00:00A line in your column sticks out to me, and that is that, to my mind, financial conditions have eased too far beyond what's consistent with the Fed's objectives and beyond what expectations of further rate cuts alone should merit.
00:13So if that's the case, Bill, I mean, how do you think that that should inform Fed policy going forward, especially as it pertains to cuts?
00:21Well, I think they should be cautious. And obviously, they're going to cut rates next week. Nothing's really changed.
00:25They don't have any new information to contradict the path that they're on. So they're definitely going to cut rates at next week's meeting.
00:32The point I'm trying to make in the article is very simple. The Fed is basically saying monetary policy is modestly restrictive.
00:39We need to make it less restrictive because the downside risks to the labor market are increasing.
00:44But if you assess monetary policy not by the level of the short-term interest rates, but by financial conditions, monetary policy doesn't seem to be restrictive at all.
00:52Financial conditions right now are actually quite accommodative. The Federal Reserve Board staff has developed a financial conditions index.
01:01And at the end of August, which is the most recent reading from their model, they thought that financial conditions at the current setting was going to boost real GDP growth by almost a percentage point.
01:13That's easy financial conditions. That's not a restrictive monetary policy.
01:16So I think the Fed should be putting a little bit more weight on the fact that the stock market's been very strong, buying yields have fallen, the dollar has weakened, credit spreads are narrow.
01:25All those things are supporting economic activity and put a little bit less weight on the level of the federal funds rate.
01:31Right. I hear what you're saying, especially when you think about all the different measures that do make up financial conditions.
01:36But, I mean, you take a look at some of the potential warning signs here, especially what you're seeing in terms of the credit space right now.
01:43We know that Tricolor Holdings basically filed for bankruptcy.
01:48Then today, this morning, you had Primalent also file for bankruptcy.
01:52So you add it together, you are starting to see some stress among lower-income Americans basically falling behind on car loans and the like.
02:00There is that concern about the labor market as well, Bill.
02:02I mean, are those things that can be helped by lowering interest rates?
02:08I mean, it can help a little bit.
02:09I mean, obviously, if you lower interest rates and bring down bond yields, that's going to support the U.S. housing market, make housing more affordable.
02:16But you're right. Monetary policy is a very blunt instrument.
02:19And right now, it's a tale of two economies.
02:22If you're a high-income household that has, you know, good exposure to the equity market, you locked in your mortgage back during the COVID pandemic, you're feeling pretty good about things.
02:32If you're a low- or moderate-income household, don't have a lot of savings, don't have financial asset exposure, you know, job hiring has tapered off a lot.
02:42You're not doing very well.
02:44But the Fed basically has to take the entire economy into consideration in terms of setting monetary policy.
02:49Monetary policy is not very good.
02:50It's sort of oriented towards one, you know, income sector of the population.
02:54I think the message right now is financial conditions are extremely accommodative, you know, basically as accommodative as they've been over the last few years.
03:03And I think the Fed just needs to put a little weight on that, especially in an environment where inflation is continuing to run above their 2 percent objective.
03:10Next year, we're going to have inflation above 2 percent again.
03:13That'll be the fifth year in a row that inflation is above the Fed's 2 percent objective.
03:16So, yes, there are some downside risks to the labor market, but there's also some upside risks in terms of inflation expectations becoming less well-anchored.
03:25I mean, what exactly could the Fed do, Jake Powell do, to sort of, I guess, re-anchor, for lack of a better phrase, those inflation expectations?
03:33Is it just about what he says, or is there something more tangible that they can do?
03:39Well, right now, the market has a lot of easing priced in over the next year.
03:42If you look at the federal funds futures market, by the end of 2026, they have the federal funds rate below 3 percent.
03:49What the Fed could do is say, look, we don't think we're going to actually have to cut rates that much more because financial conditions are so accommodative.
03:57And if you did that, then you'd take out some of that easing that's priced into the market.
04:03Bond yields would firm a little bit.
04:04The stock market would react to that.
04:06And financial conditions would be less tight, would be less easy.
04:09So the Fed could sort of slow things down a little bit in terms of how much stimulus financial conditions are providing by making it clear that we're not going to cut rates as far as the market thinks.
04:20I am curious, though, Bill, when we start to talk about this idea, we talk a lot on this show, I should say, about AI and the potential for enhancements to U.S. productivity across industries as well.
04:32Is it too early for the Fed to try to take that into account as well?
04:35Well, right now, it's probably actually pushing up the equilibrium level of interest rates because it's leading to this huge investment boom that's sort of independent of the business cycle.
04:46So right now, you're seeing a lot of additional investment that you wouldn't normally be seeing at this stage of the business cycle.
04:51Now, eventually, that AI investment spending is going to lead to significant increases in productivity growth.
04:57But those are probably later as opposed to right now.
04:59And, Bill, just quickly, we don't have a lot of time left, but we should talk a little bit about the government shutdown and basically the fog that the Fed is having to make monetary policy.
05:09And we are going to get that delayed CPI release on Friday.
05:12But even so, we haven't gotten official updates on the labor market, on some of these other measures that we know are important.
05:19And with that in mind, I mean, I would love your perspective on how basically you can proceed and make monetary policy with this type of uncertainty.
05:28Well, you know, the cloudier it is, the more cautious you want to be.
05:34So you want to basically slow down to avoid making a policy mistake.
05:38But with lack of government information makes it very hard for the Fed to be confident about their economic forecast because they're not seeing anything that either confirms or contradicts it.
05:47So I think this is another reason why after they cut rates next week, maybe they need to go on to a pause to see which way is the economy really heading.
05:56If you look at the Atlanta Fed GDP now forecast for the third quarter, that's tracking 3.8%.
Be the first to comment