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Fed Chair Powell Thinks Rate Cuts Too Easy to Swallow
Federal Reserve Chairman Jerome Powell has been so eager to take credit for engineering a soft economic landing that it has now made that landing much more difficult to achieve. His prediction this week that the next move in interest rates will likely be downward rather than upward perpetuates his error. A little more restraint in recent months would have served the Fed chairman and the economy much better.
The Marshmallow Test is a psychological experiment designed to measure delayed gratification in children. Developed by psychologist Walter Mischel in the early 1970s, the test places a child in a room with a marshmallow and offers him a choice: he can eat the marshmallow immediately or wait for a set period of time, usually around 15 minutes, and receive a second marshmallow as a reward for patience. The test became famous for its implications regarding self-control, willpower and future success.
Powell faced his own version of the Marshmallow Test last fall. After a nearly 20% rise in the price level since the start of 2021 and the Fed’s fastest rate hike cycle in 40 years, Powell appeared to finally be getting inflation under control.
FED CHAIRMAN SAYS NEXT MOVE TOWARDS LOWER RATES LIKELY, BUT TIME UNCERTAIN
Core personal consumption expenditure (PCE) inflation slowed to 2% annualized in the third quarter of 2023 and financial conditions became materially more restrictive. A soft landing and meeting the 2% inflation target seemed within reach. He just needed to refrain from devouring the proverbial marshmallow of rate cuts and keep financial conditions tight for a few more quarters. Unfortunately, he ate the marshmallow.
Treasury Secretary Janet Yellen was one of the main figures pushing the Fed to lower interest rates.
To be fair, Powell came under tremendous political pressure to ease monetary policy, with former Fed chairman and current US Treasury Secretary Janet Yellen told CNBC last December that it would make sense for the Fed to consider lowering interest rates.
Not to be outdone, President Biden himself has delved into monetary policy numerous times in recent months, telling an audience in Philadelphia earlier this year, “I can’t guarantee that. But I bet — you can bet — that these rates will come down further, because I bet that little piece of equipment that sets interest rates is going to go down.”
At the Federal Open Market Committee (FOMC) press conference in December, Powell took a notably more dovish stance, suggesting that the Fed was more focused on when to cut rates than when to raise them, despite the symmetrical language of the FOMC statement. , and despite the Fed’s own projections that inflation would surpass the 2% target over the next two years.
The story continues
Powell’s dovish pivot in December triggered a dramatic easing of financial conditions and sowed the seeds for inflation resurgence that we are experiencing now. In fact, the S&P 500 rose 11% over the next three months and high-yield credit spreads narrowed by more than 70 basis points.
The resulting wealth effects will now ensure that the pace of consumption growth remains inconsistent with a return to 2% inflation. Since December, core PCE inflation has recovered to 3.7%, and core CPI (Consumer Price Index) has risen even more strongly, an annualized 4.5% increase over the past three months.
If only Powell had refrained from signaling rate cuts in December and stuck to the “bigger for longer” script, the economy might have slowed enough to allow real rate cuts in the coming months. No doubt the Fed will still be under enormous political pressure to do so before the November elections, but rate cuts will likely be off the question indefinitely with inflation so high.
Powell’s lack of self-discipline has distributional consequences. While the richest 20% of households got a tremendous boost to their asset portfolios due to Powell’s conciliatory turn, the poorest 50% are struggling.
With few assets and debts with relatively higher floating rates, they will end up paying the cost of “bigger for even longer”. According to the Federal Reserve Bank of Philadelphia, 3.5% of credit card balances are more than 30 days past due, the highest figure since the survey began in 2012.
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If the FOMC were serious about targeting inflation, it would reverse Powell’s December pivot and completely eliminate the easing trend, signaling that the next move could very well be a move higher. In his recent press conference following the May FOMC meeting, Powell had ample opportunity to do so. For now, he remains reluctant to abandon the flexibility bias. But it can only hold out for so long if inflation continues to stay so far above the Fed’s own target and forecasts.
If only he hadn’t eaten the marshmallow.
Scott Bessent serves as CEO and chief investment officer of Key Square Group LP, a Connecticut-based investment partnership he founded in 2015.
Original article source: Fed Chair Powell Thinks Rate Cuts Too Easy to Swallow