In his 1851 novel Moby-Dick, Herman Melville paints a picture of a single-minded Captain, Ahab, the master of the whaling ship Pequod. The Captain had become obsessed with pursuing the “great white whale.” In a previous encounter, Moby-Dick had bit off Ahab’s leg, and now he wore a stump, fittingly made out of whalebone.
The novel is in the tradition of a Greek Tragedy, where the protagonist fails to see all the risks in his quest for Moby-Dick and ultimately dies in the pursuit. Making the novel even more downcast is that Ahab’s reckless actions cost not only his life but the lives of his ship and crew.
Life can be like that, where the monomaniacal pursuit of one goal, to the exclusion of all else, can end in tragedy. For the last year and a half, we’ve seen the US Federal Reserve behaving in just such a singularly focused manner. By Law and tradition, the Fed has two principal objectives, Stable Prices (i.e., low Inflation) and full employment.
And, as you know, the Fed’s chief goal is to bring Inflation back down to 2%. It’s a goal Jerome Powell mentions repeatedly each time he comes to the podium. In the latest Minutes of the Federal Reserve Open Market Committee (FOMC), this goal is mentioned not once but three times, just in case we forgot.
The Fed begins by noting that: “Inflation remains high.” Then goes on to say: “The Committee seeks to achieve…inflation at the rate of 2% over the longer run.” And then again, just before they end their statement, the Fed confirms:
“The Committee is strongly committed to returning inflation to its 2% objective.”
Not too subtle, are they? No less than three times, in a very brief statement, does the Fed tell us that fighting Inflation is their number one job. OK, we get it. The Fed is focused.
But what if this is a time to expand the Fed’s horizon? For the Fed to look to other concerns in the economy? Remember, the singular focus cost Ahab both his ship and his life. What if, in this incredibly complex economy, there are other concerns to deal with besides prices?
Bloomberg reports that most on Wall Street believe the economy will be in Recession by the end of the year. And the Conference Board’s Leading Economic Indicators have been declining for 15 months, the longest losing streak since the Great Financial Recession of 2008.
Unfortunately, none of this caution has reached the Federal Reserve. These latest minutes from the July 25th FOMC Meeting not only indicate the 2% Inflation goal, it also describes how the Fed looks to achieve that goal. The first step, as we’ve all seen, was to raise the Fed Fund’s Rate to 5.5%, a rate last observed 23 years ago. In other words, the Fed has taken us from the lowest interest rates in a generation to the highest. And they’ve done it all in less than a year and a half.
Additionally, the Fed is committed to reducing its “Balance Sheet.” That’s Wall Street’s saying that the Fed is now backing out of the monetary push they used to stimulate the economy. In the years following the Great Financial Crisis, the Fed purchased US Treasury Bonds, Notes, and Agencies, which sent money into the financial system. It was called “Quantitative Easing” (QE).
The Fed ended up with a ton of US Government Securities. They will now reverse all that as the Fed’s stimulus becomes a monetary restriction. The Fed will sell those Bonds, taking cash out of the Financial System, which will dampen financial activity. And combined with their increase in interest rates, they will cause the tightest monetary conditions in memory.
With this kind of restrictive monetary policy, we may see a sharp and dramatic reduction in Inflation. Much of that decrease in Inflation has already occurred in a measure that the Fed does NOT use. Looking at Consumer Prices (CPI), Inflation peaked last year when in June, Inflation hit double digits on an annualized basis. That’s taking one month’s reading and extending it over a year. While in the latest report for the CPI (July 2023), Inflation annualized is only fractionally above the Fed’s Target of 2%. These are raw numbers and not seasonally adjusted, but the inflation trend is still clearly lower.
Recession, not Inflation, ought to be the Fed’s chief focus. At least that’s what the Conference Board, many Economists, and a near majority on Wall Street believe.
Note that both economic growth (GDP, red) and the number employed (Civilian Labor Force, green) have recently begun to decline while the Fed continues to hike rates (Fed Funds, blue). They are raising interest rates into a possible Recession.
Unfortunately, this Fed has not proven adept at making rapid course corrections, which may be needed in the months ahead. Remember when they failed to act when this bout of Inflation first began? They told us that Inflation would go away quickly. It was only “transitory.”
This inability by the Fed to change from stimulus to restriction in considerable measure began the rapid rise in prices. Today, the opposite may be the case. If the Recession does begin, the Fed will need to move quickly from a restrictive monetary policy back to stimulus. As Captain Ahab demonstrated, this kind of course correction is never easy. But it may be needed to save the ship.