Weekly Update 6/21/2019 Is the Fed Policy Misguided?
by Zach Marsh on Jul 12, 2019
Weekly Update: Is the Fed Policy Misguided?
This week the Federal Reserve Open Market Committee concluded its monthly meeting and, in its statement, set the stage for an interest rate cut at its next meeting in July. While many financial news prognosticators and market cheerleaders are encouraging the cuts, the timing and necessity for them is anything but certain.
By most measurements, the economy seems to be doing pretty well. Unemployment is still at rock bottom levels, GDP numbers are encouraging, yet wage growth remains underwhelming. The one thing that continues to confound central bankers is the lingering low inflation rate. While briefly eclipsing 2% last year, inflation has fallen back below the Fed’s target level. Since the “Great Recession” the Fed has been doing everything in its power to push the inflation rate back to 2%. Quantitative Easing’s main purpose was to prevent the deflationary trap that has hampered Japan for nearly 30 years.
That being said, last year’s systematic rate hiking strategy appeared a bit aggressive. Many, at the time, believed that the Fed could allow the economy/inflation rate to burn a little hotter, thus giving it some breathing room above the target rate. However, the Fed pushed forward with the rate hikes and, at the start of this year, it found the stock market down nearly 20% from its highs, while threats of trade wars threatened global growth. Now, 6 months later, they are set to reverse course.
Today, as the debate over the timing and necessity of the cuts heats up, maybe we should step back and ask some more basic questions. After more than 10 years of aggressive monetary policy, are we certain that the Fed has or has not achieved its goal to re-inflate the US economy? Is the standard measurement of inflation used by the Federal Reserve even a pertinent metric? Finally, does the Fed possess the tools necessary to address the inflation as they measure it?
The Fed’s general measurement of inflation is the Core Personal Consumption Expenditure Index (PCEPI). This index includes categories like Food, Housing, Apparel, Medical care, Transportation, Education, Recreation, plus other goods and services. Looking over the categories, it’s hard to accept that there hasn’t been some inflationary pressures. Who among us believes that housing, education and medical costs have not increased pretty dramatically over the last couple years, let alone over the last 15-20 years?
Second, outside the categories listed in the index, one thing that the easy monetary policies of the last 10 years has accomplished quite effectively is aggressive inflating of nearly all asset classes. Bonds, stocks, and housing have all staged remarkable recoveries. Stocks are up over 340% since the end of 2008, while the interest rate on the 10 year US Treasury bond has actually declined 20%. Even housing prices, as measured by the S&P Case-Shiller Home Price Index, are above the hyper-inflated 2006 levels. From an asset valuation perspective it’s tough to make the argument that we are not in an exaggerated inflationary environment.
Which brings us to the ultimate question which is: Aside from achieving asset price inflation, can the Fed actually achieve the goals of pushing the prices of other goods and services higher, by means of pushing wages higher, thus creating actual demand necessary for upward price movement? The answer to that question is extremely difficult to ascertain. After 10 years and little progress, it seems dubious to assume they can. Many things, mostly demographic, are stunting global growth and general wage growth. That being said, the Fed suffers from “A man with a hammer syndrome,” to the hammer everything is a nail. The response of the economy, and the market, in the aftermath of the 2008 global meltdown to quantitative easing and low interest rates has provided the Fed with evidence they want to continue marching down this same path. Unfortunately, these are also some of the same policies which have greatly expanded the divide between the haves and the have nots. If we want to address those issues, perhaps we should stop relying upon the Federal Reserve Bank to solve all of our problems.
Thanks for reading,
Zach and Dave
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