Musings: Just How Far Will the Fed Go to Beat Inflation?

Question

I think that a lot of people dismiss the actions of the Federal Reserve right now. They feel that they are all politicians and won't allow the economy to slide.

I'm not so sure. I'm going to argue (or "muse") here, that the stars have aligned, giving Jerome Powell and the Fed a clear mandate and little in the way of distraction to doing whatever it takes to beat inflation.

And, at the risk of involving politics, I'm going to give my take on the situation and open up the discussion, because I feel that understanding how politics, interest rates, and real estate intersect is vital to the best interests of the people on this forum.

Going back in time into the 1970s and 1980s, we've seen that the Fed is willing to push interest rates as high as they need to go to fight their first enemy - inflation, and that they are willing to conduct brutal monetary policy that affects jobs to do that.

I also observe that the Federal minimum wage has not increased since 2010 - we have the lowest real minimum wage in this country that we've had in nearly 70 years - since the 1940s and 1950s. It's hard to see how unemployment can increase right now in a meaningful sense when the minimum wage is this low - and it's hard to see how a big wage hike passes at this point. Instead, I think that we will simply see real wages fall relative to inflation. And the faster the pace of inflation, the lower the real minimum wage over the next few years.

That's really important for investors, because the Fed's dual mandate is to keep both inflation and unemployment low. Unemployment is likely to remain low simply due to the fact that the minimum wage is so low, giving the Fed wide room to run in tackling inflation - again, what I like to refer to as their "first" enemy. It will be really hard for unemployment to skyrocket right now, even if the Fed keeps a lead foot on the accelerator of rising interest rates for some time to come.

Last, I wonder, with the Republicans predicted to pick up a lot of seats in November, whether the Fed is likely to attempt to stimulate a Biden Administration economy at this point. If I'm Jerome Powell, my task is clear - beat inflation. It's not to save the economy to support the Biden Administration. I can't really see a political advantage for him in doing that at this point - his term ends in 2026, and I think many people would not bet on Joe Biden being in office at that point. This is yet more reason for Powell and the Fed to go after inflation with a single-minded focus.

I think that there is no real political incentive for Powell to save Joe Biden's administration at this point in time.

I don't think the stars could align any more than they are currently for Jerome Powell and the Fed to have carte blanche to attack inflation, and I think that they will do whatever they feel is necessary to beat it.

Investors beware.

I personally will not underestimate Jerome Powell right now.

Crisselda Clark · Answer

I definitely think it a time to tread cautiously and with intention, tighten up underwriting, maintain a level of liquidity to weather the current cycle. However I do still think there are opportunities popping up, just takes a different set of guidelines and creativity.

Elbert O. · Answer

While I wouldn't be surprised to see another hike next month, I don't think the Fed has the same kind of room to spike rates the same way we did in the 80s. Our debt is substantially more today and massive spikes could lead to the federal government defaulting on loans. Also, I think it's in the Biden Administration's best interests to tame inflation and accept what would hopefully be a minor recession.

Nick Barlow · Answer

@Scott Trench I agree with what @Elbert O. Said-debt levels are much higher today, and government solvency is at Risk if we sustain higher interest rates for a long term.Not getting too political, but higher costs leads to either default, or a combination of higher taxes and rationalizing social services/entitlements, and reducing the latter is politically damaging.In my opinion, the Fed has a ceiling on interest rates, and I think we’re getting close to it.I also think we won’t know that exact number until we’ve passed it, which we will, and they’ll be back to QE by end of year fixing the damage from “over correcting the response to inflation”.

Scott Trench · Answer

One additional thought: The leverage associated with rate hikes has never been higher than it is today. Moving rates from 5% to 15% is a massive jump that we saw in the 1980s. That happened in 5 years. Today, could go from 0% to 5% in a matter or a year or two. That's a much greater relative increase for most investors, homeowners, and CEOs to deal with than the 5-15%. Mortgage rates jumping from 3% to 8% over the next 3-5 years is an even bigger relative increase than rates going from 8% to 18%, in percentage terms. And with rates so low, every hike has a relatively greater percentage impact on payments and prices. Don't underestimate the Fed, and don't underestimate how the reverse leverage of rising rates can't compound losses. Don't get me wrong either - I'm still in real estate, and investing with a long-term focus. But, I'd hate to have time dependent investments (like development projects or 2-5 year syndication holds) right now.

Scott Trench · Answer

I hope extremely low

Karl B. · Answer

The Fed is finally going to do their job and there will be a lot of catching up to do. They use terms like 'unconditional fight' and 'whatever it takes'; they should have upped one full point as they have much more raising to do before they're going to get inflation back to 2% which is where the Fed claims they want to return to.

Jonathan R McLaughlin · Answer

@Elbert O. The fed has been consistently clear about their intentions. The short term bond market (ie 2 year treasuries) has baked in another 1.25 % rise in the prime rate over the next year or so. If you look at the forward curves, the expectation is these increases will allow the fed to ease off in about 3-5 years. Next pres. will be loving that.All the talking about “tanking the economy” is standard issue self interest in the part of big banks trying to keep their borrowing cost as low as possible for as long as possible.

Jeremy H. · Answer

No they will purposefully trigger a recession - they may kick the can down the road a little bit but it's a loss one way or the other...inflation goes up people can't afford stuff...recession we lose a few jobs and control inflation. Unemployment has room in increase, so we will see a recession, in my opinion

Bruce Woodruff · Answer

The Fed is limited in what it can do once inflation gets rolling....If you lived through the 70's and 80's, you remember the efforts of the Fed and it's seeming inability to stop inflation. Even Ford's famous slogan WIN (Whip Inflation Now) did nothing, a big surprise :-) And they have to be careful not to trigger a recession by screwing around too much with rates.The rate now is 8.3 with the high of the 70s being 11.3 (I think), so we are down 3. It peaked in April of 1908 at 14.76%, and went down quickly once Reagan took office. Sometimes it the perception of who is in power that drives this stuff.I expect it to continue upwards for a couple years. Will it reach even 15%? Maybe so........

Jeremy H. · Answer

So we'll just raise the debt ceiling...