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 0.6% for the week.
- The Fed has been criticized by the Trump administration for its restrictive interest rate policy. Is it time for the Fed to lower its target policy rate?
Jerome Powell, the Chairman of the Federal Reserve, has become the target of persistent and pointed criticism from President Trump during his second Administration. The President believes that the effective overnight interest rate under the Fed’s control should be set at 1%, substantially lower than its current level of 4.3%. Presidential criticism of the Fed Chair is nothing new. Most politicians prefer lower interest rates.
President Trump’s main problem with the Fed’s current interest rate stance is that it has resulted in trillions of dollars of interest cost to the federal government. On this point, he is correct. Per Matthew Klein, since 2019, almost the entire growth in the federal budget deficit relative to GDP can be explained by the change in net interest payments. Famed hedge fund manager Ray Dalio has made a persuasive case that the best way to lower the deficit relative to GDP is via lower interest rates.
“Deficit reduction”, however, is not explicitly part of the Fed’s mandate. The Fed’s dual mandate as stipulated by Congress is pursuing the economic goals of maximum employment and price stability. “Maximum employment” is hard to define as it cannot be boiled down to one number. That said, the unemployment rate remains quite low relative to history. Prime-age employment is also strong.
Which means that the Fed is chiefly focused on inflation. Headline PCE has been declining, yet strictly speaking, the Fed has not achieved its goal of 2% year-over-year PCE inflation for over four years.
The Fed is cognizant of the inflationary risks of lowering interest rates too far and too quickly. Mr. Klein notes that Americans are sitting upon $35 trillion in home equity, up $20 trillion since 2020. Overall net worth is up $50 trillion over that time. If the Fed successfully lowers the long-term interest rates that matter for households (those tied to mortgages, home equity loans, and car loans), spending will likely pop as households save less and monetize the wealth that has been built up over the past five years. That could lead to demand-led inflationary pressure on the economy.
The Fed is walking on a tightrope, trying to keep the economy balanced. While economic data has been generally good, there are some cracks appearing. Payroll growth is stalling. Real spending in the economy may also be slowing. By waiting too long to lower its policy interest rate, the Fed risks choking the economy into a recession.
Unfortunately, that would be par for the course. Historically, the Fed has typically kept interest rates too restrictive for too long in the business cycle. In a speech this week, Fed Governor Christopher Waller made some thoughtful points in defense of a pre-emptive rate cut, stating the Fed should not wait until the labor market deteriorates before cutting the policy rate. Perhaps that view will become more pervasive as the year unfolds.
Editor’s Note: Our weekly note will return in August. Thanks for reading!
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