Bye-Bye, Goldilocks

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Last Friday’s GDP number came in weaker-than-expected at 1.6% annualized, the weakest quarterly gain in almost two years.

I’ve written for months that there would be no interest rate cut by the Fed at their June meeting. Wall Street was putting the odds of a rate cut at around 70% and the stock market was rallying in anticipating the cut.

They were wrong, I was right. That’s not to brag, it’s just that I use a better set of analytic tools than they do.

Today, every top Wall Street analyst is proclaiming there will be no rate cut in June, and maybe not in July either. Thanks, guys and gals. You’re only about three months behind the curve.

That’s worthless forecasting, but it’s what Wall Street does best.

Now there’s a chance that we won’t get any rate cuts this year. So Wall Street has been wrong about rate cuts for almost two years, and they’re wrong now.

Recall, by the late summer of 2022, Wall Street was already talking about the “pivot.”

This was jargon for a rate cut. No one expected it that soon, but early 2023 was Wall Street’s target date for the pivot. That never happened. Wall Street extended the pivot date of mid-2023. Then late 2023. Then early 2024. Wrong, wrong and wrong.

Moving the pivot date from June 2024 to later this year is just the latest blunder.

Pivot Mania

This pivot mania has gone by several other names. One was the “soft landing”: the idea that the Fed had beaten inflation without causing a recession and could put the economy on a sustainable growth path.

In effect, a masterpiece of Fed finesse. Another name was “Goldilocks” on the view that Fed policy was “not too hot, not too cold, just right!” another tribute to Fed finesse.

It’s all nonsense: a narrative designed to lull investors into complacency and to buy more stocks. The truth is the Fed has no idea what it’s doing, the Fed doesn’t matter that much anyway and Wall Street is in the tagalong business, not real forecasting.

One reason Wall Street has been so wrong about forecasting the Fed is that the Fed is wrong itself. With armies of researchers, practically unlimited computing power and supposedly top-flight governors, how can the Fed be so wrong?

The answer is that the Fed models are junk science. Those models will always get the wrong result. If that’s true (it is), and if Wall Street is following the Fed (they are), then Wall Street will get the forecast wrong also. It’s the blind leading the blind.

Explain This, Fed

We can start with the Phillips curve. This model says that there is an inverse correlation between unemployment and inflation. If unemployment is low, one should expect inflation to be high, and vice versa. The rationale is that tight labor markets lead to wage demands that increase spending and feed inflation.

The problem is there is no empirical data to support the model.

In the early 1960s, the U.S. had low unemployment and low inflation. In the late 1970s, the U.S. had high unemployment and high inflation. In the 1930s, the U.S. had high unemployment and low inflation (actually deflation). From 1974-1975, the U.S. had low unemployment and high inflation.

Do you see a correlation there? Stop looking, there isn’t one. The Phillips curve is garbage. There are many causes of both unemployment and inflation, but a strict inverse relationship is not one of them.

The Fed also takes the view that interest rate cuts offer “stimulus” and interest rate hikes offer “monetary tightening.” That’s also garbage.

The Fed Doesn’t Get Interest Rates

During times of severe economic distress (the Great Depression is a good example), interest rates drop to near zero. When economies are booming, interest rates rise because more companies are competing for more funds to expand capacity and to make investments.

Things can go too far. High rates will eventually lead to overcapacity and a recession. Low rates will eventually lead to investment opportunities and a new expansion.

But those turning points happen at the extremes as part of a normal business cycle. In the normal state of affairs, higher rates are associated with good times and low rates are associated with recessions or worse.

The Fed has this exactly backward. The Fed does not lead the business cycle, they chase it.

Another economic indicator the Fed doesn’t understand is consumer confidence (typically reported in a monthly survey by the University of Michigan). The Fed assumes if consumer confidence is rising, that’s a sign that people might be spending more, which can be inflationary. That’s also nonsense.

Not only does consumer confidence not correlate with inflation, but it also doesn’t even correlate with consumer spending. The only strong correlation for the consumer confidence survey is the stock market. If stocks are up, consumer confidence goes up. If stocks are down, consumer confidence goes down. That correlation is strong, but no one on Wall Street or at the Fed has figured that out.

I could go on, but you get the point.

The Fed’s preferred models are either junk or they don’t mean what the Fed thinks they mean. This is at the root of why Fed forecasting is always wrong and why the tagalong Wall Street analysts are wrong too.

No Cuts Anytime Soon

Moving on, the next FOMC meeting is May 1, just days away. It’s clear the Fed won’t cut rates. There are several reasons for this, but the strongest reason is that the Fed doesn’t like surprises.

This is the “no drama” Fed. If they were going to cut rates on May 1, they would have dropped some strong hints by now, and they haven’t. Jay Powell will make his usual statements about waiting for “more data” before deciding to make a move.

The Fed won’t cut rates at the June meeting either. A rate cut at the July 31 meeting is possible, but it’s too soon to tell. We’ll have two more months of inflation, unemployment and GDP data between now and then.

Yet the Fed never turns on a dime. They like to see three months or more of confirming data before changing policy. We’d have to see lower inflation for April, May and June for the Fed to cut rates in July.

Don’t count on it. If the Fed does cut rates in late July, it won’t be for good reasons. It’ll be because the economy has fallen into a recession. But given the boost to U.S. growth from out-of-control government spending in an election year, the recession may be postponed.

So don’t count on a July rate cut either.

There’s no Fed meeting in August. The next meeting after that is Sept. 18. The Fed may be ready for a rate cut by then, but here’s the problem: Sept. 18 is just seven weeks before the election on Nov. 5. The Fed pretends it’s non-political but, in fact, is highly political.

Bye-Bye, Goldilocks

A rate cut in September will be viewed as helping Biden by boosting the economy and hurting Trump. At the same time, Trump is the likely winner based on currently available polling data and trends. The Fed won’t want to be in the position of appearing to boost Biden and hurt Trump if Trump is going to win.

Trump will make the Fed Public Enemy No. 1 and that’s the last thing they want. So the Fed will take a pass in September.

There’s no Fed meeting in October. The next two Fed meetings after that are on Nov. 7 and Dec. 18, both safely after the election. The Fed could cut rates at both meetings. But the Fed has painted itself into a corner on that.

Beginning at the FOMC meeting on March 30, the Fed promoted the narrative that there would be three rate cuts before the end of the year. If they don’t cut in May, June, July or September (for reasons noted above), and there are no meetings in August or October, then the Fed would have at most two rate cuts this year in November and December.

In short, the Fed is running out of meetings in which to conduct three rate cuts and may have to settle for two. Wall Street has already abandoned its expectation of three rate cuts this year. Some analysts are saying there won’t be any. At least one prominent figure, Larry Summers, has warned that the Fed may even raise rates to fight inflation before they start cutting.

Bye-bye, Goldilocks.

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