The Fed fumbles

Credibility concerns re-emerge, as will inflationary pressures

The Fed made a policy error this week.  No cut was actually needed, but it has been clear since the start of this cycle that the FOMC were only grudgingly tightening policy out of embarrassment at the worst inflation miss in more than a generation and would seize the first chance that the data might excuse to ease.  Still, despite the concerns I raised about their credibility at the start of the year, I was surprised that they cut by 50bp, so quickly abandoning the prudence they’d shown in delaying easing by three quarters after their errant rhetorical pivot in December.

In the press conference, Chairman Powell, demonstrating his lack of personal framework, blamed the need for more aggressive action on softening Beige Book readings while calling the economy sound, employment growth robust and admitting that inflation still has the capacity to threaten.  Yet he pushed the 50bp cut through a Committee that the Summary of Economic Projections (SEP) shows is increasingly bifurcated between slaves to models thoroughly discredited by the economy and a breakaway group that, though still underestimating r* (the neutral real interest rate), at least understands the models are inconsistent with observed reality.

The path forward – with widening risks – will be determined by the answers to three questions: (1) Is inflation yet fully contained?  (2) How restrictive are policy rates?  And, (3) How firm is the Fed’s commitment to its inflation target, both now and post election?