Why “Higher For Longer” = “The Fed Calling In an Airstrike on Its Own Positions”

For devotees of the (missing and suspected dead) Phillips Curve cargo cult, the Fed can’t stop raising rates until we see major unemployment.  I do not share their faith in the defunct Phillips Curve or an all-powerful Fed.  I agree the Fed can deliver that unemployment.  In this cycle, the Fed would do that by sacrificing a bunch of Regional Banks and the (huge) family/dynastic wealth tied up in Commercial Real Estate (CRE).

Is the Fed likely to make that sacrifice? 

“All animals are equal, but some animals are more equal than others.”  – George Orwell, Animal Farm.

Here is where messy politics complicates the tidy narrative…    If you only see the forest, you overlook that some trees are more important (and more vocal) than others.  Banking and Commercial Real Estate are VERY important trees – loved and protected by many in power.

Where will a wealthy mob carrying pitchforks and torches go when they look for retribution for their personal losses?  The path from higher rates to the Fed’s doorstep would be obvious.  Especially if that doorstep is littered with dead/dying regional banks clutching defaulted CRE loans.

  • The Fed cares a LOT about the banks.  That is where Fed staffers go to get jobs.  The 48 Senators and 409 Congressmen who are NOT from New York also care a lot about “their” local banks run by their friends and donors.
  • The top 10% cares a LOT about CRE as an asset class.  The Fed wouldn’t be blowing little people out of their homes in Vegas (like 2008).  The Fed would be blowing up dynastic wealth that underpins most “millionaire next door” fortunes outside of the major mega cities.  Commercial Real Estate underpins the fortunes of a lot of Congresspeople themselves, much less their donors and neighbors.  Real Estate underpins the fortune of a deeply selfish Orange-Haired demagogue who doesn’t play fair.  Look at how immediately effective (and comically pained) the SVB’s depositors howls were.  Now multiply those howls from that same class nationwide.
  • The Fed cares MOST about its independence, prestige, and mystique.  Those will all come under attack if they end up blamed for “Blowing up my community’s regional bank and destroying MY family’s hard earned fortune.”  Congress is not full of people inclined to sacrifice for the greater good.  Payback would be brutal.  It might even be pre-emptive.  Facing this well-heeled mob, the Fed likely comes out a shadow of its former self.  The Fed knows that.  It will avoid that conflict.

So the tidy market narrative of “The Fed stays the course and we get a recession” decomposes into messy political reality of “If the Fed stays the course, it would be calling in an airstrike on its own position.” 

Maybe you genuinely believe that steely eyed Powell has the stones to do that.  From what I’ve seen so far, I don’t think he will.  They will cut rates before too many banks go under.

They are playing for time.  Hoping to get some economic softening, lower CPI numbers, and a bit of unemployment.  That gives them a fig leaf to justify the move.  The economic numbers will likely give them that.

But if they don’t get that fig-leaf, they do the rate cuts naked.  Because the path to a deep, unemployment-driving, Phillips Curve Cargo-Cult recession leads through too much pain in sectors that have too much political pull.  That is the messy reality.

The cult of the all-powerful Fed will paper over the (obvious) cracks in their narrative and declare this another great victory.  But the world will know this a little more in its heart;  Interest rates are a blunt-force instrument with wildly differential impacts across different economic sectors.  There are other, better tools for managing the economic cycle.  At some point, the fever dream will break and we’ll go back to a more balanced toolkit.

The lady doth protest too much, methinks. (“used in everyday speech to indicate doubt of someone’s sincerity, especially regarding the truth of a strong denial)”.  Fed quotes from Friday March 24…

  • WASHINGTON, March 24 (Reuters) – St. Louis Federal Reserve president James Bullard said Friday the U.S. likely will need higher than expected interest rates to contain inflation as the economy remains strong and stress in the banking sector likely eases.  (how is stress in the banking system – caused by higher short term rates – going to ease if short term rates go higher than expected?)
  • Federal Reserve Bank of Atlanta President Raphael Bostic acknowledged banking sector woes made the central bank’s interest rate hike call this week challenging, but he said the Fed’s main job must remain focused on getting inflation lower. Speaking in an interview Friday with National Public Radio, Bostic said “there was a lot of debate but this wasn’t a straightforward decision” to raise rates this week even as the banking sector is under stress. But, “we have to get inflation under control and back to our target,” Bostic said.
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