With the current inflation situation the Fed signaled pretty clearly there will be forthcoming increases in rates. The total number of increases? The end goal for the fed funds rate? Those are not entirely clear, but let’s start with the a look at the historical data, the long history. For the next graphs do pay attention to the rate axis (y), it changes as we narrow time, and that is part of the reason for the different graphs.
The Fed Funds rate is at historic lows and has been for much of the 21st century. Yes some of the declines were responses to financial crisis and COVID though we will address these in a bit. My reason for showing the above graph is simply to cut off the doomsayers suggesting increases are problematic. I think they are overdue. Let’s look at a narrower time span.
Rather than looking from 1954 let’s start in 2000. There were three somewhat dramatic events occurring in this timespan: terrorist attacks in 2001, financial crisis in 2008-9, and COVID-19’s economic disruptions. The fed response in each was to lower rates. Not pictured here are the novel policy interventions from the Fed, such as Operation Twist, or asset purchases.
I think the “winding down” of the non-traditional policy options is what is concerning some market participants the most. When you undertake novel policy market’s need to adjust and learn, and when you take the novel policy away it is a new learning process all over again. Lastly, let’s look at a further narrowing.
Fed Funds was at low levels, I call it AB0 for All But Zero, for much of the decade and only started a gradual increase to less than 2.5% before COVID-19 impacts started. It might not be fresh in the minds of some but the Fed rightly said they had no real “solutions” for the economic problems precipitated by COVID. The better option was a fiscal response and that set us on the course we experienced since mid-2020.
So multiple times on the radio I suggested the Fed was slow to raise rates, and I still think that was the case. If an increase of rates to somewhere between 0.5% and 1% in 2012 or 2013 was going to be cataclysmic for the economy then why were we not looking at strategic and structural changes. The need for something approaching normalization was clear and yes, it would cause economic pain but those are the breaks. Instead you likely get excess asset price appreciation (housing anyone?) and the possibility of bubbles or at least shakeouts in the sectors experiencing the worst excesses.
Some call for immediate and large rate increases to shock markets. I am not sure this is necessary, especially since the Fed does not like to spook the markets, but consistent 50 basis point increases would not be off the table I guess. The first would likely shock but the next few would not. So what is my concern? Politics.
The Fed is a favorite target for both political parties, but the attacks of former President Trump on the Fed were direct, unprecedented, and pretty silly. From a policy perspective President Trump had an addict approach, wanting it all now and worry about consequences later. So my concern is this, with the prospect of former President Trump once again becoming President Trump, will the Fed deliberately overshoot on rates to have room to lower rates and appease the White House?
Unfortunately I am not sure that is off the table, which is pretty concerning for policy.