In Defense of The Fed and of Not Cutting Interest Rates
If you will forgive me, I intend this week to write about something other than energy. Or, at least, not to address energy stocks or commodity prices directly. US interest rates, often considered a somewhat boring, nerdy storyline by many traders and investors, are still one of the biggest factors in determining the prospects for the global, as well as the American, economy. It is, therefore, essential that investors in energy, as just about the most sensitive sector to global conditions, follow the ongoing saga at the Fed.
As I write, on Thursday morning, the Federal Reserve Bank of the US has just announced that there will be no change to interest rates this month. That was the expected outcome of the January meeting, but much more interesting than the lack of a rate change was the fact that two of the rate-setting bodies, the FOMC, dissented, with both declaring that they favored a 25 basis point (0.25%) cut in rates.
That may not seem all that significant given that dissenting votes have been fairly common over the last year or so. However, given that since 1936, only around 5% of votes have been dissents, they are still the exception rather than the rule. The fact that a failure by the FOMC to offer a unified front has become so commonplace recently is a problem, and it is one that should concern all investors, because it threatens the very existence of an institution that has been instrumental in promoting the relative financial stability and rapid growth…
If you will forgive me, I intend this week to write about something other than energy. Or, at least, not to address energy stocks or commodity prices directly. US interest rates, often considered a somewhat boring, nerdy storyline by many traders and investors, are still one of the biggest factors in determining the prospects for the global, as well as the American, economy. It is, therefore, essential that investors in energy, as just about the most sensitive sector to global conditions, follow the ongoing saga at the Fed.
As I write, on Thursday morning, the Federal Reserve Bank of the US has just announced that there will be no change to interest rates this month. That was the expected outcome of the January meeting, but much more interesting than the lack of a rate change was the fact that two of the rate-setting bodies, the FOMC, dissented, with both declaring that they favored a 25 basis point (0.25%) cut in rates.
That may not seem all that significant given that dissenting votes have been fairly common over the last year or so. However, given that since 1936, only around 5% of votes have been dissents, they are still the exception rather than the rule. The fact that a failure by the FOMC to offer a unified front has become so commonplace recently is a problem, and it is one that should concern all investors, because it threatens the very existence of an institution that has been instrumental in promoting the relative financial stability and rapid growth that the US has seen since the end of World War II.
I know, defending the Fed makes one unpopular with some people. Many on the left see it as a group of rich, largely white, mostly men, who are only concerned with making their already rich friends and banking colleagues even richer, rather than with designing policy to forcibly take money from those who might have earned it and redistribute it to the downtrodden masses. Meanwhile, some on the right believe that the central bank’s failure to do exactly what Donald Trump asks is proof that they are part of the “liberal elite” or “deep state”, or whatever is this week’s preferred phrase for those who disagree with anything the President says or does.
Hyperbole aside, the criticism from each side is understandable. There is a huge wealth gap in this country that at some point could well cause major problems, if it hasn’t already, and the FOMC is an unelected body, whereas the President’s agenda was voted on by the people. However, I just can’t shake the feeling that any institution that draws criticism from the ideologically driven left and right is probably doing something right, and the rise of the US to a world-dominating economic superpower under the guidance of an independent central bank over the last 80 years or so supports that contention.
As I said, dissenting voices on the FOMC, while rare historically, are not unheard of, so why are the two such opinions this month of any concern? It is because they come at a critical moment in the Fed’s history, a moment when the independence that has been its hallmark is under threat.
The last few months have seen attempts to bully Fed Chair Jerome Powell into cutting rates through social media posts, announcements, and speeches, an attempt to fire a sitting board member, and the launching of a lawsuit against the central bank that looks to be legally questionable at best. All of this represents a concerted attempt to get Powell, who lest we forget, was appointed by Donald Trump, to fall in line with the President. The Fed Chair, though, seems to be winning the argument at the moment, with the courts deciding that firing a board member is illegal, a ruling that Powell described this morning as “the most significant in the Fed’s 113-year history.”
It is no surprise that the President would like to see interest rates lower. For starters, he is a real estate guy, so his experience tells him that low rates equate to prosperity. In addition, he campaigned on improving the economy, but as this week’s consumer confidence figures show all too clearly, most people don’t feel that their lot has improved over the last year. An interest rate cut that would reduce mortgage payments, make credit card bills and home loans more affordable, and stimulate growth to put upward pressure on wages would be a big help to the administration.
Unfortunately, though, at this point, it would also be a massive mistake. That is in part because of Trump’s own signature policy achievement. The “Big Beautiful Bill” that he got through Congress will mean American taxpayers will receive more and bigger tax refunds over the next few months than they have before. That should provide significant stimulus to the economy. Until the impact of that extra cash in people’s pockets is seen, cutting interest rates risks boosting inflation, which, while lower than its peak, is still stubbornly above the Fed’s target 2% core rate.
Nor will cutting rates necessarily be stimulative to the job market. If, as seems likely, job losses at the lower end of the wage scale are the result of increasing AI-enabled automation, lower interest rates could actually make matters worse. They would make it cheaper for companies that have not yet replaced people with AI programs to do so, causing further job losses. History shows that the improved productivity that comes with that would eventually create more jobs and be a good thing, but for a politician, even short-term job losses can be a big drag on popularity.
As you can probably tell, I come down firmly on the side of Powell and the Fed in this fight. That is not because I am a shill for the far left or the far right, but simply because the evidence and the data indicate that an independent Fed, acting without regard to political considerations, is a good thing for the US economy, and therefore for the world. The two consistent dissenters to FOMC decisions, however, suggest that the Fed is, like many previously “independent” institutions, now politicized. That may or may not be the case, but even the perception of it is potentially extremely damaging to all of our wealth in the long term.