The Federal Reserve has coaxed an easier environment from financial markets, which paradoxically makes rate cuts more challenging for the central bank, a leading economist said.
The Bloomberg U.S. Financial Conditions Index indicates that the availability and cost of credit in money, bond and equity markets are significantly more favorable today than when the Fed began raising rates in March 2022, according to Apollo chief economist Thorsten Slok.
That follows a U-turn by the central bank in November, when Chairman Jerome Powell signaled that inflation was cooling enough to stop raising rates and start thinking about when rate cuts might begin.
Wall Street interpreted the comments, incorrectly as it turned out, to mean that rate easing was imminent and that there would be as many as six rate cuts in 2024, triggering a massive rally in the stock market.
IN Blog Post On Wednesday, Slock estimated that the S&P 500 stock index has added $9 trillion in market capitalization since then, and compared it to $19 trillion in consumer spending last year.
“In other words, in just a few months, the household sector saw a windfall equivalent to about 50% of last year’s consumer spending!” He wrote.
Meanwhile, the federal government is spending trillions of dollars on infrastructure, green energy initiatives and semiconductor manufacturing capacity.
As a result, the economy remains strong as this fiscal stimulus continues to boost growth while easier financial conditions offset the Fed’s rate hikes, Slock said.
In fact, the economy was so strong earlier this year that inflation figures were higher than expected and showing signs of accelerating again. That prompted Powell to warn that rates could remain high “as long as necessary” as inflation appears to be taking longer than expected to reach the Fed’s 2% target.
However, he later acknowledged that further rate hikes were unlikely and confirmed that the Fed’s next move – whenever that might be – would likely be a rate cut.
And this is precisely the mistake that Slack believes Powell is making.
“Looking ahead, with the stock market hitting new all-time highs and fiscal policy remaining supportive, markets should expect the economy to continue accelerating in the coming quarters,” he wrote. “You could call it the reflexivity paradox of the Fed’s rate cuts: the more the Fed insists that the next step in rate cuts is a cut, the more financial conditions will ease, making it harder for the Fed to cut.”
Of course, GDP growth in the first quarter slowed compared to the fourth quarter and was revised to an annual rate of 1.3% from the previous figure of 1.6%. The latest report also showed that fiscal stimulus had less of an impact.
But consumer spending on services remained strong, and the latest data on jobless claims showed the labor market continued to be buoyant.
Meanwhile, minutes from the Fed’s latest meeting showed the economy’s resilience in the face of rates at a 23-year high has prompted some officials to question whether all their tightening is putting enough pressure on economic growth. High interest rates “may have less of an impact than in the past,” the minutes said.