A lot of experts (most of them ex-governors of the Fed) are insisting that the Fed should lower their target fed funds rate, and many of them are saying the Fed should do it now instead of waiting until its next meeting on Sept. 18. After looking at the two charts below, I can see why they are so insistent.
First is the latest version of the inflation chart I've been posting periodically, showing two versions of the inflation rate on Personal Consumption Expenditures (PCE), and also the inflation rate perceived by the buyers of 10-year treasury notes. All three measures imply that inflation is not just falling, but plummeting. That's disinflation (...and, if and when it falls below zero percent, it's deflation.) Click to enlarge:
Based on that chart, it looks as if we now have disinflation (a falling inflation rate) in consumption goods. But the pundits are also pointing to falling asset prices (houses) that may be a precursor to more downward pressure on consumption goods prices. That's a double-whammy, and it's the reason several ex-governors are clamoring for a reduction in the fed funds rate soon. They do have opponents who say a reduction is premature or unnecessary; however, I'm with those calling for a reduction. Reason: I have a strong dislike for inflation, and an even stronger dislike for deflation.
The Fed's primary job is to maintain a stable value for the dollar. That's nearly unanimous; the few who disagree seem to think the Fed's job is to maintain a stable supply of dollars, as opposed to a stable level of purchasing power for the dollar... but even the Fed Board of Governors says the first of its four duties is the pursuit of "stable prices"—not "stable money supply" (see The Federal Reserve System: Purposes and Functions). Not only is the dollar not stable when it is inflating unexpectedly, it is also not stable when it is deflating. Unexpected inflation hurts lenders (eg, banks and savers), deflation hurts borrowers (eg, businesses and entreprenuers), and both conditions hurt the economy. The Fed exists to prevent both situations, if it can. To prevent the pain of inflation, it typically increases the target fed funds interest rate; to prevent the pain of deflation, it typically decreases the target rate. [Because the Fed cannot lower its target below zero, it needs room to maneuver, and that's one big reason why its target rate is usually in the 2% range.]
Another of the Fed's four duties, by the way, is "maintaining the stability of the financial system and containing systematic risk that may arise in financial markets." And that brings us to the second chart, showing what looks mysteriously like an unannounced rate reduction by the Fed (see white line).
The target rate is still 5.25% (green line); but the Fed's open market actions have managed the actual result (white line) to 4.92% average since mid-August. I strongly suspect the liquidity crisis two weeks ago, plus the market's flight to the safety of short-term US Treasury bills (possibly still in progress), go a long way to explaining why. I'm just wondering if it's a signal that the Fed will in fact lower its advertised target rate one day soon.
It looks like a duck, and it walks like a duck; maybe the Fed should start calling it a duck.
In any case, the stock market has already priced a Fed rate cut into stock prices, according to many of the pundits. If the Fed does not do it by Sept. 18, I'll be surprised at that—but I wouldn't be surprised if the market then reacted with an immediate nosedive.
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Source data:
• Inflation rate, PCE
• 10yr T-notes
• 10yr inflation-protected treasuries
• daily fed funds rate
• 3-month T-bill rates
My theory of the Cold War is that we win and they lose. What do you think about that?
