Fed Preview

The word of the year has had no competition. Pivot. Practically from its launch, this Fed rate hiking cycle has spawned rampant speculation about a Fed “pivot” to a cutting cycle. But watch out, pivot. Words like “pause” and “skip” are barking at your heels.

Take all of it with a big grain of salt. Financial media lite is Wall Street’s PR megaphone. Wall Street is in the business of selling stocks. Ergo, easier money is always right around the corner. Such prognostications are usually carefully cloaked as academic-sounding arguments as to why monetary policy should be easier, or why it will be easier. Because the Fed is reticent to surprise markets, creating an expectation is a self fulfilling prophecy strategy.

The Fed has more reason than usual to lean against it though. Expectations don’t uniformly call for a hike-free announcement; a meaningful portion of wagers call for a hike. Two other central banks, Australia and Canada, have just put in hikes widely characterized as surprises. Measured progress on consumer price inflation has recently ground to a halt, and the leading indicator, financial conditions, shows renewed upward pressure. The dollar has flagged in foreign exchange markets, and stock prices have embarked on a renewed inflationary jag. The upshot is the Fed has ample justification to tighten policy.

The options under discussion include the so-called “skip” or “hawkish pause”, in which the FOMC would pass on a hike this meeting and pencil at least one more in for the next. This would be the worst outcome … if the Fed knows it needs a higher rate, why not do it now? Deferring appropriate policy would be an admission current policy is inappropriate. But given its recent history, the slow torture path seems the most likely.

Yet it is not at all clear that its rate hiking campaign is actually tightening. The labor market is historically tight as unemployment remains near multi-decade lows, stock prices are soaring in a widely acclaimed “bull market” … if this is what “tight money” looks like, what would easy money look like?

Sure, five hundred basis points of Fed funds hikes looks hawkish historically, but it has to be kept in mind that for most of history the Fed funds rate had nothing to do with the Fed paying the rate. Since 2008, it has. Because of the expansion of the Fed’s balance sheet, the Fed has found it necessary to pay interest on bank reserves to support its rate target. And since the Fed creates the money to do it with, raising rates has an expansionary dimension never seen before.

This isn’t a criticism per se. I’ve argued for years the Fed could use balance sheet expansion to normalize rate policy. But that was when the Fed was holding rates unnaturally low in an attempt to generate more inflation. In an environment where it ostensibly is trying to reduce inflation, it’s the right thing at the wrong time … too much too late. Rates are high enough … one and done would be more appropriate than a “hawkish pause”, “hawkish skip”, or any of the media’s other favorite word salad ingredients. Instead, the balance sheet, which most of the ecopunditry would prefer we just forget about, could use some more work.

So much for what should happen. What will happen? On this count, Financology is firmly on the fence. This week’s meeting comes right on the heels of a fresh CPI release. A soft reading would give the Fed cover to step up its water torture program by slowing the pace of hikes. A hot reading would make a failure to hike look weak. For a Fed that has already lost credibility by dithering for months while inflation accelerated, optics loom large.

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