It’s all about the Fed?

Earlier today, I heard a CNBC commentator discussing today’s decline in stock prices. He said something to the effect, “It’s all about the Fed.” In fact, it’s rare that there is a day when it was so little about the Fed. Yes, higher interest rates played a role in lower stock prices, but these interest rate movements had nothing to do with the Fed.

There was no Fed meeting today, nor were there any important speeches. Instead, interest rates shot up after a strong jobs report.  You can think of rates being influenced by several factors.  The Fisher effect and the income effects impact the equilibrium rate of interest.  In addition, the Fed has some ability to move short-term rates above or below the equilibrium rate of interest.  Today’s jobs report probably led to slightly higher expected growth in nominal GDP (both higher inflation and higher real growth.)  That’s why interest rates rose—it had nothing to do with the Fed, at least in the way that most people think about Fed policy.  (One can argue that the strong growth partly reflects previous Fed stimulus, but of course that’s not what the reporter meant.)

Some people say interest rates rose in expectation of future Fed rate increases.  That’s putting the cart before the horse.  Expectations of the future fed funds rate rose because market interest rates rose today.  The Fed mostly follows the market.

Today’s jobs report also revised several previous reports.  The peak unemployment rate in 2024 was revised down from 4.3% to 4.2%, making a “mini-recession” less likely.  (I define a mini-recession as an increase in the unemployment rate of at least one percentage point.)  The cyclical low in unemployment was 3.4%, so it would have to reach 4.4% to rise by enough for me to consider it a mini–recession.  Last summer when the unemployment rate was reported as hitting 4.3%, I thought that outcome was very likely to occur; now I’m much less sure.  At the same time, I’m increasingly less confident that the Fed has inflation under control.  These two issues are related, as the Fed is trying to walk a fine line between too little NGDP (with a risk of recession) and too much NGDP (leading to high inflation.)

To summarize, the soft landing hypothesis is still quite plausible, but not certain.  If inflation falls below 2.5% in 2025 and unemployment stays low, then I would view it as a soft landing—three years with very low unemployment and low inflation.  It would be the first soft landing in US history.  A trade war would make a soft landing more difficult to achieve.  As always, an NGDP growth rate of 4% makes a good outcome more likely.  My hunch is that we won’t land at all in 2025–inflation will stay elevated due to high NGDP growth.  I hope I’m wrong.