By the Fiendbear

The Curmudgeon and Victor were unable to work on a commentary this weekend, but they may be able to make a mid-week update before the Fed meets on Tuesday and Wednesday.

Perhaps the Toughest Spot for the Fed Since Volcker was in Charge

The consensus seems to be that the Fed will raise rates by 50 basis points this week. There are some calls for a 75-basis point hike but given the recent negative GDP report this seems unlikely. I could almost see that given the recent weaker than expected economic reports the Fed is probably loath to go 50 bps, but they probably don’t have a choice if they want to maintain any kind of credibility.

I’m sure they wish they could just do another 25 bps and I suppose there is always that chance, but they have backed themselves into a corner by insisting that the economy is strong and can take strong rate hikes in May and June. The Fed was grossly wrong about inflation being only transitory and I’m guessing they will be equally wrong about the economy being strong enough to take rate hikes that still leave rates well below the reported inflation rate.

I’m thinking the Fed secretly probably knows they will push the economy into recession (if we aren’t already there) and feel that it would be mild and that they would have the tools to turn it around when needed. The whole fiasco of the 2020 Covid response has likely given the Fed the believe that they can do no wrong. The fact that their response of providing unprecedented liquidity causing an unprecedented bubble is lost on them.

Stocks dropping 20 or even 30 percent wouldn’t worry them and if it takes the edge of inflation, it could give them room to turn on the spigots again. The only problem with this thinking is if inflation continues (I don’t see why it won’t) it puts them in the position to either hike rates as the economy falters or to push rates to zero again (or lower) and fire up QE without even make much of an effort to drawdown their $9 trillion balance sheet.

I haven’t watched the markets as long as the Curmudgeon or Victor but I’m unfamiliar with the Fed being in a tougher spot where they could literally make the wrong policy decision no matter what they do. Even so, I saw a Bloomberg survey where nearly 70% saw the Fed somehow achieving a soft landing. The believe in the Fed remains but I suspect it will be challenged in the weeks and months ahead.

The only prediction I will hazard is that I don’t think the Fed will get much past a Fed funds rate of 1.5% (maybe a total hike of 1 to 1.25% in May/June). The Fed might knock a few billion of their balance sheets, but I doubt it will even get back below $8 trillion before the wheel really start to fall off the economy. I doubt the Powell-led Fed will have a Volcker-like vison to wring inflation out of the economy.

This should be an interesting week and there is even a jobs report on Friday to top it off.