Three Reasons the Fed Better Not Give in to Recession Doves

There’s no doubt the Fed’s been aggressive trying to deal with inflation up to this point. Their launch from zero to 2.5% took less than half the time it took them the last time they pumped rates to this level. 

To save any credibility, the Fed had no choice but to be aggressive in the current situation. 

Not unexpectedly, inflation hasn’t noticed. Also not unexpectedly, as the consumer “mega-high” that came with all the stimmy spending has run out, the long awaited recession is finally here (or nearly here). 

You can tell because no one connected to the federal government is allowed to say the “R” word out loud. But even so, because it is on everyone’s mind, talk has begun about how the Fed needs to deal with it. 

(This is how addicted to cheap cash we’ve become. Rates have been rising for a little over three months, and the talk is already about how the Fed needs to lower them again!)

But the Fed lowering rates at this point would be a bad and pointless move. Here are three reasons why…

Ignoring Inflation is the Wrong Move

First off, inflation has to come first. I’ve said it before and I’ll say it again, the Fed’s entire credibility hangs on their ability to maintain price stability.  It’s their core mission — their reason for existing (according to them at least).  

In addition, if they start back easing in order to kick start economic growth they’re going to undermine the only thing that really will tame this bout of inflation — a demand-killing recession. (I believe they know this, even though they’d never say it out loud.)  In the worse case, not addressing inflation would only extend the pain…

The second reason is that this economy needs to get back to a level of positive real interest rates. Since 2009, real interest rates have largely been negative. That’s a drain on people’s wealth.

If you’ve been reading this letter for more than a week, I don’t need to remind you how tapped out people are today. 

Personal Savings

Source: Tradingeconomics.com

Negative rates only exacerbate people’s personal loss of wealth. From 1983 to roughly 2002, interest rates largely outpaced inflation meaning people earned a positive rate of return. Interest rates should offer a positive real return!

But the most important reason is that easing from 3% or 3.5% most likely won’t do anything to spark the economy.

The last two times the Fed went into ease mode to try and support a sinking economy was during the tech crash in 2000 and the housing bust in 2007.

Back in 2000, the Fed pushed the funds rate from nearly 7% (I know… That sounds ridiculous today.) down to 1% where they held them for nearly a year before starting to raise them again.

When the housing bubble went bust, rates had risen back to nearly 5.5%. In August of 2007 they started pushing them all the way back to near zero — and then held them there for the next eight years!

In both cases the Fed had significant room to ease. 

When the pandemic lockdowns hit, fed funds were hovering around 1.7% — too low for the Fed to make any kind of impact. (Which led them to make up a lot of “creative financing”…) 

Face it, if the economy is choking with interest rates at 3%, there’s not going to be a lot the Fed can do without going back into money printing mode…

The Next Couple Months Will Be Critical

Next month’s CPI will be out on August 10. 

If the print is down from last month’s 9.1%, expect to hear a lot of talk about “the Fed easing so we don’t slide into a recession.”

They’ll be making a huge mistake if they do…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Daily