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The Broken Clock & Less Effective Transmission Mechanism
The Fed will win with a forceful hand to push inflation back to its 2% target. Yet the Fed will err on the side of caution, move slowly to make sure a lower Fed Funds does not reignite inflation. When it lowers rates later this year, the Fed would be wise to pause to access risk that monetary doesn’t cause inflation to reaccelerate. After initially lowering rates, the Fed will likely skip a meeting or two to measure the impact of its monetary stimulus. Markets are placing >90% probability that Fed will cut in September. Markets have incorrectly predicted Fed actions over the past 2+ years, but given the recent CPI, PCE and jobs softening, I expect the Fed to cut rates 1-2x in 2024, beginning in September, subject to conformational July/August data. The chart below should show lower Fed Funds and higher unemployment rate in the coming year as these two lines cross back.
“Reassessing the Effectiveness of Monetary Policy” is the title of Jerome Powell’s keynote speech at Jackson Hole in August. This is a particularly important subject matter given the Fed’s models predicted recession and the more meaningful impact it expected from its monetary actions. Fed Chair Powell should acknowledge that the following dynamics contributed to the lack of effectiveness:
1) QE continued for 1-year after inflation fist surged and 6 months after it started raising rates
2) massive government spending stimulus offset monetary policy as this added to growth, blunting the impact of higher rates
3) wealthy homeowners with record low mortgage didn’t feel the impact from higher rates
4) soaring stock market led by tech and recently fueled by AI has enabled massive broad-based wealth creation
5) higher money market rates and coupons from floating rate debt are a windfall for savers
6) excessive consumer savings plus strong wage & job growth
7) financial conditions eased when the Fed signaled they were done tightening.
Powell and the Fed will reassess, and when they reflect, they should evaluate why they took so long to tighten when everyone knew the inflation genie was out of the bottle in 2021.
A broken clock is right twice a day so despite the wide miss by economists & Fed watchers over the past two years, it looks like forecaster will finally get it right this time. If the SOFR and fixed rate forward curves are also correct, we should expect higher rates for longer as R* (real rates) remain elevated. Never say ‘never’, but ZIRP is a thing of past. Markets never expected the Fed to raise rates by 525bps, never expected Fed Funds to remain so high for so long, with the Fed pausing so long.
How do you forecast the Fed’s monetary policy impacts markets for UST, Fixed Income, Credit, Equity, PE, Growth, VC and Real Estate?
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