FOMC 2022 1214

The Federal Open Market Committee today announced a 50 bp hike to 4.25%-4.50% in the Fed funds target. It’s solidly in line with expectations.

FOMC 2022 1214

This is a clear policy mistake. The FOMC should have hiked 75 bp to 4.50%. Does that make me sound like a hawk? If so, it’s misleading, because I would omit all the hawkish talk about further hikes. Either say nothing about the next move or say that we’ll evaluate the data and decide at the time. If the data warrant, we’ll hike again in February, or if they warrant a cut, we’ll cut.

Why? Powell’s stated operating thesis behind the reduction in pace is that he doesn’t want to cut soon after hiking. But he doesn’t say why that would be a problem. He doesn’t because it wouldn’t.

Ironically, it increases the odds the Fed will cut sooner after it finishes hiking. Given the looks of the yield curve, the data could support cuts as soon as the second quarter (if not sooner … it could be cutting now if it hadn’t waited so long to get started). If the Fed is still hiking in February, that would would not only leave it short of its “terminal rate” hopes, but well short of its “how long to leave it there” too.

Moreover, it’s encouraged an easing in “financial conditions”, which the Fed itself says it doesn’t want. In plain terms, the dollar has again been weakening in the capital markets, against not only other currencies, but stocks and bonds. Asset prices have been rising again, which is more upward pressure in the consumer price pipeline. The Fed appears to assume more gradualism in policy will translate into more gradualism in market responses. Nothing could be further from the truth … Exhibit A: 2008.

Okay, that explains why it’s an error but not why the Fed is committing it. We can only speculate about what’s going on in their minds, but mine is that they are worried about the extreme inversion in the yield curve. They’re trying to smooth that out a bit by trading slightly lower rates now for higher rates in the future … a misguided attempt to move markets with “forward guidance”.

It’s not working. Nothing the FOMC says now commits it to policy two or three or four meetings out and the markets know it. Instead the Fed has set markets up now for a bigger decline later. The economy will follow. What has happened since they started talking about slowing the pace in favor of a higher “terminal rate”? A even deeper yield curve inversion … an object lesson in the perils of substituting facts and logic with dogma and wishful thinking … in not getting what you say you want but what your actions produce.

As always, the markets will have the last word. If the dot plots and hawkish talk manage to turn asset prices lower in a sustained way, consumer price inflation will continue to moderate. Some damage has already been done, but it’s not too late to contain it. The Fed’s credibility and unnecessary volatility remain casualties.

Yet nobody’s even talking about the bigger problem … the dogma that says policy changes may only be made in long series of unidirectional moves. This has led to policy being perpetually behind the curve. First because it’s making such a major commitment, an overwhelming accumulation of evidence must pile up for the Fed to even begin to act, and second because the policy then takes many months to be implemented. This isn’t a hawks-versus-doves debate, it’s between reason and superstition … and isn’t even debated, just assumed. Because the Fed is chronically late, it winds up being pro-cyclical, with the result that the economy careens from bubble to bust. After decades of this destructive dogma, you would think these folks would look at this and say to themselves, “hey, this isn’t working; let’s try something else”.

The “something else” is simply to worry less about hubris … projecting an image of “we know what the right policy is way ahead of time”. … especially when markets already know they don’t … or at least weigh it against its the massive cost. Instead cultivate a habit of fine tuning policy at every meeting – higher or lower, as the data may indicate. If a rate increase is followed by a cut and then another increase, so be it. It’s not indecisiveness, it’s the way real markets operate. The ten year yield, stock prices, commodity prices all behave this way. By trying to eliminate volatility from short term interest rates, the Fed forces it out into the macro economy, where it is amplified into booms and busts. As markets grow accustomed to the new norm, they will find the degree of financial stability that has for so long been sought by the Fed.

Leave a Reply

Your email address will not be published. Required fields are marked *