How do we assess the Federal Reserve and recent economic slowdowns?

Recently published in Worth, Edition 1, 2019

As we are studying the cycles of the Federal Reserve’s monetary policy, a

most interesting statistic crossed our desk during the holiday season. The average

length of time from the last Fed rate hike to the first Fed rate drop was a mere

five months. That’s correct: only five short months to the first rate drop. This statistic made us very uncomfortable with how the Federal Reserve handles monetary policy. Because of the 2008 financial crisis,

we have seen more Federal Reserve involvement in the economy in the last

few years. The easing and free money from the Fed shows a lot of stimulus

coming from an institution whose stated goals are keeping inflation in check and

full employment.

How do we assess a Federal Reserve that has low inflation and full employment

but still raises rates? The answer is simple: The Fed has modestly strayed

from its mandated goals. There are some legitimate reasons for the Fed to raise

rates, but most of them involve fixing what the previous Fed chair—from 2014

to 2018—got wrong. It seems that Janet Yellen should have raised rates a little

more during her tenure, to bring us back to some level of normalcy. Since neither

she nor Ben Bernanke did much to fix the enormous and long-in-the-tooth period of easing monetary policy that they helped create, Chairman Jerome Powell, with a better economy, did it instead. However, it was so late in the cycle that there was no way to actually get back to a normal world, where the Fed was no longer continually stimulating the economy, without causing another problem.

As you can see in the opposite chart above, raising interest rates does cause

big problems for the economy going forward. In addition, most Fed watchers would tell you that the Fed contributes most to problems in our economy by

overshooting and undershooting in its monetary policy. That is why the most

recent action by the Fed is disconcerting. Chairman Powell knows all this history

and had the opportunity to chart a new course for the Fed, creating a much

softer landing for the economy by not raising rates when inflation allowed him

to. At this stage, most investment professionals do not want to see the Fed

lower rates because that would translate to real problems, such as a recession or

another economic dislocation. The Federal Reserve had all it needed to make

this great leap toward changing the outcomes of its own actions, and yet it

chose the wrong path once again. Granite Group believes that the Fed should

adjust its actions swiftly so a market dislocation does not occur. Powell raised

rates at an opportune time in the cycle, but that time has come to an end. The

only reason to raise rates from here on would be an unforeseen trend that

pushed inflation higher than what we are seeing or predicting. It may be too

late at this point to keep the United States from going into a recession, but

any more rate increases would all but guarantee that outcome.

Our Federal Reserve is an amazing institution and does great work, but this

continued ebb and flow needs to be changed. Members should heed the following words: “The definition of insanity is doing the same thing over and over

again and expecting different results.”




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