Last month, the Federal Reserve raised the fed funds rate by 75 basis points (.75%) which was the largest rate increase in nearly three decades. Today, they did it again and raised another 75 basis points. The market was already up on Google and Microsoft results that while below estimates, weren’t as bad as feared. (In fairness, there were some positives in certain business lines at both companies.) Once the Fed announcement came out at 2pm, the market rose more, and when Fed Chairman, Jerome Powell, spoke at 2:30, it rose even more. Even though the “leaked” guidance was for 75bp, clearly, the market was relieved we didn’t get a full 1% hike. In addition, people seemed to put a lot of emphasis on Powell’s comment that they’d evaluate inflation and other economic data to determine when to slow the pace of the rate hikes. A few notes on the whole situation:
– We think the market is putting too much emphasis on Powell’s data-driven comment. Of course the Fed will consider the effect of rate hikes on inflation and the economy. Considering that exact issue is about 90% of the job of the Federal Reserve. We also think there’s a bit of sentiment in the market that the harder and faster the Fed raises rates, the sooner we can get back to rate decreases and more fun quantitative easing. It feels like “let’s hurry up and get over the hangover so we can restart the party”.
– Powell’s comments made it explicitly clear that fighting inflation is still his top priority. He noted that inflation is hardest on lower-income people who spend most of their money on food and shelter. He’s also aware that the Fed responded to inflation late, and he’s worried that if they don’t fix the problem, inflation will become endemic and much more difficult to fix later. He can survive the US going into recession, but if he can’t lower inflation and the problem gets worse, history will judge him harshly.
– Despite back to back biggest-in-decades rate hikes, the fed funds rate is still only 2.25%. With official inflation at 9.1%, real interest rates (interest less inflation) is negative 6.8%. We think the actual rate of inflation is in the mid-teens which would make actual real interest rates negative 13% – 14%. In addition to that, the Fed balance sheet is still at $9 trillion (trillion!) dollars. I don’t know why the market thinks this is the all-clear signal, but with inflation at 40 year highs, real rates at record negative levels, and the largest Fed balance sheet in history, there’s still a lot of uncomfortable adjustments that need to be made.
– Powell also mentioned that he doesn’t think the US is in a recession, that he sees many pockets of strength in the US economy, and that he’s focused on the low unemployment rate. The market seemed to like these comments as well. We note that ALL of those things are reasons the Fed can/will keep raising interest rates.
– Tomorrow, we get the 2Q GDP number. If it’s negative, then the US is “officially” in a recession. The White House, political pundits, and the media can try to spin this any way they want, but the definition of recession is two straight quarters of negative GDP growth. Please note that like the CPI, GDP isn’t an actual number; but rather, a statistic manufactured by a government agency to advance a narrative. Government spending counts towards GDP so a Congress or White House that wants to avoid the dreaded “R” word, can spend more. At Deep Knowledge Investing, we also adjust the “official” number for inventory restocking and under-counting of inflation because both can raise GDP, but neither actually contributes to economic growth. By our numbers, 4Q ’21 and 1Q ’22 were both negative so we think we’ve already hit recession.
– If the official GDP number tomorrow is slightly positive, there are a lot of people in Washington DC who will be happy that they don’t get tagged with the “recession stigma”. But if the US isn’t in recession, then Powell has a lot more rope to keep raising rates.
– We’ve pointed this out before, but US on-balance sheet debt is well over 100% of GDP. With debt at that level, the Fed can’t raise rates the way Paul Volker did in the late 70s/early 80s. We simply can’t afford the interest payments so Powell needs to get inflation under control fast. The Fed has painted itself into a corner and won’t have any good options if it can’t lower inflation quickly and without raising rates too much. They could sell the $9 trillion of assets on the Fed. balance sheet, but doing that would dry up liquidity and crash the market. Given that almost everyone’s IRA and 401K has no short positions in it, that would be a huge problem. (And no – shifting out of owning stock to owning bonds won’t save you in that specific disaster scenario. The Fed selling $9 trillion of bonds will crush fixed income too.)
– Certain politicians in Washington DC have been castigating Chairman Powell for raising rates and potentially causing a recession (even as they deny it’s a recession). While the Fed should shoulder plenty of blame for the current economic pain the US is experiencing, let’s take an honest look at the situation. People can keep saying “Putin price hike” as much as they want, but inflation was at multi-decade highs and rising fast before Russia invaded Ukraine. Over the last couple of years, the US printed trillions of dollars, and started frantically delivering them to individuals and businesses while preventing people from working. More dollars chasing fewer goods is what led to insanely high levels of inflation. We have (justifiably) criticized the Fed for printing trillions of dollars and debasing the currency, but it was Congress that authorized and spent the money. It’s Congress that has the “power of the purse”. It’s Congress that has been running multi-trillion dollar deficits for well over a decade no matter which party was in charge. The Fed is simply creating the dollars necessary to cover Congress’ insane overspending. At least the Fed is starting to get serious about addressing the problem. No member of Congress should complain that the Fed is raising rates right now. That’s the equivalent of robbing a bank, and complaining that your getaway driver is breaking the law by speeding.
Be sure to check in tomorrow or Friday. There’s probably something interesting in the GDP print…