Is the rate hike pause in play?
That question remains up for debate after the May Federal Reserve Open Market Committee meeting.
But when you break it all down, the underlying economic reality is far more important than the messaging coming from Powell and Company. And the underlying economic reality is that inflation isn’t beat and the economy is heading toward a cliff.
THE RATE HIKE AND BALANCE SHEET REDUCTION
At the May meeting, the Fed raised interest rates by another 25 basis points. That brings the target range for the Fed funds rate to between 5.0% and 5.25%. It was the 10th consecutive rate increase since March 2022.
The official FOMC statement gave some indication that the central bank might be prepared to pause rate hikes. The committee removed language saying that it still “anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” It replaced that with a statement saying, “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
The new language is reminiscent of verbiage in the statement released by the Fed before it paused rate hikes in 2006. Of course, that tightening cycle ultimately led to the subprime mortgage crisis, the 2008 financial crisis, and the Great Recession. It’s interesting to consider that it took nearly two years for the negative impact of those rate hikes to play out in the economy.
The FOMC statement emphasized that “the Committee is strongly committed to returning inflation to its 2 percent objective.”
We’re still a long way from 2%. In fact, core inflation ticked up in March and the GDP data released for the first quarter of 2023 also reveals underlying inflationary pressure.
The FOMC continues to claim that “the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans.”
The problem with this statement is that it hasn’t come anywhere near reducing its balance sheet according to the plan it announced a year ago. In fact, it has never reduced its holdings of mortgage-backed securities by its $35 billion per month target. Even if the central bank met its balance sheet reduction target, it would take more than seven years for it to unwind all of the quantitative easing that it did during the pandemic.
During his post-meeting press conference, Federal Reserve Chairman Jerome Powell tried to downplay a rate hike pause and slammed the door on the possibility of rate cuts this year. He emphasized that the Fed is now in a “data-dependent” mode and insisted that “a decision on a pause was not made today.”
We on the committee have a view that inflation is going to come down—not so quickly, it will take some time. In that world, if that forecast is broadly right, it would not be appropriate to cut rates.”
He also tried to sound a hawkish note, saying, “We are prepared to do more if greater monetary policy restraint is warranted.”
On the other hand, Powell said he thought the current interest rate level is close to being restrictive enough to slay the inflation dragon.
“Policy is tight, you see that in interest-rate sensitive activities and you are beginning to see it more and more in other activities. Once you put the [banking] credit tightening and the [Fed’s] quantitative tightening on top of that, I think we may not be far off, or possibly already, at that level.”
That would seem plausible if the CPI accurately reflected the extent of rising prices. But inflation is worse than the government data suggest. This CPI uses a formula that understates the actual rise in prices. Based on the formula used in the 1970s, CPI is closer to double the official numbers. If the CPI is running close to 12%, a 5% interest rate isn’t nearly tight enough.
It’s important to remember that inflation is an increase in the money supply. Price inflation measured by the CPI is a symptom of monetary inflation. Since 2008, the Fed has created nearly $8 trillion. The central bank can’t ring that amount of liquidity out of the system with 5% interest rates.
But it can burst a lot of bubbles and break a lot of things in an economy dependent on easy money with 5% interest rates.
Nevertheless, Powell continues to insist it is possible to meet the Fed’s inflation target and bring the economy to a “soft landing.” He based this on the initial signs of weakness in the labor market.
There are no promises in this, but it just seems to me that it’s possible that we can continue to have a cooling in the labor market labor market without the big increases in unemployment that have gone with many prior episodes.”
WHAT WILL BREAK NEXT?
As Peter Schiff said in a recent podcast, the Federal Reserve has screwed up everything that is a function of interest rates. Rate hikes have already precipitated a financial crisis that is still in its early stages. Despite Fed’s insistence that “the US banking system is sound and resilient,” government regulators seized control of First Republic Bank over the weekend and sold the majority of the bank’s operations to JP Morgan Chase. It was the third major bank failure this year and the biggest bank to collapse since the 2008 financial crisis. It was the second-largest bank by assets to fail in US history.
If we are to believe the mainstream narrative, the failures of Silicon Valley Bank, Signature Bank and First Republic Bank were isolated events and do not reflect a broader problem in the banking system. But as we have reported, these bank failures are just the tip of the iceberg. A report by the Wall Street Journal cites a study from Stanford and Columbia Universities that found 186 US banks are in distress.
As Schiff pointed out, there are plenty of other things at risk of breaking in this bubble economy, no matter what Powell and the other central bankers are saying today. Ultimately, the Fed is going to reverse course to keep banks from failing, stop the auto industry from imploding, save the housing market, prop up the government, and bail out over-levered corporations.
“Today’s 1/4 point Fed rate hike, basically another price increase, won’t do anything to subdue inflation. Consumer prices still have a long way to rise due to past QE and will rise even further as a result of future QE as the Fed soon responds to a worsening financial crisis,” Schiff said in a tweet.
Today’s 1/4 point #Fed rate hike, basically another price increase, won’t do anything to subdue #inflation. Consumer prices still have a long way to rise due to past QE and will rise even further as a result of future QE as the Fed soon responds to a worsening financial crisis.
— Peter Schiff (@PeterSchiff) May 3, 2023
As far as a “soft landing” goes, that seems as implausible as a big win against inflation. In an interview, Schiff said, “We’d be very lucky to escape with just a recession. I think this is a depression. We’re probably already in it. It’s just going to get worse.”
As just one example of the rot in the economy, the Conference Board Leading Economic Index (LEI) for the US fell by 1.2% in March. It was the 12th straight month of declines in the LEI.
No matter what Powell says, it’s only a matter of time before the Fed has to abandon the pretense of an inflation fight, pivot, and start cutting rates. Even if this tightening cycle brings down CPI in the next few months, it will only be temporary. The moment it is forced to reckon with the damage done by decades of easy money, it will return to easy money like a pig to mud — no matter what the central bankers are telling you today.
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