Some Thoughts About Fed Interest Rate Increase

An update to a Fed interest rate increase on Wednesday May 3. Something to keep in mind is that we have an economics “team” that this last week was awarded as the most accurate in 2022 by Consensus Economics. Brian Westbury is the teammate we go to daily for the antidote for conventional wisdom. Here is a summary of thoughts this week and they reflect our position moving forward. 

 In the recent past, the Federal Reserve held interest rates at zero year after year. In 2017 and 2018, they lifted rates and it was all anyone talked about. Then they cut them to zero and the noise went away. Now, with rates headed up, all eyes are again on the Fed, and investors are parsing every word of its statements and the Powell press conferences. 

As of Friday, the futures market expects a quarter-point rate hike on Wednesday, but then a series of rate cuts that start in the third quarter. 

Why the market expects rate cuts is unclear. The next key inflation print – the consumer price index for April, which arrives, May 10 – is coming in hot. At the same time, longer-term bond yields are drifting down, and stock prices have been rising. That’s not a tightening of “financial conditions” that some models of monetary policy watch. And we have yet to see the kind of weakness in the labor market that would get the Fed to stop hiking rates. 

At the same time…M2 is down 4.1% in the past eight months, the steepest decline since the early 1930s. If it continues through 2023, then by 2024 the economy could be in for not only a recession but also a sudden and sharp decline in inflation. Why the press never asks about a decline in M2 that we haven’t seen since the Great Depression is a mystery. 

So far this year, we think most investors have convinced themselves of overly pleasant narratives about the economy and the path for monetary policy. One of them is that the Fed will cut rates this year. We don’t think this happens and maybe a re-thinking of those pleasant narratives by the public markets starts soon. 

Demand for labor dropping sharply over last few months plus new tenant rent price index shows a sharp decline – good for inflation and a clear indicator of a looming recession and number three the inverted yield curve (short term is higher rate than long term) has always indicated a recession.