Markets by Trading view

The Real Reason US Interest Rates Are Staying High

Federal Reserve relaxes Volcker Rule

Federal Reserve relaxes Volcker Rule

The Western financial media has got itself into a lot of bother over the Federal Reserve’s interest rate policy in recent months.

At the start of the year, the narrative from the FTBloomberg, and others was that lower rates in the US were inevitable. “The Fed’s battle against inflation is almost complete,” wrote a FT columnist in January. “Central bankers gear up for interest rate cuts,” another opined. “How low will rates go?” they asked.

To be fair, this narrative was encouraged by the Chair of the Fed himself, with Jay Powell saying on several occasions in February that the Fed expected to make three quarter-point cuts in 2024. Markets also started to price in substantial interest rate cuts.

But to many commentators, it was obvious that this did not make any sense at all. It was clear at the time that inflation in the US had become persistent and, indeed, that prices were poised to start rising again rise. Disruption Banking asked in February: “what’s going on at the Federal Reserve?”

“Officials at the US central bank seem to be in complete denial over a looming round of inflation that appears to be practically guaranteed in Western markets. The disruption to supply chains caused by Houthi attacks on commercial shipping in the Red Sea is causing billions of dollars’ worth of goods destined for Europe and the US to be diverted around the Cape of Good Hope, delaying delivery times by up to a month.

With shortages already appearing in some industries, higher prices in the US and elsewhere are highly likely. The prospect of higher inflation means that monetary easing – which would only serve to fuel even higher prices – should be off the table.

Despite this, central bankers in the States are suggesting that a cycle of rate cuts could be about to start. While taming expectations of an imminent decrease next month, Chairman Jay Powell suggested in an interview earlier this week that the Fed still expects to make three quarter-point cuts in 2024. Powell also said that “almost all” of the members of the Federal Open Market Committee (FOMC) think that the Fed will be lowering rates at some point this year.

Such talk, just at the time when prices could be about to start rising again, is bizarre.”

It seems likely that the FT and others were engaged in fanciful thinking over interest rates because 2024 is an election year in the US and they were desperate to see rates come down and the economy to get a boost to strengthen the Biden vote. However, with inflation persistent and the economic impact of high rates starting to become unignorable, with a strong dollar undermining US manufacturing for example, they have been forced to pivot.

Rather than acknowledge their misjudgement, they have instead opted to try and square the circle. The FT now reckon that “the US economy is too strong to cut rates.”

This is sheer doublethink. There is only one reason that the Fed cannot cut rates – and that is because inflation has not been defeated. Inflation remains at just under 3.5%, almost double the Fed’s target. And in reality, prices are continuing to rise much faster than most people realise, or most central bankers acknowledge.

Indeed, Larry Summers, former US Treasury Secretary and prominent Democrat, revealed recently that, using the formula the same formula the government used to use, inflation reached almost 20% in 2022. By including the cost of things such as mortgage interest payments, auto loan interests, and credit card interest, which were included in the inflation calculations until the early 1980s, a starker picture is revealed which challenges the view that the Fed has managed to get prices under control in a particularly meaningful way. 

This would also help explain why Americans are saying that the cost of living is becoming so painful, despite central bankers insisting the economic picture is rosy. In January 2024, 63% of US adults said that recent price increases have caused severe or moderate financial hardship for their household. 17% said that rising prices have caused severe financial hardship. This simply does not chime with the Fed narrative of an economy so “robust” that they do not need to cut rates.

The real reason that interest rates are staying high in the US is that inflation is also staying high – and Americans are continuing to feel the pain caused by higher prices.

Author: Harry Clynch

#Inflation #InterestRates #FederalReserve #US

One Response

  1. Expecting clear thinking and objective decisions during an election year may be the new definition of insanity. Take a hard-look at our unemployment and employment numbers as reported and how they’re adjusted 3 months later…. to the actual numbers… And you will see the obvious effects of an election year on objective government reporting.

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