In the history of the Federal Reserve, the most revered presidents are William McChesney Martin, Paul Volcker and Alan Greenspan. They all gained their reputation through decisive monetary policy action at a time when the stock and bond markets did not want or expect them to act.
William McChesney Martin was blamed for creating recessions in the late 1950s and early 1960s because of his efforts to tighten monetary policy soon, before inflation could take place.
Paul Volcker is widely credited with ending the uncontrolled inflation of the 1970s by pushing the US economy into a double-dip recession.
The Fed has just raised interest rates by 0.75 percentage points and this is being compared to the 1994 rate hike of the same magnitude under Alan Greenspan. But in 1994, the Fed raised interest rates long before investors expected rate hikes or before inflation really became an issue. Not only was the Fed “ahead of the curve,” but it dictated to the market what interest rates they would be.
Meanwhile, the Fed’s darkest period was in the late 1960s and early 1970s, when politicians influenced weak presidents who asked them to cut interest rates to avoid a recession or to react to a supply shock as the oil crisis raising rates.
In my opinion, the Fed under Jerome Powell repeats these mistakes. Recall that until the beginning of January, the Fed advocated a moderate trajectory of rate hikes that would exceed 2% in 2024, while bond markets traded at a much faster rate of up to 2% by the end of 2022. its January policy meeting, the Suddenly, the Fed changed direction and increased its orientation in line with what the markets had set.
In February, Russia invaded Ukraine, a supply shock similar to the 1973 oil crisis and the Iraqi invasion of Kuwait in 1990. In 1973, the Fed panicked and began to raise interest rates. Today we know that this was one of the biggest political mistakes in the history of the Fed and the beginning of the stagflation of the 1970s.
Compare that to 1990 when the Greenspan-led Fed did … nothing. Yes, the price of oil rose 170% from August to November of that year, and inflation had risen to its highest level since the 1970s. However, there are no rate hikes. Investors were panicking about inflation, but the Fed had learned its lesson from the 1970s.
Jerome Powell has done the opposite. Since the Russian invasion, the Fed’s monetary policy stance has become more brutal and has indicated faster rate hikes. At its June meeting, the Fed rose even more aggressively than expected, as markets raged after the surprise inflation data. Its “dot chart” that was used to indicate political expectations now shows that the Fed’s fund rate reaches 3.4% by the end of the year.
The beneficial interpretation of the Fed’s actions is that its economists were only catching up with what the bond market already knew. In my opinion, this beneficial interpretation makes no sense. The Fed has been harassed by the market with increasingly aggressive rate hikes in light of a major supply shock.
I estimate that about two-thirds of current inflation is directly or indirectly due to supply shocks in the energy and food markets that cannot and should not be fought at higher interest rates. Instead, the right political action would be taken by Alan Greenspan in 1990: look at core inflation and demand dynamics, not general inflation.
Clearly, there is a strong labor market and strong demand that justify rate hikes. But to know how much you need to raise rates, you need to know how much of the underlying inflation is due to this demand shock. In addition, we need to focus on core inflation, not general inflation.
A strong Fed could explain this to the public and withstand market pressure to raise rates quickly. Instead, under Powell we have central banks again that let the tail move the dog and outsiders dictate monetary policy.
The result is clear. It’s no longer about whether we’re going into recession, it’s about when. The combined effects of high energy prices and rising tariffs will dampen economic growth and create a recession. By succumbing to market expectations of rapid rate hikes, the Fed will create the same recession as the bearish equity market already predicts.
Joachim Klement is the head of strategy for Liberum, an investment bank. This is adapted from its Klement on Investing Substack newsletter. Follow him on Twitter @JoachimKlement.
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