The Fed seems unable to cool the economy
By Joe Higgins, Quest 4 Quality
The Federal Reserve has done everything in its power to slow down the economy.
Over the past 24 months it increased interest rates 11 times, raising them from near zero to 5.25%, with the express purpose of getting inflation down to 2%. But last week’s Consumer Price Index (CPI) report disappointed potential home buyers, home builders, investors and home goods retailers as inflation became hotter than expected.
The stock market took a massive hit last week, with Dow Jones losing over a thousand points as bond yields surged. Investors realized that a June interest rate cut is off the table, and some analysts were worried that the economy could be on track for a downturn. Others have made the point that the current path the Fed has chosen has not been as restrictive as needed to get inflation to the targeted level.
I am not an outlier here, as I am concerned that rising inflation levels could force Fed Chair Jerome Powell to change his inflation goal to 3% or hold rates steady for longer, which could cause a recession. It is a no-win scenario for the country.
Over the past 24 months the Fed has tried to slow the economy by raising rates to reduce consumer spending, restrict private lending and increase unemployment. Usually these actions would have achieved their intended effect. However, after two years of restrictive monetary policy, consumer spending is still robust, lending has slowed slightly, unemployment is at an historic low and the markets are still at all-time highs. All these indicators are inflationary, and the economy is as strong as ever.
The March CPI report came in higher than expected, reaching 3.5% vs. consensus estimates of 3.4%. The CPI has remained in this 3% range for eight months and has not moved any closer to the target rate of 2%. The last 1% is often the most difficult, especially when all the other indicators are increasing. The solution during past recessions has been to raise rates until more Americans lose their jobs and spending falls. No one wants to do this, but with inflation stalled in this range, it may be Powell’s only move left.
Most investors were hoping for a rate cut in June, but I do not see any hope for lower interest rates between now and July. I am also convinced that rates will not be raised, as this would be too damaging to the economy. So the only solution is to hold rates steady, let them continue to filter across the financial world we all live in and hope they will gradually bring down inflation.
This brings us to mortgage rates, which move along with the 10-year Treasury note. One of the negative results of the Fed’s interest rate hikes was that they significantly increased mortgage rates and thus stifled growth in housing and home-related industries.
The most meaningful change that could help contain rising consumer prices has been the steady decline in wage growth, which has fallen from 6.7% to 5% over the past two years. Higher wages, spurred by the shortage of workers, has been a key factor driving inflation, pushing incomes higher.
The Bottom Line
Economists are strange; they wait anxiously for each report, which can completely change our view of the economic landscape and the economy’s direction.
Interest rates have an oversized effect on our lives, as can be attested to by last week’s CPI numbers. We’ve been expecting the Fed to cut rates, which would encourage consumer spending, lower mortgage rates and invigorate housing sales. But the March CPI report changes that outcome.
For me, it is a little like watching your favorite team; they start slow, build momentum and take the last shot with three seconds left in the game. In my case though, I’ll have to wait until next month’s CPI report to see if they won.
Joe Higgins is a 44-year veteran of GE and Whirlpool Corp. who brings his executive experience to bear as a business consultant, AVB keynoter and YSN contributor. Visit his website, Quest 4 Quality with Joe, at Q4QwithJoe.com.
