The Rate Cut Mistake

I wanted to comment on the Federal Reserve’s most recent interest rate adjustment. Danielle Kaye reports at the BBC:

The US Federal Reserve pushed forward with an interest rate cut as inflation fears continue to take a backseat to concerns about a stalling labour market.

It came despite the US government shutdown, nearing its one-month mark, which delayed official data and left central bankers “flying blind” about the job market, economists said.

The US central bank said on Wednesday it was lowering the target for its key lending rate by 0.25 percentage points, putting it in a range of 3.75% to 4%.

The Fed last month cut interest rates for the first time since last December. Economists expected the move to jump-start further reductions, but the data drought means the trajectory for future cuts looks murky.

The move was completely predictable for several reasons:

• It’s what the market wanted
• It’s what President Trump wanted
• Unemployment is likely to be rising

I think it’s a mistake for several reasons.

As I have pointed out in the past the Fed governors remain wed to the Phillips Curve despite the curve having been obsolete for thirty years (at least). Since (at least IMO) rising unemployment will be considerably less affected by interest rates than they seem to assume, lowering interest rates won’t be effective. Managers, with visions of reducing overhead in favor of oversold LLM AI dancing in their heads, will reduce payrolls. As I’ll show in a later post that will have a disproportionate effects on retail sales.

Importantly, the move violates what the Taylor Rule would suggest.

The move will be inflationary and higher inflation is the very last thing we need right now. Interest rates should be increased not decreased. Contrary to what they might believe the Fed does not “run the economy” and that is not their already massively difficult dual mandate which does not include ensuring that the DJIA rises.