The Fed kept rates unchanged at today’s meeting, but whether they are done with rate hikes or simply at a pause is yet to be determined.
Today’s Fed statement itself was mostly a copy/paste of September, with some minor wording changes noting that the economy is growing at a “strong” rather than “solid” pace, and employment gains have “moderated” rather than “slowed”. The only new information came with the addition of “financial” conditions to previously noted credit conditions as factors weighing on household and business activity.
At the press conference, Chairman Powell noted two primary factors that seem to be weighing on Fed decision-making. The first is the tightening in financial conditions, as higher rates on everything from mortgages to corporate borrowing will have an impact on activity moving forward. The second – and related – factor is that the Fed thinks the full effects of policy actions to date have yet to be fully felt.
In our view, the Fed is watching the wrong metrics. It should be paying more attention to the money supply, which is signaling that it is already tight. The M2 measure has declined in eleven of the last fourteen months, has contracted 3.6% in the past year, and is down 4.4% off the peak in July of last year. Meanwhile, bank credit at commercial banks as well as their commercial and industrial loans are both flat to down. If this isn’t tight, we’re not sure what tight means.
It remains to be seen how quickly the reductions in the money supply will translate into inflation getting back to the Fed’s 2.0% target, but the Fed has gained some traction against the inflation problem. Given time, the mission can be accomplished, but the Fed must remain patient. One of the biggest risks in the year ahead is the Fed jumping the gun on cuts should economic conditions deteriorate.
For now, each FOMC meeting remains “active,” meaning the Fed is ready to raise rates further if the data suggests more work to be done. But without a clear path forward the looming geopolitical tensions, resumption of student loan payments, slowing economic and employment growth, and higher oil prices could make the Fed’s path bumpy. History may show that the Fed finished rate hikes in July, but it will still be a while before they can call their mission complete.
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/1/2023
