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The Federal Reserve Has Made A Huge Error

The central bank took too long to raise interest rates. It’s now playing catchup.

(Photo by Mark Wilson/Getty Images)

In May 2020 I was on Anthony Pompliano’s podcast describing the likelihood of high inflation in the coming years and the Federal Reserve trying to catch up to it.

Turns out, it all came true since then. I said the following at the time:

“I don’t see how … say, 2021 or 2022, that if the economy is really rebounding that we don’t have 3%, 4%, 5% [core] inflation, and I think you could have the Federal Reserve chasing their own tail raising rates.”

We shouldn’t blame the Fed for everything. After all, the central bank didn’t cause all of the current inflation. That was mostly created by trillions in government spending (the Treasury and fiscal policy) and the complex mess of supply-chain snags during the pandemic.

But the Fed could have done a lot more to get in front of rapid inflation before it got out of hand. And that’s where its response is worthy of criticism.

Unfortunately, the subjective nature of discretionary interest rate policy has left the Fed doing what it typically does: looking at 12-month trailing data in a reactive manner and then responding when it becomes clear that the economy is drunk.

The Fed now wants to swipe a punch bowl that it should have been watering down long ago. The problem is policy makers are on the verge of swapping the punch bowl with sleeping pills as parts of the economy look increasingly fragile. The Fed is now at risk of tightening policy into an economic slowdown.

Let’s look at the rising risks of recession. Among other indicators:

  1. Flattening and inverted yield curves, which always precede slowdowns and recessions.
  2. Crashing freight data.
  3. Sharp drop in mortgage applications.
  4. China PMI contraction.

Those signals are leading indicators of a worsening economic slowdown.

At the same time, we’ve transitioned from an economy where a demand-led price shock has increasingly transitioned to a Russian-led supply price shock. And yet the Fed feels the need to play catchup to try to save face in the wake of what is already proving to be a policy error — that is, leaving rates at 0% for too long.

Source: Marketwatch written by Cullen Roche

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