Nothing to stop the Fed from cutting rates
In economic news, the Federal Reserve began its two-day meeting on Tuesday. The economy continues to grow faster than expectedThis was buoyed by an unexpectedly strong consumer spending report and a strong increase in industrial production.
The Fed Industrial Production GDP rose 0.8% in August, much stronger than expectations for a modest 0.1 percentage point increase, driven by gains in the cyclical parts of the monthly industrial production report, with manufacturing growing 0.9% and mining (which includes oil and gas drilling) growing 0.8%.
Retail sales Retail sales also fared well, rising 0.1%. Excluding autos and gasoline, sales rose 0.2%. Compared to the first eight months of last year, sales rose 2.9% overall and core sales rose 3.7%. The long-awaited collapse of the American consumer has not yet arrived.
Following this morning's news, Goldman Sachs raised its third-quarter GDP growth forecast to 2.8%.The Atlanta Fed's GDPNow model just adjusted its forecast from 2.5% to 3%.
You would think Champagne will be flowing at Federal Reserve HeadquartersRemember, the Fed thinks the economy's long-term potential growth rate is just 1.8%, and its most recent forecasts call for growth at a median rate of 2% this year — that is, growth is more than 50% faster than potential and about 0.5% higher than Fed officials expected.
This has all the ingredients for a soft landing, if only the Fed would refrain from acting too hastily with monetary easing. But instead, officials are preparing for their next move: what they do best. They cut interest rates at exactly the wrong time..
Tomorrow, the Fed will conclude its September meeting. Interest rate cuts of up to 50 basis points expectedYes, a half percentage point cut. The economy is growing at nearly 3% and unemployment is at an all-time low. This is the kind of thing the Fed is good at: pre-emptively striking when there is no visible recession, but only a vague inkling that one is looming. To be fair, it's a game the Fed has played before, often with short-term success but long-term regret.
Strong growth, low unemployment, and uncertainty over inflation have not prevented the Fed from cutting rates in the past. Spoiler alert: Inflation or asset bubbles He always seems to find a way to ruin the party.
1965: Preemptive rate cuts pave the way for inflation
In 1965, the US economy was booming. GDP was growing at a staggering 6.5% and unemployment was below 4.5% – a textbook example of full employment. Inflation was benign at 1.6%, perfect for the Fed to do nothing. But central bankers hate sitting back when it's time to step in, so they The Federal Reserve preemptively cut interest rates to get the economy back on track..
And it worked, at least for a while. The stock market responded enthusiastically, with the S&P 500 rising 9.1 percent in 1965. But by 1966 the real story began to unfold: Inflation had risen to 3 percent, and the market, no longer content with the Fed's hand, fell more than 13 percent. By 1967, Inflation strengthened further, reaching 4.2%.Then the Fed belatedly realized this and started raising interest rates to calm things down.
Cutting interest rates when GDP growth is above 6% and unemployment is below 4.5% has proven to be the perfect way to add fuel to the inflationary fire.The Fed Should Have Learned From Hard LessonsBut as we will see, it is not clear that the Fed has learned anything.
1967: Deja vu again
If the precautionary cuts of 1965 had not served as a lesson, 1967 was the year the Fed doubled down on policyThe economy was still going strong, with unemployment at a low 3.8% and GDP running at 2.7%. But inflation had already risen to 3% by the time the Fed decided to cut rates again. Why? To ensure growth, of course. Who cares about a little inflation when growth is in jeopardy?
The stock market saw its usual celebratory rally, with the S&P 500 rising by more than 20% in 1967. But the rally was short-lived. By the end of 1968, inflation had soared to 4.7%, forcing the Fed to raise interest rates and tighten credit to contain price increases. By 1969, inflation had reached 5.4%, GDP growth had slowed, and The stock market fell 11.4%It's a stark reminder of the costs of stoking inflation.
once again, The Fed's good intentions paved the way for inflationary hell.
1998: Crisis averted, bubble emerges
Fast forward to 1998 and the US economy was in a similar situation to today: strong growth, low unemployment, and a central bank that felt the need to act. GDP was growing at 4.6% per year, unemployment was low at 4.2%, and inflation was benign at 1.6%. Nevertheless, the Fed tried to save the day by cutting interest rates three times in the latter half of 1998 to ease market fears about the Russian debt crisis and the US financial crisis. The collapse of Long-Term Capital Management.
The market cheered: The S&P 500 soared nearly 30% in 1998 and rose another 19.5% in 1999. For a while, it looked like the Fed had succeeded in pumping up the stock market, which is its specialty. But inflation, which had always been lurking in the shadows, began to creep up. By the end of 1999, inflation had reached 2.7%, and by early 2000 it had risen to 3.4%. But inflation wasn't the real problem.It was the tech bubble.By mid-2000, the bubble had burst, and things only got worse as the market fell 10 percent by the end of the year.
So the Fed may have saved the markets in 1998, but at the same time, The 2000 Tech Collapse.
2024: Another round of precautionary cuts?
Fast forward to today, and the Fed appears poised to repeat its biggest mistake yet. Inflation remains well above the Fed's 2% target, hitting 2.5% in August. Core inflation is at 3.2%. Central CPI, It has been fluctuating between 4.2 and 4.3 percent year-over-year for four months, according to calculations by the Federal Reserve Bank of Cleveland. The three-month annualized average is about 3.1 percent. This is one of the best indicators of underlying inflation, and the message is clear: Inflation is stagnating at elevated levels.
Despite strong growth and persistent underlying inflation, the Fed has made it clear that it plans to begin a rate-cutting cycle.
of course, Markets rejoice when the Fed cuts interest ratesand perhaps the S&P 500 will rebound again, especially if the Fed delivers the 50 basis point rate cut the market craves. But history shows that it's only a matter of time before inflation kicks in and the Fed is forced to slam on the brakes. The problem with preemptive rate cuts is that they rarely happen without consequences, which typically manifest in the form of a spectacular collapse of inflation and market bubbles.
The Fed's eternal dance with inflation
In 1965, 1967, and 1998, the Fed decided to cut interest rates even when the economy was growing and unemployment was low. It boosted markets in the short term, but created inflationary headaches in the long term.Inflation doesn't go away just because the Fed says so — it rises quietly and almost imperceptibly until it can no longer be ignored — and by the time the Fed finally acts, the damage has already been done and markets must brace themselves for the inevitable rate hikes that will follow.
As the Federal Reserve prepares to cut interest rates again, it's worth remembering that rate cuts are never free, even if they seem like an easy fix. The fun continuesBut the rewards rarely come later.
So, enjoy the rally tomorrow, but make sure you have an exit plan in place before your bills come due.
