18 months into one of the fastest, steepest Fed hiking cycles in history, the market myth of an all-powerful Fed is looking pretty… mythical.
A year ago, “Team Interest Rate” was predicting economic Armageddon in January 2022 whilst expecting a MUCH SMALLER hiking cycle. The high estimate for rate increases was about 1.75 points. Those 1.75 points were expected to put the economy on the ropes. A crushing recession was sure to follow. The debate was whether it would be like 2001 (do.com) or 2008 (GFC).
18 months later, the Fed has raised rates by 4.5 percentage points. One of the biggest rate hikes in history. We have seen some impact. How much? We’ll never know. But it is pretty obvious reality has not met prior expectations.
In bumper sticker terms, karma just ran over that dogma…
But most market commentators keep on seeing reality world through the lens of their preferred myths. What and why do they see?
I recently struggled through “The Price of Time: The Real Story of Interest” by a man who believes, deeply, in interest rates. In his economic worldview, interest rates explain everything. Rates drive everything. Rates are… everything?!? It was a little weird (and a turgid read). Yet I’ve seen it cited a few times (like in the FT). So it clearly clicked with some folks out there. People who see the Fed and rates as a one-factor economic driver…
He is sort’ve correct that interest rates REFLECT everything. But do they drive? Or are they driven? Do we understand the world better by looking at the component things that make up “everything?” Or do we understand it better boiled down to a single, desiccated measure of that whole?
The right answer is we should look both ways. Look at the forest and the trees. The market consensus, centered around an unhealthy cult of “hallowed be the Fed.” is only looking at the forest… Breezy talk of “a recession” avoids the specifics of a recession led by what sectors and caused by whom?
The whole over-focus on interest rates (and the Fed) as the “only thing that matters” keeps reminding me of Plato’s allegory of the cave (below). Decades of experience has trained multiple generations to just watch the shadows on the wall…
They see big, messy, vibrant economic and political chaos it reflects. But (perhaps through disgust at that chaos?) they deeply believe the flickering shadows hold some greater truth than the chaos reflected. Reality just goes on its untidy way.
In sum: A lot of investors and reporters have grown up with a deep belief that “everything” can be explained by fine-grained movements of the Fed’s short-term interest rate target. This faith was never well supported by academic economics or the Fed’s own research output. Reality itself is also not cooperating.
Wikipedia – Allegory of the Cave https://en.wikipedia.org/wiki/Allegory_of_the_cave
In the allegory “The Cave”, Plato describes a group of people who have lived chained to the wall of a cave all their lives, facing a blank wall. The people watch shadows projected on the wall from objects passing in front of a fire behind them and give names to these shadows. The shadows are the prisoners’ reality, but are not accurate representations of the real world. The shadows represent the fragment of reality that we can normally perceive through our senses, while the objects under the sun represent the true forms of objects that we can only perceive through reason. Three higher levels exist: the natural sciences; mathematics, geometry, and deductive logic; and the theory of forms.
Socrates explains how the philosopher is like a prisoner who is freed from the cave and comes to understand that the shadows on the wall are actually not the direct source of the images seen. A philosopher aims to understand and perceive the higher levels of reality. However, the other inmates of the cave do not even desire to leave their prison, for they know no better life.