The Fed: Totally Just Winging It
A 75 basis-point rate hike wasn’t even on the table a month ago. It appears that the central bankers over at the Fed were crawling around under the table because they found a 75-basis point rate hike.
The Fed went big at the June FOMC meeting in response to hotter-than-expected May CPI data just a week earlier. Jerome Powell admitted that Fed members were “surprised” but another big spike in prices.
So, what’s the plan here? Well, by all indications, there isn’t one.
As Mises Institute senior editor Ryan McMaken put it in an article published by the Mises Wire, it’s pretty clear that the Fed is winging it.
McMaken notes that this was just the third rate hike of 2022 even though inflation began to accelerate in the first second half of 2020. He also reminds us that last week’s big hike came “mere weeks after the Fed chair Jerome Powell slapped down the idea of a 75 basis point increase in June.” As Reuters reported on May 4, Powell insisted “a 75 basis point increase is not something that the committee is actively considering.”
That didn’t last long.
The fact that the Fed was forced to hike the target rate by more than it had suggested was even possible earlier in the year is a reminder that the Fed and its economists are simply in a reactionary mode when it comes to the US economy’s problem with mounting price inflation.
As even Powell admitted during today’s press conference, the Fed was surprised by how high price inflation has grown. The Fed then had to pivot in order to answer calls that the central bank ‘do something’ about price inflation.
But when it comes to the Fed’s decisions about where to set target rates, it is increasingly obvious there is no model. The ‘plan,’ to the extent one exists at all, amounts to ‘let’s see how bad inflation is, and then we’ll pick a target rate and hope that solves the problem.’
In other words, the Fed is winging it.
Meanwhile, the central bankers continue to insist that the economy is “strong enough” to handle tightening monetary policy. The FOMC assessment of the economy was that it’s still improving.
Overall economic activity appears to have picked up after edging down in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained low.”
Jerome Powell was even more upbeat during his press conference.
Overall spending is very strong. The consumer is in really good shape financially. They’re spending. There’s no sign of a broader slowdown that I can see in the economy. People are talking about it a lot. Consumer confidence is very low. That’s probably related to gas prices and also just stock prices, to some extent, for other people. But that’s what we’re seeing. We’re not seeing a broad slowdown. We see job growth slowing, but it’s still at quite robust levels. We see the economy slowing a bit, but still growth levels—healthy growth levels.”
McMaken points out that the Fed continues to cling to strong employment data as the best evidence that the economy is robust. But the Atlanta Fed just revised its Q2 GDP growth projection to — zero. That follows on the heels of a -1.5 GDP print in the first quarter. And there are other signs of recession as McMaken points out.
The yield curve is flattening, retails sales are down, the S&P 500 is in bear territory, and home sales are falling off as mortgage rates rise. Consumer credit is rising to historic highs as the savings rate collapses. But at the Fed, they showcase an economic indicator that trails most others: employment. In other words, the Fed is keeping its eye fixed on the rearview mirror in order to sing the praises of the Biden economy.”
Regardless, the central bank couldn’t just sit on its hands in the face of an 8.6% CPI. The Fed had to do “something.” But as McMaken asks, why 75 basis points?
When asked during the press conference to quantify how 75 basis points is better than 50, Powell had no answer beyond saying the committee simply decided to speed up the time frame of rate increases. The standard employed for coming to this conclusion, according to Powell himself, came down to ’75 [basis points] seemed like the right thing at this meeting.’ Needless to say, this didn’t answer the question of what we are to expect from that additional 25 basis points.”
The mainstream narrative is that this was a very “hawkish” move. But as McMaken observes, it really isn’t.
Powell himself stated that in his opinion, ‘right now our policy rate is well below neutral’ and that a target rate of 1.75 percent is only ‘moderately restrictive.’
If a forty-year high in inflation calls for only moderately restrictive policy that remains below neutral, it’s difficult to imagine how much inflation will be necessary before the Fed regards truly restrictive policy as actually necessary.
So, what’s the plan? Well, there really doesn’t seem to be one.
The FOMC “dot-plot” indicates that rates could reach 3.8% next year. But will this be enough to slay the inflation dragon? Powell assures us “We’ll know when we get there.”
This doesn’t inspire a lot of confidence. In fact, it feels like the central bank is winging it.
And it seems highly unlikely that the Fed will ever get interest rates to 3.8%. If the historical trend continues, this last hike will likely tip the economy into a downturn, if we’re not there already.
McMaken sums up the economic difficulties the Fed faces.
In practice, however, it is very unlikely the Fed will allow the target rate to rise much above 3.5 percent, no matter what. With federal debt still exploding, allowing rates to double from today’s rate would drive up interest on Treasurys and place an enormous burden on federal budgets in terms of debt service. This would require very large budget cuts to popular programs. So far, it’s hard to believe the Fed will abandon its current de facto policy of supporting federal deficit spending through suppressing interest rate growth.
The Fed also continues to take an ultrasafe approach when it comes to Wall Street and employment. Powell at today’s meeting explicitly claimed the Fed is still trying to avoid a recession. In other words, inflation is still preferable to recession. That suggests we should continue to expect inflation rates well in excess of the Fed’s arbitrary 2 percent target.
If the Fed continues as it’s going, we’ll need to get used to declining real wages and near-zero real growth for a while.
The Fed plan is no plan — just wing it and hope everything works out.