Broker Check

Does the Fed Have the Right Recipe?

June 06, 2024

Does the Fed Have the Right Recipe? 

Have you ever baked a cake? Nothing fancy, nothing complicated. You obtain a recipe, follow the instructions, bake, and out pops a cake ready to enjoy. Simple, right? 

The cake recipe includes specific instructions on the required baking time and temperature. 

Well, the Federal Reserve has an anti-inflation recipe it has been following. It consists of one primary ingredient: interest rates. 

However, the Fed’s recipe for interest rates is not as straightforward. 

The Fed must use its knowledge and know-how, making an educated guess at the appropriate interest rate level (temperature) and how long it should maintain that rate (how long in the oven) so that it may achieve its goal of price stability without throwing the economy into a recession. It’s a tall order. 

Too low a temperature and not enough time in the oven, or too high a temperature and too long in the oven, will not produce the desired results. 

In today’s post-pandemic, high-deficit, AI-powered world, the correct time and temperature in the oven may have changed. 

Despite a lackluster Q1 GDP, most metrics suggest the economy continues to expand at a solid clip. 

Job growth is strong, layoffs, as measured by first-time claims for unemployment benefits, are low, and consumers aren’t shy about spending on items they desire. 

But last year’s remarkable progress on inflation has stalled. 

Inflation makes it tougher for consumers and those on a fixed income to make ends meet. For investors, hopes for a series of rate cuts, which have helped power stocks this year, are fading. 

Higher for longer is dead. Long live higher for longer. 

Last year, the Fed often talked about keeping rates “higher for longer.” As inflation improved, chatter about rate cuts increased. 

But inflation is no longer following the Fed’s script. Progress has stalled. And in some cases, we’re witnessing an acceleration. 

Consequently, expected rate cuts have been delayed, and market volatility has risen in response. 

What’s going on with inflation? Well, it’s the tale of two cities. On the one hand, price hikes for consumer goods have ended, according to the U.S. Bureau of Labor Statistics, which releases the monthly Consumer Price Index. 

In fact, prices have actually fallen, as mucked-up supply chains have righted themselves. 

But services are what economists call “sticky.” In fact, price hikes have started to accelerate. 

And here lies a problem, as services such as insurance and health care are more resistant to Fed policy. 

It’s possible that the recent uptick in inflation is temporary, and the road to price stability is just bumpier than many had anticipated. Come August or September, we may be having a different conversation. 

Final thoughts 

Stocks have an excellent long-term track record, but they don’t rise in a straight line. We expect detours over the shorter and medium term. 

Taking a more aggressive stance simply based on market action can lead you down a road that may be too risky for your tastes. But we are also mindful that when stocks hit turbulence, we don’t want to shift to a more cautious stance simply based on volatility. 

Market timing is rarely a profitable strategy. Simply put, you must know when to sell near a top, and when to buy near a bottom. We know of no one who has mastered that concept. 

For investors with a long-term time horizon, it’s not about timing the market; it’s time in the market that has historically produced long-term results. 

I trust you have found this review to be informative. If you have any inquiries or wish to discuss other matters, please don’t hesitate to contact me or any team member.