The Fed Needs To Practice Patience

It’s beginning to look a lot like 50 basis points.

OK, that’s not as catchy as that more famous Christmas tune. But that’s shaping up to be the likely outcome at the Federal Reserve’s next two-day monetary policy meeting December 13-14.

While inflation has slowed only a little bit since the Fed’s last rate hike on November 2 — its fourth 75-basis point increase in a row – the consensus seems to be that the Fed will moderate the size of its next hike to 50 bps, for no other reason perhaps than to see what effect its rate-raising process has had on the economy.

Indeed, the minutes of the Fed’s previous meeting at the beginning of November signaled such an outcome. “A substantial majority of participants judged that a slowing in the pace of increase would soon be appropriate,” the minutes said.

The Fed has now raised its benchmark federal funds rate by a cumulative 375 bps since it started hiking rates back in March, when the rate was at zero. A 50-bp hike in December would put the fed funds’ rate at an upper range of 4.25%.

While a slight moderation in the next increase will be welcomed by just about everyone, from Christmas shoppers to homebuyers to investors, it’s not likely to be the last, and possibly for a while yet.

That was the word handed down this week by New York Fed President John Williams. While he “did nothing to push back against expectations” of a half-point rate rise at the December meeting, the Wall Street Journal’s headline was more hawkish, quoting Williams as saying that “inflation fight could last into 2024,” meaning more rate hikes over a longer period of time than the market expects.

“Mr. Williams said he expected that rates would have to rise in 2023 to somewhat higher levels” than he had estimated back in September, the Journal said.

If the whole point of the Fed’s rate-raising regime is to try to slow the economy and thus reduce the heat under inflation, you don’t have to be a Harvard-trained economist to see that it hasn’t made that much of a dent so far and that it’s a long way from ending its restrictive cycle.

I was in Bethlehem, PA, for Thanksgiving weekend and the stores and sidewalks were jammed with shoppers and party-goers (note to Xi Jinping: only a handful of them were wearing masks). The parking lots at my local malls in the Northeast have been filled for weeks. I’m sure it’s no different in your neck of the woods.

Government data on retail sales and consumer spending back up the anecdotal evidence. The job market also seems as buoyant as ever; not enough workers to fill the available openings remains the biggest problem.

The bigger question, perhaps, is whether the Fed can actually wring inflation out of the economy by trying to kill the economy. The short answer is that, yes, it probably can, although at what cost? And is it even necessary?

Until Covid-19 hit, we had almost no inflation to worry about for more than 20 years, without the Fed having to take any extraordinary measures to make it so. Indeed, the Fed’s biggest worry during this time was to try to raise inflation to its 2% target, not to lower it to that level, which is what it’s trying to do now.

It wasn’t terribly successful in trying to raise inflation, so there’s no reason to believe that it will be any more effective in trying to lower it through monetary policy, barring some scorched earth policy that will make Paul Volcker seem like a dove by comparison.

This is not to suggest the Fed should do nothing. The Fed held interest rates artificially low for too long, and certainly contributed to the inflation levels we have now, so a return to historically “normal” interest rates—say a 5% yield on the 10-year Treasury note—seems in order and overdue. But there’s only so much the Fed can do to lower inflation unless it wants to create yet another economic crisis.

The main driver of today’s current inflation was the post-pandemic imbalance between supply and demand: Supply stifled by lockdowns and pent-up demand fired by government stimulus and consumers returning to normal. That imbalance is already starting to correct itself, which should temper inflation going forward, as it already seems to be doing.

So there’s little reason for the Fed to go overboard and try to correct 10-plus years of profligate monetary policy in one-tenth the time.

Let’s do 50 bps in December and check the economy’s temperature later on. That seems to be the most prudent course.

George Yacik Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.