Is The Fed Behind The Curve In Cutting Interest Rates?


Behind the Curve?

Please consider The Fed Is Behind the Curve on Cutting Interest Rates by David Malpass, undersecretary of the U.S. Treasury 2017-19.

My inline comments are in braces [ ].

Inflation slowed to 0.1% in May, providing another opportunity for the Federal Reserve to rethink its behind-the-curve interest rate policy. Many signs indicate that rates should be lower, but the Fed has chosen to keep the interest rate steady because of its limits-to-growth economic models.

[I do not believe that is the reason. I think the Fed is concerned about the very real possibility that tariffs may cause a jump in inflation].

The Labor Department’s May survey of households found 700,000 fewer people with jobs than in April, a clear sign of strain in small businesses. The prime interest rate is 7.5%, too high for most businesses. Credit-card interest rates are above 20%, a record high. The mortgage rate is prohibitive, driving up housing costs and rents. Monthly mortgage payments are at a record high, and builder confidence is down.

[All of that may be true, but where is inflation headed?]

Other major central banks, including the European Central Bank and the Bank of England, have cut their rates repeatedly in recent months, recognizing the global trend toward disinflation. The fed-funds rate, at 4.3%, is at least double the policy interest rates in Europe and Japan. President Trump’s tariffs have stopped China from dumping products here, but rather than reduce excess manufacturing, China has responded by dumping its products worldwide, exporting deflation. Global growth forecasts have slowed markedly, with the U.K. reporting a contraction in gross domestic product on Thursday.

This leaves the Fed as far behind the global disinflation trend as it was behind the inflation trend during the 2023-24 election cycle. These repeated lags in interest rates—driving through the rear-view mirror—harm the economy by widening the swings in inflation and interest rates.

[Is the Fed behind the curve or ahead of it?]

A clear path is available to the Fed to lower interest rates as Mr. Trump’s policies add critical manufacturing and energy capacity and give priority to a stable dollar as the world’s reserve currency.

[Actually, rate cuts would tend to weaken the dollar.]

Strong growth based on increased market-based production is fully consistent with the Fed’s dual mandate of price stability and full employment. Price stability leads to strong private-sector investment and job growth, which in turn fosters the robust production needed for price stability. It’s a virtuous circle that leads to lower interest rates, higher wages and improved affordability.

[How can anyone think we have price stability when no one really knows the impact of Trump’s on-off tariff policy]

Voters elected Mr. Trump not only to boost the economy but also to fix broken monetary policy, promote after-tax wage gains, and protect the dollar. The president champions the forgotten man, and his economic policies so far have been a home run. In a growth economy, small businesses can offer more jobs at higher wages and still make a profit.

[This one is a real hoot because it is crystal clear Trump wants to increase the deficit which would tend to weaken the dollar and stir up inflation.]

By contrast, the Fed’s models depend on slowing the growth rate to avoid overheating. The Fed is locked into high rates by a “limits to growth” fallacy—the idea that the U.S. economy has a low potential growth rate that shouldn’t be exceeded.

[Again, Malpass assumes the Fed is doing what it’s doing because of its models whereas I believe it is for other reasons.]

The Fed has created multiple obstacles to small business lending. The Fed’s regulatory policies guide banks away from small business loans. Further, its post-2008 balance-sheet policy of owning long-term government bonds favors government and big business at the expense of small and new businesses. The Fed is offering such high interest rates to banks (4.4%) and money-market funds (4.3%) that it crowds out small businesses. This limits the growth that is needed to pay for wage increases.

[The major thing “crowding out small businesses is Trump’s tariff policy and tariff uncertainty.]

Many innovative small businesses are confident in what they have to offer but can’t afford new investment, so they wait too. The risk is that underinvestment could impede necessary growth in domestic supply chains.

[They wait because none of them know what the hell Trump will do.]

As the Fed drags its feet, taxpayers also bear a huge cost because the U.S. government and the Federal Reserve are the world’s biggest borrowers in short-term credit markets. The Fed’s choice of high rates is adding rapidly to the government’s interest expense and the national debt. The Fed uses the loans it gets from banks and money-market funds to hold on to a $6 trillion bond portfolio that is deep underwater. Today’s Fed is effectively the world’s biggest hedge fund. Its losses are already $1 trillion and will grow until interest rates come down.

[The Fed’s losses are on paper an irrelevant. As former undersecretary of the U.S. Treasury, Malpass should know that. As for taxpayers bearing the cost, I agree. They are bearing the cost of inept policy out of Congress and a fiscally poor One Big Beautiful Bill proposal by Trump.]

The Fed is using the same demand-side models that have caused cycles of inflation and deflation since the 1970s. In these pages in 2002, I argued that the Fed hadn’t analyzed its deflation mistake of the late 1990s—the mistake that led to the Asian financial crisis and the 65% decline in the Nasdaq index—and was at risk of making repeated mistakes in inflation and deflation because of the lagging nature of its indicators. Those models need to be replaced with pro-growth, stable-dollar principles that can achieve both the Fed’s dual mandate and Mr. Trump’s vision of a strong, productive, high-wage economy.

[I sympathize with every criticism of the Fed. And I agree that the Fed has sponsored many boom-bust cycles. But Trump’s vision of a global economy and getting rid of the IRS based on tariffs is crazy.]


Is David Malpass Right or Wrong?

Should the Fed cut? I have no idea. Nor does anyone else.

But what we can see is Malpass is a rah-rah cheerleader for misguided Trump policies.

The reason we don’t know what the Fed should do is no one can possibly know what Trump will do or how the US and global economy will react to those moves.

Nor do we know what happens to the One Big Beautiful Bill.

If there is a reasonable chance for stagflation, and there is, then the Fed is best advised to wait.

The Fed absolutely does not want to make a move in the wrong direction.

Right now, my assumption is that if the Fed cut rates, the dollar would sink further and long-term yields would rise.

Technically, it appears that long-term treasury yields may explode to the upside.


Related Posts

April 5, 2025: Trump Wanted a Weaker Dollar, Wish Granted, Euro Highest Since 2021

Futures are in a nasty mood tonight except for a new record high in gold.

April 9, 2025: Trump Promises $1 trillion in Defense Spending for Next Year

Even bigger budget deficits are now in store due to the first $1 trillion defense budget.

On May 3, I commented Ominous Looking 10-Year and 30-Year US Treasury Yield Charts

The technical patterns on long-dated treasuries suggest rising yields. What about fundamentals?

Nothing has changed.

On May 6, I commented Gold Soars to Another New High, What’s the Message?

There are three messages. Do you see them?

Since then, gold has made many new highs. And it’s at another new high right now at $3,453 per ounce.

And as long as the bond market is unconvinced rate cuts are needed, so am I, especially with gold blasting to new highs.


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