The Fed Hath Paused -- James Locke #5837

Federal Reserve – to hike or not to hike Pause is expected – further notes after the release of the interest rate move Bullish stocks, low bond yields and recovering housing market suggest interest rates aren’t that restrictive The Fed’s mission has been to get interest rates high enough to slash inflation from its current 4% to 5% range to 2%, even if that means pushing the economy into recession and unemployment higher. If the Fed had succeeded, you probably wouldn’t be seeing these things: stocks entering a new bull market, a rebounding housing market or long-term Treasury yields well below the inflation rate. Typically, when the Fed raises short-term rates, stock prices fall, and long-term bond yields and the dollar rise. That’s what happened for the first six months of Fed tightening in more or less textbook fashion. But since October, all have changed direction. The S&P 500 is up 22% since last fall’s low. This reflects rising earnings forecasts and excitement about artificial intelligence Behind the rally in stocks is a belief that inflation will soon plummet as pandemic-related distortions of prices for new and used cars, apartment rents and houses all reverse.  Then the economy will slow due to rate hikes and eventually the Fed will cut rates. Banks are tightening lending – GDP grew 1.6% (lower then long term run rates) unemployment rose to 3.7% Yet somehow we continue to see the economy moving forward. Markets are pricing in a high probability that central bank policymakers will “skip” — an expression they generally prefer to “pause” — at this month’s meeting as they digest the impact of 5 percentage points worth of increases going back to March 2022. Not an end Inflation is dropping – good sign 4% y over y probably cemented the decision to pause Stop to evaluate – what do the post meeting minutes say?  The details are important Are they leaning towards raising rates further? – likely to see a rate hike in July 25-26 meeting. What happens with GDP.  Continued improvement or a “shallow recession”. A pause recognizes that there’s a lag between what we do and when it shows up in the economy and inflation. What does Powell say at the press conference – probably committed to continued lowering inflation and keeping the hiking door open.  Most likely no comment about July move. Finding the balance between enough aggression to bring down inflation while not tanking the economy is the Fed’s ultimate goal. History suggests that central banks that pause usually commence hiking soon after they discover that inflation hasn’t been vanquished  a recession remains the most likely case for most economists. The risk in continuing to raise interest rates is something will break more structurally than it has so far Then they would have to lower interest rates if they cause a recession. In the past, we’ve had very few periods where the fed funds rate went up then plateaued. Usually, the Fed overdoes it