The latest FOMC statement came out. It was no surprise that the Fed is keeping its federal funds rate the same, which is a range of 4.25% to 4.5%. The Fed is also maintaining its same pace of reducing its balance sheet.
It was noted that the FOMC members are concerned about elevated inflation and possibly lower economic growth. Those two things conflict in the Keynesian world view, which tends to be the view of Fed members.
If you have elevated inflation, then you are supposed to have higher economic growth. Of course, that is what the 1970s disproved, but the Keynesians carry on almost as if the 1970s never happened.
So, the Fed is saying there is a higher chance of stagflation than before. But this doesn’t indicate where they are headed. Higher or elevated inflation would indicate a tighter Fed policy ahead. Lower economic growth would indicate a looser Fed policy ahead.
This is probably why the markets reacted the way they did. Stocks were generally up after the initial announcement and then lost steam through later afternoon.
The Fed is the Tail, Not the Dog
The economy is the dog wagging the tail. The Fed is the tail. It’s not that the Fed doesn’t have an impact. The Fed’s very existence has an impact. That is what holds together the banks and the U.S. debt with these economic conditions. There is no way the U.S. government could have $36 trillion in debt without a central bank or some entity that can legally create money out of thin air.
With that said, the Fed is not really dictating the current economy beyond its past actions. The Fed certainly helped create this mess of debt, asset bubbles, and misallocated resources. But the Fed is now in a position where it is almost forced to react to what the economy is doing.
You shouldn’t expect any big moves from the Fed until we see big moves in the economy. Big moves in the economy could mean a significant change in price inflation, higher unemployment, or a crash in stocks. Of course, the Fed will always intervene if there is a meltdown in the bond market or with the major financial institutions.
Mr. “Too Late” Powell (not my nickname for him) isn’t going to do anything wild. He will continue to blame the tariffs for elevated price inflation, even though price inflation was a bigger problem in 2022 and 2023 than it is today. It’s not that he is wrong in saying that higher tariffs will likely lead to higher prices. It’s just that the Fed is the biggest culprit of price inflation in existence.
Yield Curve Control
It looks like the economy is humming along for now. Don’t forget that the yield curve was inverted in 2023 and most of 2024. It is finally normalizing somewhat, even if it is still flatter than normal.
The thing that is keeping the yield curve from fully normalizing are the really short-term yields like the 1-month yield and the 3-month yield. These are the yields most directly controlled by the Fed.
This is interesting to note because the recession after an inverted yield curve comes after the yield curve has normalized. But this is often not just because long-term yields have gone up. It is more typically because short-term yields have gone down because of Fed rate cuts. In other words, the Fed is usually cutting rates prior to the start of a recession (or when the recession becomes evident) because they are anticipating one.
If the Fed would just cut its target rate by about 50 basis points, that would almost fully normalize the yield curve.
So, I wouldn’t let the lack of Fed action fool you. Just imagine that Powell and company had cut by 25 basis points in each of the last two meetings. This would be fully in line with a normalizing yield curve and a recession shortly ahead.
The Fed’s lack of action here shouldn’t fool us. Just because they don’t see a recession ahead, or they don’t want to cut rates for political reasons, or they are worried about inflation, or whatever, we shouldn’t ignore the previous inversion of the yield curve. It doesn’t look promising in the short run ahead, even though the stock market keeps humming along.