A few months ago, I dove into the reasons the Fed is seemingly always behind the curve on policy changes (https://www.cedarhillfinancialgroup.com/post/why-the-fed-is-always-late-to-the-party), waiting too long to raise rates in the face of inflation, and waiting too long to cut rates in the face of economic weakness. With inflation falling to 3.2% in February of this year, and clearly on a path towards the Fed’s 2% target, the Fed likely should have been considering rate cuts over the following months.
During the rate hiking process, the Fed mentioned time and time again that the impact of rate hikes would have a long and variable lag effect. As I said back in March, due to this lag effect, it stands to reason that by the time inflation reaches the Fed’s 2% target, the economy may already be experiencing problems that would have warranted an earlier cut. If they know that policy effects play out this way, they should have known they would have to cut rates prior to any major economic weakness to give their policy time to work.
As of July 11th, CPI had fallen to 3% on a year over year basis, and .1% month over month.[1] This once again highlights the issue I touched on in the previous write up about how the Fed’s use of year over year inflation figures leaves them looking in the rearview mirror, and as a result, behind on rate hikes and rate cuts. As unemployment continues to rise, the Fed should adhere to their dual mandate of full employment and stable prices, and begin rate cuts at the next meeting in September. At this point in the cycle, the risk that rate cuts will result in increased inflation, is outweighed by the risk of waiting too long to cut and further exacerbating weakness in the job market, especially given my view that low interest rates weren’t the main culprit of inflation to begin with.
In the end, the Fed may still be able to head off recession by acting quickly to adjust policy. However, given the lag between when rate cuts first occur, and when the impact is felt in the real economy, it is important that they begin to act at the September meeting. With inflation largely vanquished, and unemployment rising, there is no reason to continue to keep policy at levels that are this restrictive.
Disclaimer: The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
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