QI Research CEO Daniel DiMartino Booth and Fixed Income SMA Parametric Managing Director Nisha Patel discuss how inflation is impacting the U.S. economy on how money is made.
Federal Reserve Chairman Jerome Powell was keen to take credit for achieving a soft landing for the economy, which is now much harder to achieve. His prediction this week that the next move in interest rates is likely to be lower, not higher, perpetuates his error. A little more restraint in recent months would have been much better for the Fed chairman and the economy.
The Marshmallow Test is a psychological experiment designed to measure delayed gratification in children. Developed by psychologist Walter Mischel in the early 1970s, this test places children in a room with marshmallows and provides them with choices. Either you eat the marshmallow right away, or you wait a specified amount of time (usually about 15 minutes) before she eats the second marshmallow. Marshmallows as a reward for patience. This test has become famous for its influence on self-control, willpower, and future success.
Powell faced his own version of the marshmallow test this fall. With price levels up nearly 20% since the start of 2021 and the Fed’s rate hike cycle the fastest in 40 years, Powell finally appears to have inflation under control.
Fed chief says next rate cut is likely, but timing is uncertain
Core personal consumption expenditure (PCE) inflation slowed to 2% annually by the third quarter of 2023, and financial conditions tightened significantly. A soft landing and achieving the 2% inflation target seemed well within reach. All he had to do was refrain from gobbling the proverbial marshmallow of rate cuts and keep financial conditions tight for a few more quarters. Oh, he ate the marshmallow.
Treasury Secretary Janet Yellen was one of the key figures pressuring the Fed to lower interest rates. (Photo by Alex Wong/Getty Images/Getty Images)
To be fair, Mr. Powell is under tremendous political pressure to ease monetary policy, with former Fed Chair and current Treasury Secretary Janet Yellen telling CNBC in December that the Fed has He said it made sense to consider a reduction.
Not to be outdone, President Joe Biden himself has weighed in on monetary policy multiple times in recent months, telling an audience in Philadelphia earlier this year, “I can’t guarantee it, but I’m sure interest rates will be lower.” That little organization that sets interest rates is bound to collapse.”
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At the Federal Open Market Committee (FOMC) press conference in December, Chairman Powell took a markedly dovish stance, saying that despite the symmetrical language of the FOMC statement, the Fed was more likely to cut rates than raise them. It was suggested that emphasis should be placed on Despite the Fed’s own projections that inflation will exceed its 2% target over the next two years.
Chairman Powell’s dovish shift in December led to a dramatic easing of financial conditions and planted the seeds for the resurgence in inflation we are currently experiencing. In fact, the S&P 500 rose 11% over the next three months, and high-yield credit spreads fell by more than 70 basis points.
John Koudunis, president and CEO of Calamos Investments, does not predict a central bank rate hike and says there is still money in the market “on the sidelines.”
The resulting wealth effect will keep the pace of consumption growth inconsistent with a return to 2% inflation. Since December, core PCE inflation has recovered to his 3.7%, and core CPI has risen even more significantly, increasing by 4.5% annually over the past three months.
If Chairman Powell had refrained from hinting at a rate cut in December and stuck to his “high for a long time” scenario, the economy could have slowed enough to allow for an actual rate cut in the coming months. There is sex. Make no mistake, the Fed will still be under tremendous political pressure to cut rates heading into the November election, but with inflation so high, rate cuts are likely to be taken off the table indefinitely. .
Mr. Powell’s lack of self-discipline has distributive effects. While the top 20% of households have significantly strengthened their asset portfolios due to Powell’s dovish shift, the bottom 50% are struggling.
Not to be outdone, President Joe Biden himself has weighed in on monetary policy multiple times in recent months, telling an audience in Philadelphia earlier this year, “I can’t guarantee it, but I’m sure interest rates will be lower.” That little organization that sets interest rates is bound to collapse.”
With fewer assets and relatively high floating-rate debt, they end up paying costs that are “higher over time.” According to the Philadelphia Fed, the credit card delinquency rate was 3.5%, the highest since tracking began in 2012.
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If the FOMC were to take inflation targeting seriously, it would reverse Powell’s December policy and eliminate the easing bias altogether, signaling that its next action is likely to be a rate hike. Mr. Powell was given ample opportunity in his recent press conference after the May FOMC meeting. For now, he remains reluctant to abandon his moderation bias. But if inflation continues to run well above target and the Fed’s own expectations, he will have no choice but to hold out for a long time.
If only he hadn’t eaten the marshmallow.
Scott Bessent serves as Chief Executive Officer and Chief Investment Officer of Key Square Group LP, a Connecticut-based investment partnership he founded in 2015.
