It is aggravating being a governor of the Federal Reserve. The only real lever you have to bring inflation down is monetary policy, and for a year, you have been jacking up interest rates, and inflation is still coming down very slowly and the consumer and the economy are running full tilt. Now if Paul Volcker was around he’d say screw it and crash the economy into a light pole, but I don’t think Chairman Powell is Volcker, so he seems to be resisting that impulse. But some of his folks on the Fed are getting antsy.
Just to review, before the Fed started raising interest rates eight times starting last March, interest rates were very low. A year ago, the 3-month was at .36% and the 10-year was paying 1.92%. Now, the 3-month is at 4.84% and the 10-year is at 3.82%. Yes, the 3-month has a higher interest rate than the 10-year, which is known as an inverted yield curve. An inverted yield curve suggests at recession is on the horizon. It doesn’t feel like one is, because the economy added 517,000 jobs last month. But parts of the economy are in recession, like the tech sector and housing. The question is whether the rest of the economy will slow down dramatically enough. My sense now is that the Fed is going to keep raising the heat, the only question is whether it will do it fast or slow.
The problem for the Fed is that it has only limited visibility into the economy. Also, monetary policy takes time to work, and it is possible that if the Fed stopped raising rates for a while, the effects of eight rate hikes would start being felt in a lot of different ways. Imagine that you are blasting with dynamite, and you lit the fuse, and it is kind of a long fuse, and you don’t hear anything for a while but suddenly ka-boom. Monetary policy is a long fuse.