After rescuing the financial system from the 2008 financial crisis with 0% interest rates and hyperactive quantitative easing for 15 years, the Federal Reserve went on an aggressive interest rate tightening cycle. This cycle will end at the next Fed meeting.
The Federal Reserve began raising interest rates in early 2022 to combat inflation, which was driven by a surge in oil prices. This surge was influenced by market price signals, which, in turn, were shaped by policies from the current administration. Day traders respond to these signals, setting prices through high-volume trading (more on this in the next article). Commodity prices such as oil are rarely tied directly to current or actual future supply-demand dynamics. Instead, it is this high volume trading activity from market signals that largely dictates prices and shapes perceptions of future outcomes.
The Fed’s rate hikes aimed to mitigate the ripple effects of inflation as higher oil prices filtered through the global economy. In doing so, the Fed adopted an extremely restrictive monetary stance. The effects of this approach are now becoming evident, with job growth slowing and economic growth trending downward. Even oil prices have come down from their highs, stabilizing in the risk neutral mid-range as the market anticipates the outcome of the upcoming presidential election.
Historically, the Fed has been reactive, often late in beginning its easing cycles. This delay is rooted in its preference for caution, ensuring that policy changes are warranted, and to reduce the risk of moral hazard.
The traditional approach was to "save your bullets," reacting slowly to changing conditions. However, we know that monetary policy works with a lag. The effects of lower interest rates and increased liquidity take time to materialize, and the intangibles—like confidence—are vital to the functioning of the economic system.
If the Fed were not in such a restrictive position, with rates at 5.5% (the same level as just before the 2008 financial crisis), a gradual easing process, starting with a 25-basis point (bps) cut, might be warranted.
However, given the recent decline in oil prices and the downward trend in economic indicators, a more substantial cut of 50 bps is necessary to kickstart the process. If the Fed doesn’t begin normalizing rates now and the economy worsens, it may be forced into more aggressive cuts of 75 bps in the coming meetings just to return to the neutral range of 2.5% to 3%. Waiting too long could extend the timeline for rate cuts to be effective, potentially dragging the economic upturn out over a year and a half to two years. This delay would increase the likelihood of economic difficulties and necessitate even more Fed intervention.
With all the new tools now available to the Fed, it’s clear that starting early and potentially running out of bullets at a 0% Fed Funds rate is no longer the endgame—it’s the starting point for the suite of monetary policy measures the Fed can deploy. By starting this easing cycle early and with authority, the Fed has a better chance to avoid the insanity of testing the world’s tolerance for 0% rates and beyond again.
by Michael Carino, Greenwich Endeavors, 9-9-24
Michael Carino, CEO of Greenwich Endeavors, is a finance specialist with over 30 years of experience. He has owned financial firms with roles including portfolio manager, trader, accountant, risk manager and treasury manager. He typically has positions that benefit from a normalized bond market, higher yields and value investments.
