The Flailing Fed

The Fed is flailing.

For the past several years, under the leadership of both Jerome Powell and, before that, Janet Yellen, the Fed claimed it was "data dependent." But the decision last week to reduce short-term rates by 25 basis points tore that narrative to shreds.

At the prior Federal Reserve meeting in mid-June, a slender majority of Fed policymakers projected no rate cuts this year. After that, the data flow on the economy was generally better than expected, including solid reports on jobs, retail sales, manufacturing production, and real GDP. These figures undermined the Fed's forecast that real GDP would grow only 2.1% this year. In addition, both consumer and producer prices rose more than expected. If the Fed were really data dependent then, if anything, these data should have moved it away from a rate cut.

The oddest part of the Fed's decision was Powell acknowledging how little its rate cut means. "(W)e don't hear that from businesses. They don't come in and say we're not investing because...the federal funds rate is too high. I haven't heard that from a business. What you hear is that demand is weak for their products." And yet, the US consumer looks pretty strong. Core retail sales, which exclude volatile items like autos, building materials, and gas, are up 4.4% from a year ago and up 10.6% annualized so far this year.

Powell said at the press conference following the meeting that the Fed wants to "ensure against downside risks to the outlook from weak global growth and trade tensions." Yes, Europe and China have experienced slower growth. But some of the slower growth abroad, particularly in China, is a result of changes in trade policy so that the US no longer subsidizes China by turning a blind eye to that country's piracy of intellectual property. And slower growth in Europe is largely a function of structural issues that US monetary policy can't solve: too much redistribution, too much regulation, too much socialism. Moreover, it's not clear that slower growth overseas is a negative for the US; some of the slower growth abroad is because tax cuts and deregulation have made the US a better place to do business.

Another possibility is that the Fed is very concerned about the inverted yield curve, but is too scared to say it. Maybe the Fed thinks very low long-term rates are, in part, a function of weak expectations of future growth (regardless of today's solid growth) and that if short-term rates stay above long-term rates, then eventually businesses and consumers will have an incentive to postpone economic activity because short-term rates will eventually move lower, as well.