Here’s When the Fed Cuts Rates

The minutes from the Fed’s December FOMC meeting were released today. They revealed that the Fed believed rate hikes were no longer likely, but that it wouldn’t be lowering rates in the near term.

The December minutes revealed that the Fed’s target rate is “likely at or near its peak for this tightening cycle.”

Fed officials also “judged that the current stance of monetary policy was restrictive and appeared to be restraining economic activity and inflation,” but added that it was “appropriate for policy to remain at a restrictive stance for some time until inflation was clearly moving down sustainably toward the Committee’s objective.”

But the minutes also revealed that the Fed expects to cut rates by the end of the year:

Almost all participants indicated that… a lower target range for the federal funds rate would be appropriate by the end of 2024.

So is inflation dead? The Fed and markets may think so but the data says otherwise.

Even modest inflation (by recent standards) can destroy wealth and surprise investors with its impact. Let’s take a deep dive at what’s actually going on.

We’ll begin with the data and a bit of inflation math. Inflation (annualized) peaked at 9.1% in June 2022. As late as January 2023, it was still 6.4%. By September 2023, it had come down considerably but was still 3.7%. The most recent data shows inflation was 3.1% in November 2023.

Wall Street and the Fed view that as a major accomplishment. Here’s the problem.

From March 2009 to December 2019, a period of over 10 years comprising most of the recovery after the global financial crisis, inflation rarely hit 2.0% and was typically around 1.6% or less.

In 2009, inflation was minus 0.4% (actual deflation). Full-year inflation for 2010 was 1.6%. Even in 2016, five years into the recovery, inflation was only 1.3%. As recently as 2020, inflation was 1.2%.

The current rate of inflation is almost triple that 2020 rate.

How damaging is 3.1% inflation? That rate will cut the value of the dollar in half in 22 years. It’ll cut the value of the dollar in half again in another 22 years.

Put differently, if you start your career at the age of 21 and retire at 65, the dollar you earned at age 21 will only be worth 25 cents by the time you retire. That’s 75% wealth confiscation by government-caused inflation.

There’s nothing benign or comfortable about 75% wealth confiscation. But that’s where we are today.

It’s interesting that everyday Americans understand inflation perfectly, but the egghead economists and policymakers don’t. That may be because inflation is one of the biggest concerns of those who live in the real world, and it may lead to a political earthquake next November in the presidential and congressional elections.

Here’s the reality and here’s the political narrative: Reality is that prices have been going up at the fastest rate in 40 years and they are still going up. It’s true that the rate of inflation is coming down, but prices are still going up.

They’re going up at a slower rate but they’re still going up.

Not only that, but past price increases are locked in so new price increases are applied to a higher base. This is killing American consumers.

The average price of a pound of ground beef in the U.S. was $5.11 in September 2023. In October 2023, the price of a pound of ground beef was $5.23.

That’s a 2.3% increase on a month-over-month basis, which annualizes to over 25% on an annualized basis. That’s the kind of inflation that real Americans confront every day.

Below, I show you how the Fed is attempting to walk a tightrope, balancing between inflation and recession. Can it pull it off? Read on.

The Fed’s Walking a Tightrope

By Jim Rickards

The economists prefer measures of inflation that exclude energy and food prices, what they call “core” inflation. Some eggheads use measures that exclude food, energy and housing costs. They call that “super-core” inflation. Those measures are academic constructs and bear no relationship to the real world. Try living without gas in your car, food on the table or a place to live.

The ignorance of politicians gets worse when we see Joe Biden come out and say “prices are going down,” and retailers should lower their prices and avoid “price gouging.” Biden might not be mentally competent to realize it, but he’s confusing lower rates of inflation (which are still price increases) with lower prices (which are not happening).

Using propaganda to lie to the American people can work in the short run. But inflation is not one of those areas where propaganda works. The American people know what things cost, they know prices are going up, and no amount of White House lies can change that. The day of reckoning will probably come at that ballot box this November. That’s when the construct of lies about inflation will come tumbling down.

What does the Federal Reserve say about current rates of inflation? The December minutes that came out today provide insight. The Fed thinks the rate hike cycle is probably over, but doesn’t expect to actually lower rates until the end of the year.

Powell is attempting a balancing act. On the one hand, inflation remains too high, despite progress on that front. On the other hand, if Powell holds them too high for too long, the inflation could turn to rapid disinflation or even deflation accompanied by a recession.

Powell understands the dilemma, but he doesn’t know which way to turn. His solution is to do nothing and wait for more data.

That said, the Fed is currently more dovish than hawkish. Nothing is set in stone (the Fed still holds out the possibility of additional rate hikes), but the tilt toward easing instead of more tightening is unmistakable.

Again, Powell’s trying to walk a tightrope. While inflation may still be too high, interest rates may be high enough to combat inflation without further rate hikes. That’s the definition of the “terminal rate” and that’s where Jay Powell believes the Fed is right now.

At the end of December’s FOMC meeting, Powell said rates are “likely at or near the peak rate for this cycle,” and “the full effects of our tightening likely have not been felt.”

That’s another way of saying we’re at the terminal rate. As if to hammer the point home, Powell said, a rate hike “is not the base case anymore as it was several months ago.” The December minutes reinforce that position.

Powell left a few markers that rate hikes might still be needed if the economy does not play out as expected. He said, “We still have a ways to go. No one is declaring victory. That would be premature.”

He added, “Wages are running higher than what would be consistent with our policy goal.” That’s a sign that demand-driven inflation could be on the horizon in place of supply side inflation, which is waning.

To keep his options open, Powell went on to say, “We will need to see further evidence that inflation is moving steadily toward our goals,” and “We are prepared to tighten policy further if appropriate.”

The December minutes do nothing to change that perspective.

One of Powell’s more intriguing comments was that the Fed would cut rates before inflation hits the 2.0% target. The idea is that if inflation falls from 3.2% to, say, 2.5%, the Fed might cut rates at that stage.

The view is that with inflation falling quickly, it could overshoot the 2.0% target and end up at 1.0% or lower. That’s a reason to cut rates when inflation is still 2.5% and then watch inflation glide smoothly to the 2.0% target.

All of this gives the Fed too much credit for finesse. They’re not as nimble as this analysis makes them sound. But the remarks (and the minutes) do give insight into their thinking, which will help with forecasting in the future.

Powell also wrestled with an arcane point raised by a reporter after the December meeting. If inflation falls faster than nominal rates, that means real rates are going up. The real rate is simply the nominal rate minus inflation.

If nominal rates are stuck at 5.5% and inflation drops from 3.2% to 2.5%, then the real rate went up from 2.3% to 3.0%. That’s a different form of tightening but one which could cause the Fed to cut rates quickly if inflation falls quickly.

Powell also reminded reporters that “We’re not talking about altering the pace of QT right now.” QT is quantitative tightening, another form of monetary tightening. So even without interest rate hikes, the Fed is still running a tight money policy.

Powell took a nod in the direction of a recession when he said, “Maybe people bought so much stuff that they temporarily don’t want any more stuff.” That’s a reference to a recent slowdown in consumer spending.

Markets loved the dovish tilt despite the nuance about real rates and recession. On the date of the Fed meeting, stock indexes rose about 1.4% to new all-time highs. Gold rallied 2.5% to $2,045 per ounce. The yield on the 10-year Treasury note plunged from 4.2% to 3.9%, producing huge capital gains in Treasury notes. Even oil futures rose to $74.50 per barrel up from $69.00 earlier in the day.

On the whole, the December meeting was important considering that the Fed didn’t actually do anything. The tilt away from hawkishness toward dovishness, confirmed by the minutes, was critical. It triggered rallies in stocks, bonds and gold, what some traders call an “everything rally.”

The bottom line is inflation is still too high. But the Fed believes that rates are high enough to cause inflation to come down on its own without further rate hikes.

If they’re wrong, inflation may come roaring back. If they’re right, inflation may indeed fall to acceptable levels but for the worst possible reason. In that world, inflation will come down because we’re in a severe recession.

So those are the choices for investor allocations. Either inflation that destroys wealth or disinflation due to recession that destroys wealth in another way.

The only solution is a balanced portfolio of cash, gold, silver, Treasury notes and selected stocks in the energy, agricultural, defense and certain other sectors.

That kind of diversification will see you through.