Following its December meeting, the Fed announced to the world it was hiking interest rates for the first time in almost a decade—a meager 0.25%—and that further increases would come at a gradual pace looking at “realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.”
With the economy already at maximum employment by the Fed’s definition of the term and inflation heading higher, economists read the Fed statement to mean an interest rate hike at every other meeting.
Then came January.
Global markets fell sharply to start the New Year. The S&P 500 was down more than 9% in the first couple weeks of January. The sell-off rattled some cages at the Fed, but after looking like a slave to Wall Street last September when it delayed a hike because of a stock market correction, most Fed members stuck to their guns.
Yellen & Co., did nod at the stock market volatility following their January meeting, but they didn’t back off of their plans of hiking rates at a gradual pace.
Wall Street threw a fit. After being rewarded with easy money every time there was a correction, the Fed’s non-response was a disappointment. The S&P 500 took another leg down in February, hitting a new low.
Suddenly after a new round of stock market losses, we started to hear that some members of the Fed had changed their outlook for the economy.
What made these “data dependent” economists change their view on growth and inflation? It wasn’t the data. With unemployment still at 4.9% the economy is at maximum employment. And inflation, even by the Fed’s downwardly biased core PCE measure, is up markedly from the Fed’s last meeting. Core inflation is running at 1.70%—its highest level in two years.
It was the stock market correction of course. Despite its leaders’ better instincts, the Fed remains a slave to the markets. And as has been the case for years now, just as Fed members started backing off their plans to hike interest rates, the stock market staged an impressive rally making Fed members look like fools.
Yellen & Co. would do every American a favor if they recognized that after years of propping up stock prices with monetary stimulus, markets aren’t going to like it when the Fed takes away the punch bowl. The Fed now acts as if it needs to maintain a perpetual drip of liquidity to prevent every stock market correction from deepening. That’s misguided. Corrections burn themselves out when prices reach compelling values. To think otherwise is to misunderstand the nature of free markets.