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Stability Over Speed: The Argument Against Quick Rate Cuts by the Fed

With inflation still painfully high after a year of aggressive tightening, the Federal Reserve faces mounting pressure to pivot and begin cutting interest rates. But while many in the market want quick cuts, working families cannot afford a premature policy shift. The prudent course is to hold rates steady until inflation shows clear signs of cooling. 


Prices Continue to Inflict Damage

The overall inflation rate sits at a stubbornly high 3.4% as of December, well above the Fed’s 2%

target. Core inflation excluding food and energy remains even higher at 3.9%, an alarming sign that broader price pressures persist.


In essential spending categories, the damage has hit the hardest. Grocery costs have climbed 20% over the past three years while medical care jumped a staggering 26%. New and used vehicle prices also saw double-digit spikes, surging over 20%.


This rapid inflation has eroded purchasing power substantially. It now takes $1.19 to buy what $1 did before the pandemic – a 19% loss of value. Families are feeling squeezed across all categories from the gas pump to the grocery aisle. 


Meanwhile, wages struggle to keep up. For typical households, earnings only rose about 4% – far below the rate of inflation. This growing affordability crisis hits lower-income Americans the hardest. Providing them with relief must be the Fed’s top priority.


Demand Seems to Be Outstripping Supply

Though some data points show weakness, the job market remains resilient overall.  The

3.5% unemployment rate sits near 50-year lows. Jobless claims recently hit a 54-year low.

Retail sales also held up reasonably well during the critical holiday shopping season despite predictions of major consumer pullbacks.


While manufacturing activity and employment softened, this appears driven more by supply chain difficulties than lack of demand. In fact, demand seems to be outstripping supply across sectors – a scenario that risks even higher inflation if unchecked.


The combination of still-strong demand and ultra-tight labor markets indicates the economy has yet to slow enough to tame inflation. Additional stimulus now could further imbalance supply and demand, pulling prices higher.



Working Families Need Stability and Affordability

After a turbulent 2023 saw the most aggressive Fed tightening in decades, expectations are growing that the central bank will pivot to lowering rates at some point this year.

In particular, the Fed’s impending leadership change is fueling speculation of dovish moves. Chair Jerome Powell has stated he will not seek reappointment when his term ends in 2023, regardless of the election outcome.


Knowing his legacy will be defined by the inflation fight, analysts believe Powell wants to re-establish his inflation-fighting credentials before departing. This may incentivize overcorrecting with excessive rate cuts on the way out.


But working families living paycheck to paycheck need stability and affordability – not Wall Street stimulating the economy into further turbulence.


Inflation Must Remain Priority #1

The latest GDP estimates do not indicate the US economy is in immediate crisis. The Atlanta Fed’s GDPNow model predicts fourth quarter growth of 2.4% - not stellar but far from recessionary.

With demand still outpacing supply and the job market tight, the primary risk remains prices spiraling upwards, not economic collapse.


The government has already provided monumental fiscal stimulus during the pandemic – over $5 trillion since early 2021. Congress just passed a near $2 trillion budget with an enormous deficit.


The prudent course is to keep the Federal Funds target rate – currently between 4.25% and 4.5% — right where it is for the foreseeable future. The Fed should also continue unwinding its enormous $8.5 trillion balance sheet to tighten liquidity.


Only after several months where inflation shows definitive signs of approaching the 2% goal should rate cuts be on the table. 


How Investors Can Position for Changing Rates

Once inflation shows real improvement, Fed rate cuts may indeed materialize later in 2023 or 2024. When this shift happens, investors should be ready to capitalize in their portfolios.


Certain sectors and asset classes stand to gain substantially from declining rates:

Real estate: Cheaper financing costs would reinvigorate housing demand. Investors can play this through homebuilder stocks and real estate ETFs.

Bonds: Lower rates drive up prices on bonds. Increase exposure to long-term Treasury and investment-grade bonds.

Stocks: Some sectors like utilities and consumer staples benefit from lower rates. Dividend payers would also become more attractive.


Expect muted stock market gains compared to real estate and bonds. With economic uncertainty lingering, valuations are already elevated.


Investors should position wisely as the Fed’s policy evolves – neither ignoring the risks, nor being overly conservative. The eventual shift to rate cuts will create opportunities across markets.


Until then, the Fed’s duty is to keep the pressure on prices, not cave to election politics or Wall Street’s thirst for stimulus. With inflation still inflicting damage, working families need monetary policy that prioritizes genuine stability over short-term gains.


Remember, as markets change opportunities change as well, and even though there are many voices, it is best to stay abreast of how these changes will affect you. 


Thanks for reading our blog.

— Joshua Dudgeon

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