The Fed's Stomach

Investment Analysis Clubs Macro Economic Trends and Risks
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Since the decisions of the Federal Reserve affect the entire economy, one would hope that their decisions are data-based and not emotional. The Fed is independent and supposedly not driven by political or market considerations.

To say the Fed needs “stomach” to keep the fed funds rate at a level they judge to be the best for the economy is not only Shakesperian language but implies that they need emotional fortitude to do so. If the Fed Open Market Committee ignores market reactions as they should the investors are the ones who should need “stomach,” not the Fed.

https://www.wsj.com/economy/central-banking/federal-reserve-meeting-interest-rates-inflation-6dcb05e8?mod=hp_lead_pos5

Fed to Signal It Has Stomach to Keep Rates High for Longer

Firmer price and wage pressures could lead longer-term rates to rise as investors continue paring back expectations of cuts

By Nick Timiraos, The Wall Street Journal, April 30, 2024

…
Fed officials will hold their benchmark federal-funds rate steady at its highest level in more than two decades, around 5.3%, at their two-day policy meeting that begins Tuesday. Firmer-than-anticipated inflation in the first three months of the year has likely postponed rate cuts for the foreseeable future. As a result, officials are likely to emphasize that they are prepared to hold rates steady, at a level most of them expect will provide meaningful restraint to economic activity, for longer than they previously anticipated…

While most Wall Street strategists think one or two rate cuts are still possible later this year, the prospect of such a recalibration without clear evidence of economic weakness remains a bigger wild card than it did just a few weeks ago. Some think the Fed might not cut at all…

As financial-market participants anticipate fewer cuts, longer-dated bond yields will rise. In effect, this achieves the same kind of tightening in financial conditions that Fed officials sought when they raised interest rates last year. Higher yields across the Treasury yield curve should ultimately hit asset values, including stocks, and slow the economy’s momentum… [end quote]

None of this should be a surprise to anyone since Fed Chair Powell has repeated that the Fed will be data driven and intends to react accordingly. They are more likely to keep the fed funds rate at its current level for a longer period of time rather than raising it. But they are unlikely to cut if new data appears inflationary. Today, the Labor Department’s employment-cost index rose by a seasonally adjusted 1.2% in the first quarter from the previous three months, and 4.2% from a year earlier.

https://www.wsj.com/economy/central-banking/why-high-interest-rates-could-be-here-for-the-long-run-c6670448?mod=economy_feat1_central-banking_pos2

Even If the Fed Cuts, the Days of Ultralow Rates Are Over

Soaring budget deficits and investment needs mean the ‘neutral’ interest rate may be higher

By Nick Timiraos, The Wall Street Journal, April 28, 2024
…
At issue is the neutral rate of interest: the rate that keeps the demand and supply of savings in equilibrium, leading to stable economic growth and inflation.

For the last 40 years, and especially following the 2008 financial crisis, economists and Fed policymakers steadily revised down their estimates of neutral. This view became embedded in bond yields, mortgage rates, equity prices and countless other assets.

But now, some see reasons for neutral rising, with the potential to change a wide range of asset prices… [end quote]

Fed Chair Powell has stated that the Fed’s intention is to bring inflation sustainably to 2% and then to maintain the fed funds rate at a neutral level. An entire generation of investors has become used to a negative real fed funds rate. They have never experienced real yields of 2% which was the historical level.

Will the stock market maintain its bubble valuation when the 10 year TIPS yield is 2.27% (plus inflation)? I think it’s stock and bond investors who will need “stomach,” not the Fed.

Wendy

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Until taxes go up on higher incomes and corporations along with economies of scale we have sticky inflation.

I have no expectations of rates budging much over the long run. Unless we go to the 1950 90% top bracket rate.

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Expect higher corporate growth rates than in the 1950s.

Debt underpins our economy. These interest rates are much more lucrative than in the 1950s. Plus they maintain the value of the USD.

Sound corporations and other institutions will be buying this debt. Individuals with assets will be buying this debt. All of their incomes will rise fueling very high GDP growth over the longer run.

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Article today in the NY Times explaining that the spending of wealthy Americans is a major driver of inflation, not poor people trying to eat or single mothers on food stamps buying diapers.

Also raising interest rates doesn’t affect the wealthy’s spending. You’d probably need some kind of consumption tax that rises with inflation on household spending above a certain level, say the median income of about $70,000/yr. Preventing middle-class people from buying a home due to high interest rates doesn’t do much to tame inflation while the wealthy can still afford to spend with abandon.

Our current problems are just the fruit of throwing money and tax breaks at the upper 1%-5% of the economic pyramid for the past 40+ years.

intercst

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The whole point of being wealthy is to be able to spend with abandon. In fact, that’s the definition of being wealthy.

Consumption tax is definitely the way to go to increase taxes on the wealthy.
I guess you could give some sort of tax credit for people whose income is below some amount, but then you start to mix income and wealth policies. Perhaps eliminating income tax and replacing it with consumption tax(es) might achieve some smoothing out of the tax burden. But there are no simple solutions - Americans will game whatever system is in place.

In theory, high interest rates should reduce debt being used by unprofitable businesses because no one will lend to them. But apparently big business manages to get around that and strip that capital into the hands of upper management. That sort of thing is probably a good place to begin the legislation change process.

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I’m not so sure that the ultra wealthy spend that much more than the poor or middle class. After all, it’s hard to have a lot of money if you keep spending it. Are their meals out 100X more expensive? Their furniture? The clothes? Groceries?

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Not 100x, but certainly a multiple and not an incremental amount.
But you used the term ‘ultra wealthy’. Those are not the people that can be impacted by Fed policies.

The wealthy are the upper 10% - not the upper 1%.
To Joe Sixpack, the wealthy bracket is probably even lower - say upper 15-20%.

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Quite so. I wouldn’t even know where to start, to blow the $30M/year that Jamie Dimon is handed.

Steve

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Sales tax is just another name for a consumption tax. It’s regressive because the poor spend more of their disposable income than the rich. And how would you keep track of the spending of hundreds of millions of people to know whether their household income is above $70,000 so their sales tax could be jacked up in stores? Absurd.

One reason I chose WA State over Oregon is because WA State has no income tax. WA has a sales (consumption) tax but we LBYM and spend less than our taxable income. OR has a high income tax but no sales tax.

If you want to penalize the rich you could tax luxury goods. That’s been tried before. It raised hardly any tax revenue but did devastate luxury industries such as yacht and small airplane builders. The luxury taxes were repealed.

Property tax is a wealth tax. (Especially if there’s an exemption for low-income people so they don’t lose their homes due to rising real estate market prices.) Most of the poor rent instead of owning homes.

The idea of a wealth (rather than income) tax has been tossed around. It has serious problems such as the impact on small business owners and farmers. Not to mention that it’s hard to calculate wealth exactly since valuations fluctuate. The British managed to wipe out many of their manor homes since the aristocrats were taxed out of them.

@intercst your clever scheme of holding stocks to minimize income while maximizing wealth would not hold up with a wealth tax. Your portfolio would be taxed in good years and bad. Talk about skim!

Wendy

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Not if the lower limit was set fairly high–such as $10-million. Small businesses are mostly smaller than that, as would family farmers.

Stock held by individuals/families also tends to be under that limit. Large holders of major corporate stocks who bought early or inherited from family would likely exceed the limit and be required to pay a wealth tax.

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Exactly! It’s unfair to people who work for a living that I’m able to do that. It’s pretty easy to fix – just end the “stepped up cost basis” for estates and make people pay their capital gains tax on death. It’s fine if you want to exempt the first $1 MM to $5 MM, just to make it easier to manage, but these large multi-generational fortunes need to start paying taxes like working folks

You don’t need to collect a consumption tax at the point of sale, you could calculate it and pay it at year end when you do your income taxes.

intercst

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Corporate taxes, capital gains taxes, and top bracket income taxes are low. Raise taxes moderately. Spend more money on infrastructure. The factory buildout will gain even more traction.

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Why exactly is it unfair? Back when you were 18/19, you started out exactly the same as all those people. You had your high school diploma and then you decided what to do next. You made good choices, got the engineering degree, worked for 15 years, didn’t spend all your money, saved enough to invest and retire at age 38. Most of those other people spent most of their money, or sometimes even overspent, they made different choices than you, but you never got anything handed you that was any different than what they could have chosen. They chose and continue to choose to work for a wage rather than save up enough to retire early and have their money work for them instead. THEIR CHOICE.

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Yes and no, which illustrates the problem.

The wealthy are not spending 100x on food. They might be spending 10x on food but their food expense will become a smaller and smaller percentage of their monthly expenses as their income/wealth grows. Same goes for energy consumption.

The same is not necessarily true for discretionary spending (travel, entertainment, toys, etc.). Louis Vitton bag vs a bag from Kohls.

What that of course means is that food and energy inflation disproportionally hit those with less income and any inflation on such is felt a lot less by the wealthy. They do indeed consume more (even though I think a consumption tax is a bad idea), they just spend it on different stuff.

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I’d start here, building a system for each of my mansions…

DB2

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The ultra-wealthy directly and indirectly finance everyone else. The ultra-wealthy do not have to spend it themselves. They own the debt instruments. They own the means of production. Meaning the corporations can hold debt or sell debt and create financing.

Cutting down the ultra-wealthy means cutting down the future of the US economic expansion. Dumb dumb dumb

Instead developing a higher velocity of money in the US economy with taxation and proper government spending promotes wealth on all income and asset levels.

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Because investment income and wealth is taxed at a much lower rate than wage & salary income. There’s no economic justification for that (e.g., we’ve learned that 40 years of trickle down economics is a scam), indeed economic output would likely be higher if we taxed work LESS and investment income and wealth MORE

intercst

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I don’t see it. Back in the early 80s, Joe and John both graduated college from engineering school and started working. Joe is a spendthrift and likes buying nice new clothes all the time, going out to eat often, and buys those $6.45 coffees at leats once a day. In the 90s, 00s, and 10s, Joe purchased 4 nice new cars, and 3 very nice new SUVs. You know, he really liked to sit up high while driving through the streets. Joe contributes 6% to his 401k to get the 3% match. Joe, despite being single most of the time, was dazzled by a McMansion with a pool and bought it for $650k in 206 because it was a “sure thing” and would go way way up. John, meanwhile, is much more frugal and maxed out his 401k, and even had a bunch of additional savings beyond that. He invested those savings in various companies, and rarely sold things to incur capital gains, and thus minimized his tax bite (even if long-term capital gains were taxed the same as ordinary income, he wouldn’t pay all that much of it). After 15 years of working, John suddenly realized that his savings and investments were sufficient to fund his lifestyle indefinitely. So he took the plunge and retired early.

Now if you look at the reality, Joe continued working for many more years than John did, and he paid all sorts of taxes over the years. His salary went up modestly each year (but, of course, his spending also went up) and he got pushed into higher tax brackets every decade or so. Finally at age 66 Joe decided to stop working, and live off of social security and his 401k that grew nicely over a 45 year career.

Let’s say there were higher taxes on capital gains and lower taxes on wages. First off, it wouldn’t affect John nearly at all because he does his best to not realize capital gains, or to offset them with losses. Meanwhile, Joe, would get an extra $1000 a month in wages. What do we thing would have happened? Do we thing Jow would have saved the $1000? No way. He would have bought an even bigger SUV, and he would have gone out to eat more often, and he would have dated classier people. Maybe he would have a nicer watch on his wrist. Would he work harder because of it? Fat chance, he works for “the man” and “the man” gets 40 hours a week, not including the bs sessions at the water cooler, and the long lunches with his VP who is his lifelong friend. I don’t see his economic output being higher. The only economic benefit might possible be a few more nice restaurants, and perhaps some foreign automaker would have extra profit. And maybe the local bar and jewelry store would have somewhat higher sales.

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I could be wrong, but I think that’s the point. There are far more workers than investors in the US. Flipping the script creates more spending money and drives our consumer based economy.

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That’s fine, but consumer spending has been powering our economy for a long time. Shift the balance too abruptly, and how does pharma (Pfizer back in the 80s) and new tech stuff (Dell back in the 80s) get funded? Since the people with capital have less of it (that’s the shift, less capital to be invested, and more wages to be spent on mostly consumables) some things won’t get funded. Who knows what doesn’t get funded? Also, I have my doubts how useful SUVs, booze, fancy watches, and expensive restaurant meals really are to an economy that should have durable growth.