The Fed may not be as almighty as Fed officials believe. The FOMC has raised the federal funds rate aggressively by 525bps since March 2022. Their goal was to slow economic growth to subdue inflation. Yet the economy grew rapidly during Q3 and the unemployment rate has remained below 4.0% since February 2022. Nevertheless, inflation has moderated significantly since last summer (chart).
Inflation seems to be to be mostly a transitory problem, after all, caused by the pandemic. Maybe labor shortages are stimulating a productivity growth boom. And, maybe retiring Baby Boomers are saving less and spending more. Perhaps, the Fed's Phillips Curve model is flawed. Solid economic growth is disinflationary rather than inflationary if it is productivity-based.
Even the credit markets aren't following the Fed's game plan. Today's Senior Loan Officer Survey (SLOOS) showed that credit conditions actually eased a bit in October's quarterly survey (chart). Last week's plunge in bond yields also eased credit conditions raising some concerns that the Fed may have to raise the federal funds rate if the Bond Vigilantes stop doing their heavy lifting in the bond market.
We are expecting that the FOMC will remain on pause and that the committee may conclude that growth isn't inflationary after all, but rather disinflationary because productivity is making a comeback. That's our story, and we are sticking to it.
