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Has the FED Gone Too Far?

December 19, 2022

The Federal Reserve is raising short term interest rates at a furious pace – faster than they have done in decades in an effort to stave off inflation. The discount rate – or the rate that commercial banks pay for overnight funding is currently 4.5%. This is the rate that sat at basically zero for most of a decade after the “Great Recession” of 2008 and returned to basically zero after the Covid meltdown in the spring of 2020.  So this is quite an aggressive hike in rates and last week the Fed intimated that there may be more hikes coming in the new year. Don’t forget that the Fed has also backed off its blizzard of asset purchases in the bond markets. As of February of 2022 the Fed was still buying $80 Billion per month of treasury bonds and $40 Billion per month of mortgage backed securities. The removal of that support plus the rapid increase in interest rates is an All-Hands-On-Deck sort of fight against the very inflation that Fed policies caused. That makes us wonder if the Fed confused its “dual-mandate” as being both the arsonist and the fireman of inflation...

Analyzing the question of whether or not the Fed is going too far by stomping on the brakes rather than tapping them is obviously not an exact science. The financial markets are so dependent on the actions – and even verbiage of comments – of the Fed that it is disheartening. No one entity should have so much influence on the capital markets of the largest economy in the world – and then by extension the entire world’s economy. But we don’t have a choice in the matter so let’s play the hand we were dealt by our overlords… Economic numbers can certainly be lagging indicators of the financial world’s reaction to what the Fed is doing. Obviously, someone has to compile the numbers from things that have already happened, package those numbers up and publish/distribute those numbers. Historically, the employment numbers have been chronic lagging indicators as businesses are not always making knee jerk hiring/firing decisions so what the Fed does may take a while to bake into the cake. We mentioned in previous posts how there are some wildly bearish indicators (Chicago PMI and residential home starts as examples) but those are just data points within a complex matrix of economic activity. Of course, an inverted yield curve is another recession warning – but other economic indicators are also starting to take shape that make us think this highly anticipated recession may actually be coming. Notably employment data is starting to turn south and considering how much of a lagging indicator that is, the situation becomes troubling. As much as employment lags, it is probably reacting to a couple of “Fed hikes” ago when interest rates were lower. The Philadelphia Fed is now indicating that its SECOND QUARTER employment figure was overstated by possibly 1 million jobs! That could be a big problem and many employers have been announcing layoffs – notably Goldman Sachs and Cisco indicated thousands of employees will be let go. Another developing situation is a potential meltdown in the US car-financing world which could easily domino into a “hard landing” economic situation that the Fed assured us it would avoid – stay tuned on this one…

An old-school indicator of economic activity – the price of crude oil is showing a fairly negative outlook. Let’s take a look…

WTI Crude Oil

The Ukraine/Russia conflict is still raging and government suppression of crude oil production continues, yet the price of crude oil is back to pre-invasion of Ukraine prices. On one hand, one might cheer lower prices of energy, but when you look at historical correlation data it is a negative economic indicator. Overgeneralizing, higher crude oil prices generally mean that the economy is humming along. At a time that one would be expecting higher crude oil prices the weakness may be indicative of an economy that is already buckling under the pressure of the Fed raising interest rates. The silver lining of this perspective is threefold as we see it. First and foremost, lower crude oil prices permeate the entire economy and should bring inflation numbers down over time (even though the Fed removes energy from the core CPI.) Secondly, a lot of negativity is still baked into the analysis of the economic world so a lot of selling of assets has already happened and many are hanging on to cash in the meantime. People are euphoric and not cautious when things are peaking, so one might expect that surprises may be to the upside. Finally, the Fed won’t be meeting again until February and the time lag may allow for the Fed to rethink its aggressive stance. The early indicators of retail spending for the holidays are not robust at all and if that spills over into the new year, the Fed may possibly rethink things in front of the February meeting. Our fear at this point is that the Fed has tightened too much – and their track record shows no indication that they will get it right. Wall Street is disappointed over the lack of a Santa Clause rally in asset prices, but things are not falling apart. Maybe things will look up in the new year! Until then Merry Christmas, Happy Holidays and New Year and we will see you in January!

Regards and good investing,

Greyson Geiler