Financial conditions are about as easy as they can be. The Federal Reserve is cutting rates and more cuts are expected. Some members of the Fed and the Treasury Secretary have successfully jawboned down the long end of the Treasury market (and thereby mortgage rates) with talk of a “third mandate.” The U.S. dollar is hovering around three-year lows.
Credit is available to corporations in an unprecedented manner. Capital expenditure, while concentrated in tech, is surging. The willingness of Americans to speculate has never been higher whether it be crypto, triple levered ETFs or NFL betting. Equity markets are making all-time highs at near all-time high valuations on a weekly basis.
Yet, demand for labor is essentially dormant. This is the issue facing the Fed and its Chairman Jerome H. Powell. Monetary and fiscal accommodation have reached the level of moral hazard, where bubbles seem to be floating all around us and yet that hasn’t been enough to stimulate hiring.
No Risk Free Path
At the last Federal Open Market Committee (FOMC) meeting, Chairman Powell said, “There is no risk-free path for policy.” In other words, both sides of the dual mandate are going in the wrong direction. Powell acknowledged that tariff-driven inflation remains in early days and the gradual pass-through of these taxes to the end consumer will build for some time to come.
The most recent U.S. Consumer Price Index report showed core and headline inflation running at 3%. Is the Fed supposed to ignore inflation running 50% above their target for the fifth year in a row or are they supposed to respect what markets are telling them, which is that they needed to “take the punch bowl away” quite a bit earlier in the evening?
The labor data that we have despite the government shutdown shows employment trends continuing toward a mild contraction. The question is “why?” Is it cyclical? Is it a reflection of weak demand? Is it just a reflection of a shrinking availability of labor due to aging demographics and deportations? Is it AI? Is it due to excess hiring that occurred after the pandemic? My guess is that all of these factors have contributed to the weak labor market. The problem is that few of these factors are actually helped by a lower federal funds rate.
Few of these factors are actually helped by a lower federal funds rate.
MMT And Baby Boomers
To make things more confusing for the Fed, there is also the increasingly accepted economic argument – largely put forth by the devotees of Modern Monetary Theory (MMT) – that argues the Fed and mainstream economic thinking has it all backwards. They essentially make the case that we live in a new world where baby boomers have most of the savings and that cohort’s spending tends to rise with higher interest rates and falls amid lower rates.
We live in a new world where baby boomers have most of the savings and that cohort’s spending tends to rise with higher interest rates and falls amid lower rates.
In other words, although cutting rates at the front end and suppressing rates at the long end may encourage more risk taking, is actually counterproductive because there is a negative wealth/income effect on a cohort that is a core driver of demand. It is an argument that I have come to believe has some credibility.
The demographic reality of the U.S. economy is clearly getting older and with that the economy is increasingly reliant on the spending and wealth transfer of these older savers. They represent a big part of the 10% of Americans who drive 50% of all consumption.
Unprecedented Times
The point here is that we don’t know the future and neither does any Fed governor. Precedent isn’t always prologue because the economy is always evolving. Never before have our demographics or wealth bifurcation looked the way they do now. Never before has our fiscal policy been so accommodative that we have war time deficits amid full employment. A monetary policy that made sense in the 20th century might be far less effective in current times.
A monetary policy that made sense in the 20th century might be far less effective in current times.
Our only recommendation for the various members of the Fed is to have a little humility. You don’t know the future and you don’t know the consequences of running an economy this hot for this long.
For investors, we offer a simple reminder that momentum works in both directions and there may come a time in the near future where it has become clear that there isn’t always an effective Fed put.
Tim Pierotti is Chief Investment Strategist at WealthVest.
