Why the Fed Should Take Its Time When Moving Rates

Balancing on a tightrope, a tightrope walker encounters the essence of a balanced outlook. The Federal Reserve, akin to this walker, finds itself teetering at the precipice of equilibrium regarding interest rates. However, this equilibrium is delicate, lacking substantial evidence to affirm the correctness of current rates. They could be either too high or too low, yet maintaining balance seems an arduous task.

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In recent remarks, Federal Reserve Chair Jerome Powell indicated that a rate hike was improbable, aligning with market expectations. However, he also moderated his previous stance favoring rate cuts, emphasizing the necessity of inflation returning to target levels before any adjustment.

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Powell perceives interest rates as restrictive, potentially hindering economic growth and aiding in curbing inflation. Nonetheless, conflicting evidence challenges this notion. Initial indicators suggest that monetary policy is indeed impeding growth.

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Employment trends manifest this constraint, with job availability diminishing and worker reluctance to change jobs increasing. Payroll figures from the previous week revealed a sluggish growth in new jobs, accompanied by minimal wage increases. Additionally, consumers and businesses grapple with mounting debt burdens, as reflected in the increasing delinquency rates on credit card payments and the heightened risk of bankruptcy among vulnerable companies.

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Despite the Fed's tightening measures, the money supply has plummeted, contradicting expectations of lower inflation. The decline in the broad money supply, M2, over 16 consecutive months is unprecedented in historical data. However, this tightening of monetary policy fails to translate into broader financial indicators.

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Economic indicators, such as the S&P 500 stock index and implied volatility, demonstrate resilience rather than distress. The persistence of favorable market conditions amidst perceived tight monetary policy perplexes observers. Perhaps the labor market's resilience stems from factors like immigration influxes or post-pandemic labor market adjustments.

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While credit woes are attributed to the Fed's rate hikes, their widespread impact on the economy remains uncertain. Although certain sectors, particularly those serving low-income demographics, face challenges, overall consumer spending remains robust. Furthermore, corporate capital expenditure remains elevated despite fluctuations.

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The diminishing money supply, often seen as a precursor to economic slowdowns by monetarists, fails to materialize into a widespread economic downturn. Mainstream economics has largely abandoned the significance of tracking money supply due to its unreliability as a predictor. Moreover, recent increases in broad money supply challenge the relevance of year-over-year changes, especially considering the extraordinary deposit spikes during the pandemic.

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The coexistence of compelling arguments on both sides underscores the complexity of the current economic landscape. The dichotomy of struggling sectors and thriving consumers and corporations paints a picture of a two-speed economy.

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The outcome hinges on whether the adverse effects of higher rates gain momentum, curbing consumer demand and inflation, potentially leading to recession. However, the resilience of consumers and major corporations suggests that demand may persist, possibly driving inflation upward. Hence, the Fed's cautious approach of monitoring conflicting pressures before adjusting rates seems prudent.

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