“Like Being Half-Pregnant”

They say you can’t be half-pregnant.

What about half-right?

I’m talking here about Jerome Powell and my predictions for what he will do…

JP and his compadres on the Federal Reserve Board of Governors will emerge from their gopher hole today to inform us if they’ve seen their shadow or not, and whether we will have six more weeks of Fed inaction on previously announced rate cuts… or whether they’re now skittish about cutting rates because inflation is back to being a nuisance.

I have been telling you the Fed will cut rates in March.

But I’ve also been telling you that inflation was not done with us.

Lower interest rates and rising inflation are inherently at odds with one another.

Generally, of course, rates will go up when inflation goes up, and come down when inflation goes down.

Which puts my two predictions—that rates will be cut, but also that inflation will persistently continue—into conflict.

Let’s look into that…

JP announced in December that he and the gang anticipated three rate cuts in 2024.

That said, we are in an election year (the most consequential in the last 100 years) and the Fed is historically loath to monkey around with interest rates as the election draws nearer.

But only five Fed meetings exist between March (the meeting results announced today) and September (the last meeting before the November elections). So if the Fed is going to give us three rate cuts, well, it has seriously limited opportunity to do so… unless it issues an emergency cut, which has occurred in the past. But that would send the markets a message of economic distress and the Fed does not want to do that.

That limited constraint is why I expected the Fed would announce its first rate cut this month. Just makes sense from a timing perspective.

Now, however, I am not so confident the Fed will announce a rate cut this afternoon.

The problem is the second bullet point: inflation.

It refuses to cooperate with the Fed’s demand to cease and desist this mishigas above 2%.

But as I’ve written too many times to count, inflation was never going to go away simply because the Fed hiked rates to 5.5% from 0% in a panic.

Sure, the Fed slammed the consumer, caused banks to fail, and radically jacked up Uncle Sam’s annual interest payments on his extreme debt—but all of that failed to bring inflation to heel.

Inflation rates softened, but they’ve remained persistently higher than 2%.

And now consumer prices are nosing up again.

And the Fed seems anxious.

The reason inflation refuses to submit is very much tied to the Fed itself.

Higher interest rates, as I noted, pushed up Uncle Sam’s borrowing costs and increased his debt-repayment costs. That, in turn, is forcing the US government to print trillions of extra dollars.

A Bank of America analyst recently calculated, for instance, that America is now adding $1 trillion in additional debt to the balance sheet every 100 days. That money doesn’t exist in a vacuum and it isn’t just a line item somewhere in the federal register. It’s real money that goes to the lenders who facilitate Uncle Sam’s addiction to debt.

In turn, that money flows back into the economy as lenders put that cash to work in various ways.

So that’s an extra $3.65 trillion a year sloshing around an economy that is $28 trillion in size. Or said another way: An amount of money equal to 13% of the US economy is dumping into that economy annually.

That leaves a mark.

And that mark is hotter inflation.

Thus, my bipolar prediction about lower interest rates and higher inflation…

They seem counterintuitive.

In textbook terms they are.

But the Fed jumped the textbook shark long ago with Quantitative Easing and other magical voodoo it has applied over the last two decades to a fundamentally troubled economy larded with history’s largest mass of consumer, business, and governmental debt.

Nevertheless, my odd couple of low rates and higher inflation might just be the only way the Fed can get out of this pickle…

Cut rates, and bond yields fall, which will help reduce Uncle Sam’s interest expenditures, which then reduces the amount of money pouring into the economy.

Bring rates down low enough, at least temporarily, and it gives Sammy time to refinance his short-term debt at lower long-term rates. Consumers and businesses would benefit from this as well.

Inflation would remain elevated for a while, probably north of 5%, but consumers and business would naturally find ways to adapt to higher prices through the “substitution effect.” In other words, replacing one item with another at a lower cost. That has knock-on effects.

Simplistically, if steak is too expensive, consumers stop buying steaks. Demand for steaks falls, and steak-maker profit margins plunge. Steak-makers stop making so many steaks. Some go out of business or convert their factory to making something else. And steak prices decline as a result.

Apply that across the whole economy and you can see how consumer buying patterns can and do change inflation.

Then, the Fed could raise rates to kill inflation as Paul Volker’s Fed did in the 1970s.

Yes, that would slam the consumer, and we’d get a more-than-mild recession. But the impact would not have nearly the same effect on government debt repayment, so the US would more easily navigate that temporarily high rate environment.

Will any of this happen?

We’ll find out today when JP steps up to the microphone to announce the Fed’s latest action, or inaction as the case may be.

More to come soon…