The Federal Reserve’s Open Market Committee meeting yesterday resulted in the Fed raising US interest rates by 0.25%, 25 basis points as bond traders say. This was the direct result of inflation that has risen since Donald Trump took office, when the rate was 3%. Drivers of this inflation are the war in Iran, tariffs and the massive US debt. In the face of these a 25 bp increase is just not enough, and the Fed will have to raise rates again before the year is out. The president is livid, but he does not understand economics. He is a congenital debtor and does better when rates are low. Therefore in his mind, low rates are always good. They are not.
The problem here is that the Fed has just one tool, interest rates. Raising or lowering rates will have zero impact on the war, on tariffs nor on the debt. It is, at best, treating the symptoms not the disease. The Congress and President have the power to solve the problems driving US inflation, but they seem to have no interest in doing so thus far. Fiscal policy in America is dead, and so is Congressional oversight.
What was rather interesting was the reaction of the equities. They are up this morning after a brief sell-off following the rate increase. Normally, higher interest rates are bad for stocks. This is a sign that Wall Street realize inflation fighting is needed and that the Fed really does intend to do just that.
“The Warsh Fed defied the Trump administration and preserved its credibility by following through on earlier signals” that it would hike rates, wrote ABN-AMRO economist Rogier Quaedvlieg in a report this morning.
The markets also got a bit of a boost from a dip in oil prices. The dip followed news that “President Donald Trump would likely discuss the Iran war with Gulf leaders next week at the United Nations General Assembly’s high-level meeting in New York,” according to NBC news. The oil market is clearly delusional. Talking to the Gulf leaders is not going to affect what Iran does. Talking to Iran might. But this is not the time to go long oil. As the saying goes, “the market can stay irrational longer than you can stay solvent.” The world oil supply is going to hit a wall in the coming weeks. Thus far, the global stockpiles have cushioned the supply shock, but the stockpiles are run down. Day traders do not care, but the price of oil is going up over the medium term.
Where the Fed came up short was in its 25 bp decision rather than 50 bp. Analysts were expecting 25 bp, and it is always good for the central banks to surprise the markets a bit. A bigger increase would have signaled that the Fed was prepared to go to war on inflation. The current hike seems more like “take 25 bp and call me in the morning.” The Fed is just going to have to do this all again at its next meeting.
It is true that 50 bp would have panicked some in the markets over the seriousness of the situation. But the seriousness of the situation is not adequately appreciated. Things are not going to get better without the White House feeling the pressure from the financial markets about which the president cares so very much. A 50 bp increase would more likely have created that pressure.
Rates are not going down any time soon. The war with Iran is not going to end until the Trump administration ends; Iran will do to him what it did to Jimmy Carter. The tariffs are not going to end until there is a new president. And the budget deficit that is adding $2 trillion to the national debt each and every year is not going away until there is enough courage in Washington to raise taxes.