A Highly Data-Independent Fed

No Surprise With Latest Decision

In his prepared remarks at his press conference on Wednesday, Federal Reserve Chairman Jerome Powell spoke of the ongoing strength of the US economy. “Recent indicators suggest that economic activity has continued to expand at a solid pace,” he said. What is more, “GDP rose at an annual rate of 2.2 percent in the first half of the year, and available data point to a roughly similar pace of growth this quarter.” Discussing other factors, he pointed that “growth of consumer spending has been resilient.” Finally, “the unemployment rate has moved up but remains low at 4.2 percent.”

Listening to these remarks you may have expected Powell to say that no new monetary stimulus is necessary. And you would be wrong!

His press conference followed the decision a few minutes earlier by the Federal Open Market Committee to lower the Federal Funds rate by not just 25 basis points but by a hefty 50bp. Why does a strong economy need such massive stimulus? In addition to the economic strength that the Chairman outlined, there were other positive developments in the economy last week.

We learned Monday that the Empire State Manufacturing Index jumped this month to the highest level since June 2022. Tuesday brought news that retail sales had risen by 0.1% month-on-month in August even after the July surge had been revised up from 1% to 1.1%. This suggested that consumer spending is robust and needs no assistance from Jerome Powell! The US Department of Labor informed us on Thursday that initial jobless claims, a proxy for layoffs, had fallen by 12,000 during the week ending September 14 to 219,000. The latest claims figure was well below market expectations, and a four-month low.

To go back to the main question for this issue of SriKonomics: With the facts that they had on hand, why did Powell and his colleagues cut the policy interest rate big time?

In going over the transcript of his press conference, what stands out are repeated references to “recalibration” of policy to explain the easing. Clearly, policy makers did not want to leave investors with the impression that fear of an imminent recession induced them to ease. If, in fact, investors thought the large rate cut signified that the central bankers know something that they (investors) did not about a growing risk of recession, that would have led them to dump equities and seek safe haven in Treasurys. Instead, Powell wanted to leave markets with the impression that the “recalibration,” i.e., policy pivot, was a natural response to inflation having come down from historically elevated levels, and a softening labor market.

If stoking the stock market was Powell’s objective, he succeeded in spades in terms of immediate results. Both the S&P 500 and Dow Jones indexes hit record highs during the day Thursday. The NASDAQ index rose by 2.5%. But what will it take for the rally to continue? The answer may lie in how market’s anticipation for the Wednesday cut forced the Fed’s hands in implementing the easing, and how expectations grew in recent days of a larger reduction — something that also was realized.

And therein lies the risk for the Fed. To keep equities on an upward trajectory, the central bank may have to keep raising rates by 50bp a clip, or even by 75bp at a time, in order not to disappoint investors and risk a correction. Once the Federal Reserve ceases to lead markets and becomes a follower, it would be difficult, if not impossible, to escape from that trap and regain independence.

There are risks in terms of the overall economy as well. The median home price for an existing home in August was the highest ever for that month. Expect this to push more first-time buyers into the rental market. Rents account for a sizable portion of the Consumer Price Index basket, and this is likely to continue keeping the CPI rising at over the Fed’s 2% target. On the fiscal front, both Presidential candidates have made proposals that would boost government spending with no credible measure to increase revenue or curb the massive fiscal deficit. This may become evident to investors during the coming months.

Finally, for Powell’s reduction of the Federal Funds rate by 50bp to succeed in bringing the economy to a soft landing, it requires the stars to be aligned on the global front — no escalation of the Russia - Ukraine conflict that could push up wheat prices, no destruction of oil production facilities in the Middle East that could reverse the recent downward move in energy prices, and nothing that would increase shipping time for goods due to a new conflict slowing transportation.

The Federal Reserve decision last Wednesday was a case of going Big Easy, not just a “recalibration”. Expect the impact on the US and global economies to linger over time.

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

September 21, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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