S. labor-market cooling on Friday that could boost their confidence they are winning their fight on inflation and open the path to a more active debate on interest-rate cuts when they next meet in late July.
The Labor Department report showing a rise in unemployment and a decline in job creation is just the latest in a string of recent data offering more evidence of slowing than what U.S. central bankers had in hand at their June meeting.
At that time, many of them felt inflation progress was so lacking and the economy still so strong that they would likely cut rates only once this year, if at all. Since then, the data has marched in the opposite direction. A couple of inflation reports have shown prices did not rise at all from April to May; other reports have signaled a slump in services and manufacturing activity and rising job openings and layoffs.”

Role of the Federal Reserve
The Fed’s modern statutory mandate, as described in the 1977 amendment to the Federal Reserve Act, is to promote maximum employment and stable prices.2 These goals are commonly referred to as the dual mandate.
The Fed judges that low and stable inflation at the rate of 2 percent per year, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with achievement of both parts of the dual mandate.

How high is inflation?
A google search will produce varying answers based upon the different definitions and time frames, but most agree that it is currently below 3%. The Fed’s preferred measure increased 2.6% in May.

What is magical about 2%?
In short, nothing – other than that the Fed, having missed the boat in taking so long to start raising interest rates, has seemingly wedded itself to a 2% target – even if there is widespread disagreement about how inflation is actually calculated.
Time magazine ran an article by Zachary Karabell in December 2023:
“The Fed’s 2% Inflation Target Is a Made Up Number.”
Karabell wrote: “Targeting inflation, let alone setting that target at 2%, goes all the way back to…2012. Before he was appointed to the Fed, Ben Bernanke as an academic was a proponent of inflation targeting both as a way to make policy more transparent and as a communications strategy to signal to markets what inflation expectations should be. Bernanke himself was sensitive to the risks that by setting a specific number, banks might become unduly beholden to that number at the expense of adjusting to fluid and often complicated circumstances that might require more nuanced approaches. But as is so often the case, as the 2% number has become set, nuance has quickly disappeared, and the number has instead become sacrosanct as if it were handed down by some economic god giving tablets to appointed Fed prophets.”

Does 2% matter rather than say 3%?
Let’s say that you bought groceries a year ago for $100, and that this year the same basket (or cart) costs $102. If it was $103 rather than $102 would that lead you to cut back?
On the other hand, the average credit card debt as of the first quarter of 2024 was $6,501, and the average interest rate (which the Fed does influence) has increased by 6% in the last two years.

Does the Fed really control the rate of inflation?
That is a very good question. According to Nobel Prize-winning economist Joseph Stiglitz, the Fed did not get to the core issue fueling inflation: The massive global supply side disruption. That may have been better served with time rather than too-high rates. He believes rates were artificially low and needed to be raised for sure, but believes they went too far, too fast, too late….and that the sharp rise in rates actually fueled inflation and made it worse. He also believes as we go through massive global transitions, wars, etc., having a slightly higher inflation target – around 3% – makes sense if it keeps employment strong.

Does the Election influence the Fed’s decisions?
Naturally, the Fed goes to great lengths to state that its decisions are economically driven and not influenced by politics. But it’s hard to believe they aren’t aware that delaying a decision on interest rates increasingly limits their options, making it more difficult to avoid accusations of political motives if they decide to cut rates later in the year.

Lags until Policy takes effect
St. Louis Fed economist and Senior Economic Policy Advisor Bill Dupor has talked of the concept of long and variable lags: “The lag is not only long, but it is also variable; that is, the time between cause and effect can differ from episode to episode in a way that is difficult to predict,” he wrote.
While many factors affect macroeconomic conditions, monetary policy is of particular interest because it is controlled by central banks and because it has important effects on inflation, output and employment, the author remarked.
Two recent estimates from U.S. central bankers put the time that it takes for changes in monetary policy to affect inflation at 18 months to two years and at nine months to a year.”

And yet this year the Fed has delayed making decisions – or rather changed its mind about interest rate cuts – based upon month-to-month historic data.

Where to now?
I am a believer in collective responsibility. On Boards I have chaired or been a member of, policy decisions are discussed until a consensus is reached – whereupon Board members are expected to support the agreed policy.
But not the FOMC, where individual members are free to express their opinions – which this year have included suggestions that interest rates may need to be raised, not lowered.
All this, of course, has only served to confuse bond markets, which tend to move in response to the latest opinion. And the opportunity was missed in February to ask Punxsutawney Phil if he’d seen his shadow, which may have been a more reliable guide to Fed policy this year.
No wonder bond markets have been confused – in contrast all equity strategists have had to do was say “buy Nvidia.”

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.”

And read these recent articles:
July Housing Inventory and H1 Sales to List Price
Marblehead House sell for $1.2 million OVER List Price

My Property Tax reports mentioned at Town Meeting
Marblehead Q1 2024 Market Summary
Swampscott Q1 2024 Market Summary
Salem Q1 2024 Market Summary
Essex County Q1 2024 Market Summary
Why Mortgage Rates will fall in 2024

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 [email protected].

Andrew Oliver, M.B.E.,M.B.A.

REALTOR®

m 617.834.8205

www.OliverReportsMA.com

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