Did the Fed Do the Right Thing?
Yesterday morning, I predicted that the Fed would raise rates by seventy-five basis points, or three quarters of one percent that afternoon. I am not saying that my prediction was genius, or even an original one: It was what pretty much everyone had expected. The central bank clearly had to raise rates; the only question was by how much. Half a percent would have left them open to criticism that they were still way behind the curve in reacting to inflation, one percent would have opened them up to criticism that they were panicking and forcing the economy into a possibly deep recession. They had little option really, but regardless of how obvious the move was from the point of view of how the Fed would be perceived, was it the right one?
On balance, I would say yes, if for no other reason than the arguments against 50 and 100 basis point hikes detailed above are both valid. Last month’s 8.6% inflation rate print made it clear that there was a real and accelerating problem that had to be addressed with some urgency, but history shows us that an overly aggressive response by the Fed risks triggering a boom-and-bust cycle that could last for decades and prove to be a seriously destabilizing force. There is a lot at stake, and the compromise position of a 75 basis point jump in short-term rates was probably the right move, for now.
If it proves to be wrong, I doubt it will be because it was too much. Inflation is hurting everyone and has to be tamed. An attempt to do that is underway, but the Fed has already left itself open to accusations of being late to the party, so a strong case could be made for a bigger increase. However, by saying that he expected another 75 basis points next month, Jay Powell headed off that criticism. Managing an economy is largely about managing expectations. The object of hiking rates is to change the behavior of individuals and businesses and that can be done by laying out future plans as much as by acting now, with, of course, the advantage that you don’t have to what you say you will if conditions change.
So, it looks like taking the compromise route while threatening more of the same is the best the Fed could make of a bad situation. The market certainly thought so, as the major indices all jumped on the news initially. That, however, was never going to last. As I said yesterday in my article, "Why the Fed Cannot Win Today," when talking about a 50 basis point hike, a relief rally was always going to come up against the reality that inflation was still raging, and that a rate hike of any kind was designed to slow growth. Sure enough, futures this morning, which were trading even higher in the after market yesterday evening, took a nosedive, and are now pointing to an opening this morning that gives back yesterday’s gains and then some as I write this.
The trigger for that reversal in index futures was the surprise announcement by the Swiss National Bank that they too were raising rates, in their case for the first time since 2007, followed by the Bank of England hiking for the fifth time in this cycle. That made it clear to traders that taming inflation was not just a matter of the Fed making a few adjustments. Contrary to what some politically-motivated commentators would have you believe, U.S. inflation is not entirely the fault of Joe Biden, Donald Trump, or Jay Powell (whom Trump appointed and Biden reappointed), or whichever punching bag any given politician or commentator decides is a convenient scapegoat.
I was in England last week, and I saw some people express with absolute conviction that inflation was the fault of Boris Johnson or Brexit, or whatever. This highlighted for me the stupidity of those here, there, and everywhere who claim inflation is the fault of one politician or party. It is a global problem, brought on by an unusual confluence of events, and it will be primarily up to central bankers, not politicians, to deal with it. The Fed, by not taking the easy option of a 50-basis point hike, and by warning of more pain to come, faced up to that responsibility yesterday. They could, therefore, be said to have done the right thing.
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