Co-Heads of Investments Jeff Klingelhofer and Ben Kirby look at what it will take for the Fed to consider cutting interest rates.
Can the Fed Bring Prices Down to Its 2% Target?
I think it’s unlikely that the Federal Reserve official fully changes their inflation target, either higher or lower, although, of course, the talk with you about raising it from 2% to maybe 3%, I think the likelihood of achieving 2% over the near term is relatively low.
And it goes back to the incredible resilience of the consumer and the strength of the underlying labor market. So, to me, I would think about the Fed’s reaction function to me is fundamentally shifted and they’ve told us as such, actually. Right? So, the Federal Reserve used to be a very proactive central bank, right. To mandates, price stability and maximum employment.
And the second they saw unemployment below their trend level, what they call nearer the non-accelerating inflation rate of unemployment, they began to fear that that strong labor market would translate into excess demand and therefore higher prices. Another way of tamping that down was by proactively raising rates, squashing demand. And what the Fed got from that was never actually achieving its 2% inflation objective. Right? They systematically undershot their 2% inflation objective for a very long period of time. Now, the Federal Reserve told us that, one, they’ve a symmetric target and that they’re willing to systematically overshoot their inflation objective as a makeup strategy. Two, they said that we’re no longer going to be a proactive central bank. We’re going to be a reactive central bank.
So only when inflation is above 2%, we think it’s going to stay there. That’s when we’ll start talking about normalizing interest rates. I think the exact same thing happens on the opposite side. So, they don’t begin to cut rates until inflation is below 2% and they think it’s going to stay there, which I don’t think is going to happen because of the strength of the labor market.
I think the last thing I would say is the Federal Reserve, in my estimation, my belief is willing to tolerate above trend inflation so long as it comes from good inflation, primarily good inflation being low wage income earners, exerting force on the labor market and then therefore that supporting the level of prices.
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