Fed Up? The Federal Reserve plays a crucial, underappreciated role in the global economy: an easy scapegoat. Democrats and Republicans, Presidents, CEOs, day traders—all can and will blame the Fed for any market outcome that does not meet their personal expectations. There’re a few clear psychological drivers for this allocation of blame. One, the Fed is perceived as inherently weird and insular. It has a sort of village witch or shaman cast to it. Us mere mortals are not always privy to the inner workings and are confused by its operating. In times of stability, this relationship is ok. When things are volatile, we look to blame the arcane institution we don’t understand. Two, we enjoy feeling like someone is in charge. Like the village witch, we ascribe magical powers to the Fed that can fix all our economic ailments. We discount the insane level of complexity in the economic system and instead feel comforted by the idea that someone out there really has control of the situation. Three, we project our own biases and rational economic positions onto the Fed. Presidents want to be re-elected and maintain political power. CEOs want their companies to make more profits. Day traders want lines to go up. Like a medieval farmer questioning a witch’s relationship to a drought, modern economic actors ask themselves, “Why won’t the Fed fix my problems?”

Last week the Fed decided, again, to do nothing. Once again, certain people – the White House – were displeased by this decision1. Chair Powell’s and other officials’ comments from the announcement reflected the cautious, hold-your-breath conditions the Fed is operating under. To be frank, I’m not a huge fan of Fed watching. At this moment, fiscal dominance and geopolitical efforts are threatening to change the global capital structure. Time is a resource and it’s worth following and understanding the deeper changes. However, it’s a good exercise to understand the Fed’s reaction function and the arguments why the Fed is wrong.

Why cut rates? The argument for cutting rates is based on economic momentum. The Fed had raised rates to combat inflation in 2021, and the Fed had begun in Fall 2024 returning rates to a normal level. Even now, the rate is probably around 1 percentage point above the neutral rate. Proponents of resuming cuts point to weakening employment data. The jobs market is in some sort of stasis. Gross unemployment numbers remain strong and layoffs are muted, but hiring has frozen entirely. The labor market appears fragile. Rate doves argue that the Fed should not wait to see layoffs to resume cutting.

Why not cut rates? The stated reason for the prolonged wait is the price effect from tariffs. Classical economic theory says that tariffs are a one-time increase in the price level. Classical economic theory, however, does not address the nonlinear interactions from complex supply chains or the use of geopolitical leverage. The Fed believes the probability that tariffs cause a sustained increase in prices is large enough to justify waiting. There’s another good psychoanalytic analysis here. After calling the initial signs of inflation in 2021 ‘transitory’, the Fed waited too long to address what was obvious to everyone else. The resultant criticism may have stuck to Powell’s psyche; he’s not willing to appear blasé about prices².

There’s additional lurking pressure from the bond market. The long end of the curve has been looking more and more unanchored from monetary policy. Last fall, the rate cuts drove a sustained rise in yields in the 10- and 30-year tenors. A continued robustness in macro data suggested a higher floor for the cutting cycle than believed in August. At present, the Fed may be worried about the bond market’s reaction once again to preemptive rate cuts. Macro data is weaker; however, the fiscal situation is at the forefront of investors’ minds and Powell himself has been discussing worries over inflation. Furthermore, public statements from the White House have put political pressure on the Fed to loosen rates. If the Fed cuts before a deterioration of labor-side data, the bond market may start asking some big questions. How reactive is the Fed to political pressure? Is the Fed choosing to ignore its own statements on the stable price side of the dual mandate? The situation is loaded with irony. If the Trump Administration gets what it wants and the Fed cuts rates, we may see a blowout in 10-year yields. At a moment when mortgage rates and consumer stress are at a sustained high, this may be far more politically damaging than the results of monetary policy. It’s a better political move to keep blaming the village witch for not managing rainfall than to try and take the problem into your own hands.

1. At least publicly. Does President Trump really want the Fed to cut rates? Imagine if Powell cuts rates, President Trump takes some drastic policy action, and we still get market volatility. Who could he blame then?
2. I think there’s something deeper here about the wider socio-political response to higher prices versus unemployment. The promise of globalization was an offshoring of manufacturing to capture price efficiency for inputs. American consumers were sold on cheap goods. For the first time in decades, the voting consumer had to face the realities of inflation.

Steven J. Wagner, Investment Adviser
Bray Farm Income Advisory LLC
3375 Brookdale Drive, Pittsburgh PA 15241
412.504.9412
412.848.2410 (cell)

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