Feeling the Fed Squeezing You Yet ?

In debate on whether Fed policy is 'accommodative' or restrictive, inflation is running above 8% with rates only above 3%; to many, this means the Fed is still accommodative.

In contrast, Fed policy is restrictive if you look at forward looking real rates or financial conditions.

The further you look out on real rates (this is comparing longer-term nominal rates with similarly termed inflation expectations rather than current CPI), the more the market is pricing in a level of confidence in the Fed rather than necessarily rates out the curve.

That said, something like one year inflation expectations one year out are presumably actual real rate forecasts and, thus, somewhat restrictive based on that way of looking at rates.

Notably, the Taylor rule would suggest the Fed should be cutting rates right now (!), albeit from a much higher level. One can plug in different parameters into the Taylor rule and argue about the level, but different parameters still lead to an easing at this stage.

Of course that's the Fed's problem: late raising, late cutting. Fmr St Louis Fed President & Merk Senior Economic Adviser Bill Poole suggests to eliminate the Fed's discretionary power and peg the Fed Funds rate to an average of CPI & unemployment:

Looking at financial conditions as an indicator on whether the Fed is accommodative or tight, there are different ways of looking at them, but a clear sign that tightening is happening is funding stress starting to tick up -- an international phenomenon, but noteworthy.

Funding stress is noteworthy because of its potential spillover into US financial markets. Remember the Fed's top priority is financial stability no matter what they say about inflation and employment.

The BoE is currently trying to have it both ways, raising rates while engaging in QE. The same with the ECB, by the way, as they are raising rates while promising to keep peripheral spreads from blowing out. Let's see whether the Fed will try to similarly square the circle.

On a side note, my youngest daughter says squaring the circle is easy: you just cut the corners. We'll find out whether it's just as easy for global central banks.

For a deeper dive, see our latest business cycle chart book, published this morning:

Let me know whether you like this format of sharing information.

-Axel

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