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Warren Buffett has a famous quote about one’s reputation. He said it “takes 20 years to build a reputation and five minutes to ruin it.”
The Federal Reserve learned the hard way about earning respect and a reputation for making tough decisions.
That’s because it played a key role in worsening the 1970s stagflation fiasco. Back then, the central bank expanded the money supply and lost control of inflation expectations. It took a heavy hand from Fed Chair Paul Volcker – who raised the short-term fed funds rate to nearly 20% in the early 1980s – to finally stamp out inflation.
Volcker’s move triggered a recession and pushed the unemployment rate to over 10%… but it helped establish the Fed as a credible force.
Following its most recent meeting, though, confidence in the Fed is on shaky ground once again as stagflation fears rise.
Uncertainty around the Fed is popping up in numerous places, and this time the stakes couldn’t be any higher…
Deep Divisions Emerging
The internal workings of the Fed appear uncertain and broken, and comments from the central bank aren’t instilling much confidence.
The Fed cut rates by 0.25% for the first time this year (as widely expected). Yet deep divisions and disagreements are emerging as inflation runs hot and the labor market weakens.
Even Fed Chair Jerome Powell stated that it’s “challenging to know what to do.”
Dissention among the Fed’s rate-setting committee is running high. The Fed releases projections on where things like the fed funds rate and economic growth could be heading.
While the median projection calls for two more rate cuts this year, it was far from unanimous. After all, seven of the 19 officials saw no more cuts needed this year.
The Fed’s rate cut also seems to contradict changes to its own outlook. The central bank actually raised growth estimates for each of the next three years.
But worst of all is the Fed’s views on inflation. That’s because the central bank is now forecasting that consumer inflation will not return to the 2% target until 2028.
And yet the Fed cut rates anyway.
The central bank officials’ lack of cohesion on tackling inflation versus concerns about the labor market threatens the Fed’s credibility and presents uncertainty for investors.
It’s hardly the only challenge facing the Fed.
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Loss of Confidence
Not only are internal divisions growing within the Fed, but external pressure is building as well.
Besides President Trump’s frequent verbal criticisms of Powell on social media, the Trump administration is taking to the courts to attempt to fire a Fed governor for the first time in history.
There’s also uncertainty over who will ultimately replace Powell as chair next year… and if Powell will even remain on the Board of Governors until his term ends in 2028.
It all poses a massive risk to confidence in the Fed and its ability to operate independently.
The stakes couldn’t be any higher. The Fed is the most important central bank in the world. Its decisions on monetary policy reverberate throughout the global economy… impacting everything from borrowing costs to stock prices.
At a time when federal debt has ballooned to $37 trillion and investors face a stock market bubble rivaling the 1990s’ dot-com boom and bust… the Fed’s ability to navigate uncertain times is being tested like never before.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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