No One Will Save Us When Stagflation Attacks
A cut to the Fed Funds rate appears in the cards, but what will it really do in the face of economic challenges ahead?
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The Federal Reserve has been in the spotlight over the past few days. On Friday, Chairman Jerome Powell provided dovish commentary from Jackson Hole. This pushed up the probably for a rate cut at the Federal Open Market Committee meeting in mid-September to above 90%. This ignited a large rally in the markets to close out last week on a high note. This week, the POTUS became the first president in history to fire a Federal Reserve board member. Whether that dismissal actually sticks, is another matter all-together.
I find it both amusing and alarming that so many investors appear to be looking at a rate cut as the trigger for the next leg up in an already overbought market. A quarter percentage point cut in interest rates will do little to alleviate the pain in the moribund and struggling housing market. There is also no guarantee mortgage rates will follow the Fed Funds rate down as well. After all, average mortgage rates are higher now than they were when the Fed last cut rates, and by a half percentage point, back in September of 2024.
In addition, it is hard to have much faith in the current leadership of the Federal Reserve, or the regime before that for that matter. This is same chairman that called inflation "temporary" and "transitionary" throughout most of 2021, before embarking on the most aggressive monetary tightening since the days of Paul Volcker. This is the same leadership that increased the monetary supply by more than 25% in 2021 alone in response to Covid. The central bank also purchased mortgage-backed securities, helping to drive mortgage rates below 3%. The growth in the money supply was a huge factor in the large rises in nearly all assets including equities and real estate. As well as the huge spike in inflation that followed. This also was the same chairman that cut rates by a half of a point just before the November election when inflation was at higher levels as well. This followed a downward revision of more than 800,000 jobs over a year by the Bureau of Labor Statistics that August.
More importantly, the war against inflation is hardly won at this point. One can make the cogent argument that the next move in inflation is higher, not lower, despite justifiable concerns around slowing economic and job growth. The impacts from the new tariff policies haven’t been fully felt by consumers yet. Corporations have taken the bulk of these new levies. It is likely, however, more of these additional costs will eventually be passed along to end consumers.
Electricity costs in many regions of the country like Maryland and New Jersey are increasing at a much faster rate than overall inflation. This is likely to continue as new AI data centers get built out, given their huge drain on the electrical grid. In addition, insurance premiums for many healthcare plans are projected to have large jumps starting in 2026.
Combined this with anemic growth globally, this is a recipe for stagflation in the coming quarters. Something that most definitely is not priced into the current market that is trading at extreme levels using numerous traditional valuation metrics.
The cavalry isn’t coming and the market reaction to interest rate cuts is unlikely to be what some investors are pining for.
At the time of publication, Jensen had no position in any security mentioned.
