Weekend Reading: The Fed’s Dilemma

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The Fed’s Dilemma

The confusion at the Fed continues.

On Wednesday, Jerome Powell justified hiking rates 0.25%, while maintaining their projections of two further hikes this year, by painting an upbeat picture of the U.S. economy.

Such may have been the case in January when the Atlanta Fed sent the current Administration into a “tizzy” with a pronouncement of 5.4% economic growth in the 4th quarter, but not at 1.9% currently. Furthermore, as I discussed just recently:

“Since 1992, as shown below, there have only been 5-other times in which retail sales were negative 3-months in a row (which just occurred). Each time, the subsequent impact on the economy, and the stock market, was not good.”

“So, despite record low jobless claims, retail sales remain exceptionally weak. There are two reasons for this which are continually overlooked, or worse simply ignored, by the mainstream media and economists.

The first is that despite the “longest run of employment growth in U.S. history,” those who are finding jobs continues to grow at a substantially slower pace than the growth rate of the population.”

“Secondly, while tax cuts may provide a temporary boost to after-tax incomes, that income boost is simply being absorbed by higher energy, gasoline, health care and borrowing costs. This is why 80% of Americans continue to live paycheck-to-paycheck and have little saved in the bank.”

The Fed’s dilemma is quite simple.

The Fed must continue to “jawbone” the media and Wall Street as economic growth has continued to remain sluggish. As shown, the Fed continues to remain one of the worst economic forecasters on the planet.

While the Fed is currently “hopeful” of a stronger 2018 and 2019, they are likely once again going to be very disappointed. But in the short-term, they have little choice.

Unwittingly, the Fed has now become co-dependent on the markets. If they acknowledge the risk of weaker economic growth, the subsequent market sell-off would dampen consumer confidence and push economic growth rates lower. With economic growth already running at close to 2% currently, there is very little leeway for the Fed to make a policy error at this juncture.

The Federal Reserve has a very difficult challenge ahead of them with very few options. While increasing interest rates may not “initially” impact asset prices or the economy, it is a far different story to suggest that they won’t. In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest-rate hiking campaign that has not eventually led to a negative outcome.

The Fed understands economic cycles do not last forever, and after nine years of a “pull forward expansion,” it is highly likely we are closer to the next recession than not. From the Fed’s perspective, hiking rates now, even if it causes a market decline and/or recession, is likely the “lesser of two evils.”