Here are the three things the Fed did wrong and what it’s still not getting right

The exterior of the Marriner S. Eccles Federal Reserve Board Building is seen on June 14, 2022 in Washington, DC.

Sarah Silbiger | Reuters

After years of being a beacon for financial markets, the Federal Reserve suddenly finds itself in doubt as it attempts to navigate the economy through a nasty surge in inflation and away from ever-darkening recessionary clouds.

Complaints surrounding the Fed have a familiar tone, with economists, market strategists and business leaders weighing a range of policy mistakes they see fit.

Essentially, the complaints center on three issues for past, present and future action: that the Fed has not acted fast enough to tame inflation, that it is now not acting aggressively enough even with a series of rate hikes, and that it is should have better seen the current crisis coming.

“You should have known inflation was widening and firming,” said Quincy Krosby, chief equity strategist at LPL Financial. “Why didn’t you see that coming? That shouldn’t have been a shock. This is a cause for concern in my opinion. But it’s the man in the street against the graduate students.”

In fact, consumers had voiced concerns about price hikes long before the Fed began raising rates. However, the Fed stuck to its “temporary” script on inflation for months before finally delivering a meager quarter-point hike in March.

Then things suddenly sped up earlier this week on news that policymakers were getting more serious.

“It just doesn’t go together”

The path to Wednesday’s three-quarter-point rise was peculiar, especially for a central bank that prides itself on its clear communications.

After weeks of officials insisting that a 75 basis point hike was out of the question, a Wall Street Journal report Monday afternoon, with little byline, said more aggressive measures were likely to come than the proposed 50 basis point hike. The report was followed by similar reports from CNBC and other outlets. (A basis point is one hundredth of 1 percentage point.)

Apparently, the move came after a consumer sentiment survey released on Friday showed expectations for longer-term inflation were rising. That followed a report that the consumer price index rose 8.6% last year, ahead of Wall Street’s expectations.

Addressing the notion that the Fed should have been more prescient on inflation, Krosby said it was hard to believe the data points could have caught central bankers so off guard.

“They’re coming up with something that just doesn’t add up, that they didn’t see that before the blackout,” she said, referring to the time leading up to Federal Open Market Committee meetings, when members are forbidden from speaking to the public to turn.

“You could applaud them for moving fast and not waiting six weeks [until the next meeting]. But if it was so bad you couldn’t wait six weeks, how come you didn’t see it until Friday?” Krosby added. “That’s the market’s view at this point.”

Fed Chair Jerome Powell did himself a disservice at Wednesday’s press briefing when he insisted there are “no signs of a broader slowdown that I can see in the economy.”

Indeed, on Friday, an economic model from the New York Fed indicated elevated inflation of 3.8% in 2022 and negative GDP growth in 2022 and 2023 at minus 0.6% and minus 0.5%, respectively.

The market did not take kindly to the Fed’s actions as the Dow Jones Industrial Average lost 4.8% this week, falling below 30,000 for the first time since January 2021, erasing all gains since President Joe Biden took office.

Why the market moves a certain way in a certain week is generally impossible to guess. But at least some of the damage appears to have come from impatience with the Fed.

The need to be bold

Though the 75 basis point move was the largest single-session hike since 1994, investors and corporate leaders feel the approach still reeks of incrementalism.

After all, bond markets have already priced in hundreds of basis points of Fed tightening, with the 2-year yield rising about 2.4 percentage points to about the highest level since 2007. The fed funds rate, on the other hand, is still only in a range between 1.5% and 1.75%, far behind the six-month Treasury bill.

So why not just make it big?

“The Fed is going to have to raise rates much more than they are doing now,” said Lewis Black, CEO of Almonty Industries, a Toronto-based global mining company for tungsten, a heavy metal used in a variety of products. “They have to start getting into the high single digits to nip this in the bud because if they don’t, if that really catches on, it’s going to be very problematic, especially for those with the least.”

Black sees the impact of inflation up close, beyond the cost of capital to his business.

He expects workers at his mines, which are mostly based in Spain, Portugal and South Korea, to start demanding more money. This is because many of them were using readily available mortgages in Europe and will now face higher housing costs as well as a sharp increase in the daily cost of living.

Looking back, Black thinks the Fed should have started raising rates last summer. But he thinks pointers are useless at this point.

“Ultimately, we should stop looking for culprits. There was no choice. This was the best strategy they felt for dealing with Covid,” he said. “You know what to do. I don’t think with the amount of money that’s floating around you can say they can just say, ‘Let’s add 75 basis points and see what happens.’ That won’t be enough, that won’t slow it down. What you need now is to avoid a recession.”

What’s happening now

Powell has repeatedly said he believes the Fed can make its way through the minefield, notably quipping in May that he believes the economy can have a “soft or soft” landing.

But as GDP tumbles for a second consecutive quarter of negative growth, the market has its doubts and there is a sense that the Fed should simply acknowledge the painful path ahead.

“Since we’re already in a recession, the Fed might as well go bust and give up the soft landing. I think that’s what investors are looking for now in the near term,” said Mitchell Goldberg, President of ClientFirst Strategy.

“We could argue that the Fed has gone too far. We could argue that too much money has been spent. It is what it is and now we must correct it. We have to look ahead now,” he added. “The Fed is way behind the inflation curve. They have to act fast and they have to be aggressive, and that’s what they’re doing.”

While the S&P 500 and Nasdaq are in a bear market — more than 20% off their recent highs — Goldberg said investors shouldn’t despair too much.

He said the current run of the market will end and investors who keep their cool and stick to their longer-term goals will recover.

“People just had this feeling of invincibility that the Fed was going to come to the rescue,” Goldberg said. “Each new bear market and recession seems to be the worst in history and that things will never be good again. Then we step out of everyone with a new set of stock market winners and a new set of winning sectors in the economy. It always happens.”

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