The Federal Reserve concluded its July meeting and elected to keep the fed funds rate unchanged. Wall Street had a meaningful probability on a small rate hike (around 33%). While I understood the logic, and would have voted to hike had I been in the room, I was on record saying I thought they’d hold. I cited uncertainty about the war in Iran and the subsequent effect on energy prices. The logic for a hike is continued high inflation even when backing out energy prices combined with a continued strong labor market. I agree with this logic. The reason I thought the Fed would hold is high energy prices contain their own solution as usage declines with higher prices. As many have pointed out in recent days, you can’t print more oil. In addition, the issue right now isn’t just the Strait of Hormuz; but rather, limited refining capacity leading to high crack spreads. A change in interest rates won’t affect that.
There were three dissents from Fed Governors who wanted a 25bp (.25%) increase in the fed funds rate. In the past year, there has been concern in the press about the growing number of dissents to Fed meetings which typically “feature” unanimous votes. I view the dissents as healthy and welcome. If everyone has the same opinion on everything all the time, then why do we need an Open Market Committee? The whole point of having voting members from all over the country is to get differing points of view. There should be disagreements and competing priorities. This was something Warsh addressed in a positive manner in his press conference. (In fairness, I believe the Fed shouldn’t exist at all, but if we’re going to have one, then there should be competing ideas.)
The market may be uneasy with the more hawkish Fed, a particular surprise as new Chairman Warsh was portrayed in the media as a lapdog of President Trump who wants much lower borrowing rates. I reiterate that I don’t think the Fed has control of the situation. Inflation is properly understood as an expansion of the money supply. This is being driven by debt-fueled Congressional overspending which will continue regardless of the party in power. The current easing cycle has lasted almost two years and in that time the yield on the 5 Year Treasury which influences corporate borrowing rates and the yield on the 10 Year Treasury which influences mortgage rates has risen. The reason for that is the bond market is pricing in higher long-term inflation expectations. A lower fed funds rate isn’t helping bring down borrowing rates and won’t until Congress stops overspending. That’s not going to happen so prepare your portfolio and household for continued inflation.
Finally, many of the people I follow on X (formerly Twitter) complained that Chairman Warsh spent his entire press conference saying little of substance. I agree with them, however, it doesn’t’ matter what Warsh says on the podium. The on-balance sheet debt of the US government is now $40 trillion dollars. Add in off-balance sheet liabilities of around $200 trillion and the total liabilities of the federal government is around a quarter of a quadrillion dollars. The Chairman can say he’s dedicated to reducing inflation, but it’s a mathematical certainty that those liabilities will be repaid in dollars with much less purchasing power. It’s either that or an Argentina-style default.
I’ll also add that a functioning healthy market shouldn’t rely on the words of Central Bankers in order to have investment opinions. The fact that the Fed matters as much as it does is an indication of a problem. You all know the line: #EndTheFed and let the bond market set interest rates.
As always, I’m reachable at IR@DeepKnowledgeInvesting.com.
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