The Fed shouldn't abandon the inflation fight
A Fed rate cut won't ameliorate the Trump uncertainty factor creating a sluggish labor market.
A sluggish labor market is presumed to cinch the case for the Fed to lower its interest rate, perhaps aggressively. However, what would seem a highly pertinent question isn’t being asked: What would a Fed rate cut do to ameliorate the conditions that are causing the labor market to stagnate? The answer would appear to be: not much, if anything.
Meanwhile, we are in the fifth year of inflation running above the Fed target of 2%. I’m in a small minority who think that the target should actually be 0%, as stable a currency as can be maintained. It is not completely a kook minority. Among its ranks was Paul Volcker.
While peak inflation has been reduced, the inflation rate seems stuck in a 2.5% to 3% range. That remains a disruptive level, economically and politically. So, the Fed appears poised to partially abandon the effort to bring inflation at least within its target in a futile effort to improve the labor market.
The stagnant labor market results primarily from a high level of uncertainty flowing from the chaos that is the second Trump administration. Erratic, arbitrary, and ever-changing tariffs. Demands that companies give up ownership, revenues, or control to gain government approvals.
Ironically, inflation and the Trump attacks on the independence of the Fed are also part of the uncertainty. What tomorrow’s dollar will be worth is an important factor in making investment and hiring decisions today.
So, let’s assume that the Fed lowers its rate from the current 4.25% to something below 4%, even to 3.5%, the most aggressive reduction being mooted. What will that do to remove the uncertainty stagnating the labor market?
Companies will still be in the dark regarding the effect of tariffs on their supply lines or whether they will be next in line for a demand for a slice of the action for necessary government approvals. They will be even more in the dark about the future value of the dollar.
Moreover, there is reason for some skepticism about the extent to which the sluggish labor market is an imminent threat demanding immediate Fed action, assuming there was something the Fed could do about it. The alarming job creation figures come from a survey of employers with inconsistent responses and large corrections over time. The unemployment rate comes from a more steady household survey. The current unemployment rate of 4.3% is very low by historical standards. So, the labor market appears to be stagnating, not collapsing.
Current interest rates aren’t high by historical standards. They appear so because we just emerged from two decades of artificially low interest rates.
Current interest rates are having a constraining effect on the housing market. However, elsewhere, companies that want to borrow are generally able to do so. Several big companies recently completed large bond sales.
If a reduction in the Fed rate led to lower borrowing costs for companies, it might, on the margin, induce investment and hiring that might not otherwise take place. However, if a company is holding back due to uncertainty about supply costs and other factors, lowering borrowing costs doesn’t change the investment and hiring calculation materially.
And there is doubt that a lower Fed rate, in this environment, will cascade into lower commercial rates generally. Lately, mortgage rates and rates on long-term Treasury debt have moved independently of the Fed rate.
Persistent inflation is the result of excessive fiscal and monetary stimulus. Under Donald Trump and a Republican Congress, the excessive fiscal stimulus continues. Under the reconciliation bill, the annual deficit would hover just below 6% of GDP indefinitely.
The Fed has done somewhat better unwinding excessive monetary stimulus, but still far from enough. It increased its interest rate, but only to what was the historical norm, not to what would be a truly inflation-fighting level. And it was slow to do even that.
Prior to the housing market meltdown in 2008, the Fed’s balance sheet – consisting primarily of Treasury debt and mortgage-backed securities – was less than a trillion dollars. By 2022, it had ballooned to nearly $9 trillion, an unprecedented stretch of quantitative easing and monetary stimulus. It is now down to $6.6 trillion, still a remarkable Fed presence in the debt markets. And there is no identified end point for the Fed’s balance sheet or a timeline to get there.
The current Fed interest rate and balance sheet aren’t really restrictive or what you’d expect from a committed effort to get inflation back into the box. The interest rate is at the historical norm. The balance sheet remains unprecedentedly high. If anything, current Fed policy is still mildly stimulative.
The Fed can’t fix what’s ailing the labor market. Only Trump can provide the certainty that’s missing.
The Fed could, if it had the will, put inflation back in the box. Why abandon what you can do for what you cannot?
Reach Robb at robtrobb@gmail.com.