Another Federal Reserve meeting has come and gone with no real action. As usual, the big news centered around what Powell & Company said and didn’t say.
For the third straight meeting, the FOMC held interest rates steady at between 3.5 and 3.75 percent. This comes as no surprise, given the uncertainty facing the economy as the conflict in Iran drags on.
The official FOMC statement noted that “inflation elevated, in part reflecting the recent increase in global energy prices.”
The cost of the basket of goods the BLS uses to calculate the CPI rose 0.9 percent month-on-month in April. That was the largest single-month jump since the height of the post-pandemic surge in 2022. The big monthly rise in prices pushed the headline annual CPI to 3.3 percent. The last time it was that high was March 2024.
The surge in CPI was almost entirely due to skyrocketing energy prices. The energy index rose 10.9 percent month-to-month. That was driven by a 21.2 percent monthly increase in gasoline prices.
The statement also emphasized, “Developments in the Middle East are contributing to a high level of uncertainty about the economic outlook.”
In fact, most observers think the central bankers will hold rates steady in the near-term, despite the market’s desire for rate cuts.
Powell seemed to confirm this perception, but also tried to minimize expectations of a rate hike, signaling a patient stance for the time being.
“We're in a good place to move in either direction; nobody's calling for a hike right now. So it really is going to depend on how things evolve.”
He also claimed that the current interest rate is effectively "neutral."
“I’ve always had it between three and four percent. We're a little north of three-and-a-half, so that's well within the range of what I consider reasonable.”
Based on the Chicago Fed National Financial Conditions Index, the current rate remains historically loose. The NFCI decreased to –0.52 in the week ending April 24. A negative number indicates a historically loose monetary environment.
While the Fed held rates steady as expected, the vote was far from unanimous. Four FOMC members voted against the move/statement. The last time four members dissented was in 1992.
As he has in the last several meetings, Trump appointee Stephen Miran lobbied for a quarter-point rate cut.
Beth Hammack, Neel Kashkari, and Lorie Logan dissented due to language in the FOMC statement. The trio agreed with holding rates steady, but they said they “did not support the inclusion of an easing bias in the statement at this time.”
They were referring to the clause reading, “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”
Since prior adjustments have been to the downside, they thought including the word “additional” hints at another cut in the near future. As one analyst told CNBC, “One gets the sense that there will be several meetings at least before we see any rate changes by the FOMC, agnostic to who the Chair of the Fed is.”
Fed Perception vs. Fed Reality
This feeds into the current perception that the central bank will keep rates higher for longer to battle potential price inflation due to the energy shock from the war in Iran.
Gold and silver have struggled to gain a footing since the conflict began due to this perception. Because gold and silver are non-yielding assets, they face headwinds when rates rise.
However, the interest rate hawks seem to be ignoring the proverbial elephant in the room – the debt black hole.
The Fed has addicted the economy to easy money, incentivizing billions of dollars in debt.
The Fed pumped nearly $9 trillion in new money (inflation) into the economy through quantitative easing alone from the onset of the Great Recession through the pandemic. That’s on top of the inflation it created with nearly a decade of zero percent interest rates.
That monetary malfeasance has consequences. It created a massive debt bubble, along with all kinds of malinvestments in the economy. The full impact hasn't manifested yet.
Debt-riddled economies don’t run on higher interest rates. This is precisely why President Trump and many others have been pushing for rate cuts. They want the stimulus. They want to facilitate more debt to keep the bubbles inflated.
In other words, they want the addict to get more of his drug.
That said, the notion that the Fed should hold interest rates higher is absolutely correct, even without the price pressure from soaring energy prices. (Strictly speaking, this is a price shock, not inflation as properly defined.) Price inflation remains well above the mythical 2 percent target. Meanwhile, the money supply is increasing rapidly. In fact, I could make an argument for rate hikes at this point, because the central bank never did enough to kill the inflation dragon. Keep in mind that then-Fed chair Paul Volcker had to jack up interest rates to 20 percent to slay the price inflation of the 1970s.
The fact is, the Federal Reserve never did enough to slay inflation. The central bank tightened monetary policy just enough to subdue the inflation dragon and hoped it wouldn’t get up off the mat. Now it has gone back to creating inflation. (Remember, monetary policy is still loose from a historical perspective.)
By declaring victory over price inflation and easing monetary policy over the last couple of years, the Fed effectively committed to creating more inflation.
So, why don’t they hike? Given the stubbornly high CPI and the looming trickle-down effects from $100-plus per barrel oil, it would be hard to dispute such a move.
Because they know that rate hikes would run a dagger through the heart of this debt-riddled bubble economy.
And that’s the Catch-22. The Fed simultaneously needs to hike interest rates to fight inflation and cut them to rescue the economy.
It obviously can’t do both.
To date, the central bankers at the Fed have been trying to walk the tightrope. But at some point, economic realities will force their hands. They’ll have no choice but to cut aggressively when the bottom falls out of the economy. The oil price shock could cause that sooner rather than later.
When the economy visibly cracks, the Fed will be forced to get even more aggressive in loosening monetary policy - elevated inflation or not. If history is any indication, it will cut rates to zero again and launch more rounds of quantitative easing (QE). That means even more inflation. (In fact, the Fed is currently running QE, although it won’t use the word.)
The worst-case scenario is a protracted period of stagflation.
You should take note of the fact that despite all the worry about hot inflation (that they’ll conveniently blame on the war), the Fed still projects a rate cut this year. Think about that. Inflation remains well above the target and appears to be heating up, and the Fed still plans to loosen monetary policy.
That reveals their priorities. If you watch the Fed closely, you will realize that central bankers tend to talk a lot about controlling inflation, but their actions tend toward looser policy to boost the economy.
That won’t likely change.
In other words, expect the inflation to continue.
And you might want to hold onto that inflation hedge.
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