Messy Data, But The Fed Should Cut

Always Behind The Curve

The Federal Reserve is always behind the curve. The real-world traders know this. In Fed world, they are slow and slothlike. It’s been that way forever. One reason is that virtually no one can predict the macroeconomic future. There are just too many variables. Instead of being proactive, the Fed is reactive.

They might need a culture change as we get better with data.

Inflation isn’t running hot. All the data shows it is coming down and all the trends show it is coming down. The Fed has a dual mandate, and the other one is for employment. The unemployment rate is ticking up slowly. If you listen to futurists, Artificial Intelligence is going to cause that rate to go up and also cause costs to go down, dampening inflation.

The bond market gets a lot of attention these days because if interest rates go up, it is a thorn in Trump’s side. There was no chatter about the potential increase in interest rates when spending went up from 2020-2024. Certainly, the US has to cut the budget and cut it big time. We will see how the reconciliation goes on the big beautiful bill, but the data I have seen pushes much of the cutting out years.

I’d also pay no attention to Congressional Budget Office estimates. They are always wrong, and instead of using dynamic scoring to make projections, they use accounting. Accounting looks backwards. It’s how governments think they can raise taxes like capital gains and think they will get more money. The result of that increased tax is that people avoid it, and things slow down.

As Mary Meeker pointed out years ago in her annual presentations, discretionary spending is only one driver of our deficit. The real drivers are the mandatory programs, which take up 70% of the budget like social security, Medicare, and things like that. The interest we pay on our debt is also in that figure. Defense is only about 16% of the spending in the federal budget, and we need defense, especially now, if you saw what happened in Russia yesterday.

We had a gigantic stock market rally in May. On X, LinkedIn, and here I called it, and I also called out the people who said tariffs were “inflationary”. They aren’t. There are people conflating the rise in incomes of US workers over the last quarter with tariffs, but they are wrong, too. Tariffs do not cause incomes to go up, and they also do not replace taxes. Tariffs and taxes are not fungible. As a negotiating ploy, it might work, but we are seeing that unravel just a bit with China right now.

Cutting rates now would be proactive, and it would help the housing market. The housing market is a big driver of productivity in the US. There is starting to be a glut of homes on the market in several places. One reason for that is that people are locked into a mortgage at low interest rates. But, the other is that the cost of capital is too expensive to either buy a new house or speculate and build houses, hoping people will buy them.

Cutting rates would also help the interbank market a bit. Banks swap securities with each other in the interbank market. The actual driver of liquidity there is Fed rules, which should also be eased, but dropping rates a quarter to half a point would ease the stress as well.

Cutting rates would also juice the stock market a little bit more since capital costs for companies would go down, changing internal hurdle rates for projects and investments.

We haven’t pushed through our yearly highs even with the rally. I think with all that is going on, the stock market will churn here for a while until it gets a signal. Even with the rally, I feel like bearish sentiment is still a bit in control.