Poised for the Fed Pivot

Given its past history, both over the long term and especially more recently, it’s inevitable, if not a given, that the Federal Reserve will screw up. This time should be no different. When exactly this will manifest itself is hard to say, but it may be soon—possibly before the end of this year or in early 2023.

The Fed, as we know well, grossly inflated prices and asset values post-pandemic by sticking too long to an overly accommodative monetary policy, holding its benchmark federal funds level at zero percent as recently as March and continuing to buy Treasury bonds, long after inflation was shown to be a lot more “transitory” than the Fed thought.

Now we are all paying the price for the Fed’s belated realization that it was wrong about inflation, as it has raised interest rates five times in the past six months, to 3.00%-to-3.25%, including 75 basis points at each of its past three meetings, and shows few signs of intending to sit and wait and see how those rate hikes will affect the economy.

In the process, the Fed has basically chucked the second piece of its dual mandate, namely maximizing employment, in order to slay the inflation beast.

The American consumer and investor are thus no better than pawns in the Fed’s game of trying to fix a situation it largely created by itself, yet there is no reason to believe that its current policies are any better or smarter than its previous prescriptions, which involved flooding the financial markets with buckets of cheap money it didn’t need.

Now it’s trying to undo all that in a few short months, all while trying not to steer the economy into the ditch, although perfectly happy to throw people out of work and gut their retirement portfolios.

(Question: If the Fed’s actions will force some people to keep working or rejoin the labor force—and there are still plenty of job openings—doesn’t that work against its plan to reduce employment?)

At some point — sooner rather than later, we hope, but no doubt later than everyone else — the Fed will suddenly come to the conclusion that it’s gone too far with tightening and will start to take its foot off the monetary brakes. It may not start to lower interest rates, necessarily, but at least take a breather and see what effect its recent new-found hawkishness has had on inflation and economic growth.

Far from being the “data dependent” experts of the recent past, the Fed has suddenly become slaves to the notion that inflation is deeply embedded in the economy and that it won’t pause until it believes the job is done, regardless of what the forward data portend. But what if the job already is done, or at least largely so? Shouldn’t we at least pause and see if it is?

What’s particularly startling about the Fed’s arrogance — there is no other word to describe it — is that it’s based on so much information and so many (book) smart people interpreting that data, yet time after time they manage to get it wrong.

One of the most astonishing things I’ve noticed about Fed policy since I’ve been writing this column is how often they’ve been caught flat-footed by the release of a government statistic — CPI or the unemployment rate, say — that you feel almost certain that it should have known about beforehand, yet it seemed more surprised about it than anyone.

So asking the Fed to forecast something — long-term inflation in this case — is asking it to do something that not only no one can do with any accuracy, but that the Fed is itself seems particularly incapable of doing. Yet here we all are at its mercy.

I do not pretend to know what inflation will be at the end of next year. But I am fairly confident that the Fed’s forecast will be wrong, as will its prescription about what to do about it.

Stock prices keep dropping and bond yields keep rising on the assumption that the Fed will continue its full-speed-ahead approach to monetary tightening. So if my premise is correct, that the Fed may be closer to ending its rate-rising regimen sooner than it now claims it is, the market may be set to reverse course and move higher.

I anticipate more bumps in the road ahead. But I’m starting to think that the stock and bond markets are going to end the year higher than where they are now, meaning the fourth quarter may turn out positive for investors, as the Fed finally comes to the conclusion that it was wrong and everyone else was right.

Treasury notes maturing in less than five years are yielding well above 4%. Should that handle get to 5, that could be the signal to start shopping.

George Yacik
INO.com Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.