Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, rose 2.2% this week.
  • A cool inflation print this week sent markets higher. Futures markets reflect the belief that the Fed will do nothing on interest rates until next May, when odds grow for a rate cut. By doing nothing, the Fed is tightening.

The Federal Reserve’s current interest rate policy is restricting borrowing and spending, or “demand”, thus curtailing overall economic activity, which will ultimately lead to layoffs at firms, which will raise the unemployment rate and reduce wage growth, all of which will snuff out inflation.

That is roughly the chain of events that mainstream policymakers at the Fed believe is still coursing its way throughout the US economy. Over the last two years, pundits and prominent economists have been vociferous in their belief that without millions of Americans losing their jobs, the Fed would be unable to meet their mandate on price stability – that is, bring down inflation.

With each passing inflation reading, it is more and more evident that inflation is declining without unemployment needing to reach catastrophic levels. Companies have become more productive and supply chains have unsnarled. The CEO of Walmart suggested on Thursday that consumers may witness outright deflation on goods this winter.

However, unemployment has crept higher, from 3.4% to 3.9% this year. 3.9% is still incredibly low, and not too long ago the Fed’s policymakers would have been aghast at such a low number. The problem is that once unemployment starts trending higher, it usually does not stop in a nice, predictable way. Historically, unemployment has tended to snowball.

This is why the Fed’s next move is crucial for the trajectory of the US economy and, by extension, the world economy. Futures markets reflect the belief that the Fed will do nothing until May, when odds finally rise above 50% for a rate cut. A decision by the Fed to cut interest rates would send a signal that it believes the balance of risks in its dual mandate (full employment, price stability) is tilting toward employment and that it is prepared to act to avoid a “policy error” and a recession.

The “doves” at the Fed, those who believe inflation will remain low and rates should come down sooner rather than later, have a growing body of evidence to support their views. Foremost amongst their arguments is that by holding its policy rate steady, the Fed is, in a sense, stealth tightening. Real interest rates, or interest rates minus inflation (however one measures it), are rising as inflation is ticking downward.

The events of the last three years will be debated by economists for decades to come. How much credit should the Fed’s interest rate hiking campaign take for the current trend of disinflation? What about supply chain and labor market normalization? What about just general normalization from the weirdness of the pandemic experience?

For the Fed, the data is what counts, and inflation has come down dramatically in 2023. As author and investor Cullen Roche wondered this week, will the Fed fumble the ball at the goal line?

From all of us in the Indiana Trust Wealth Management family, we wish our clients, professional colleagues, and partners in our non-profit communities a safe and wonderful Thanksgiving!

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