Fed Cranks Up Inflation Machine

Well, the Federal Reserve cranked up the inflation machine this week, despite acknowledging inflation has moved up and remains elevated.

The FOMC voted 11-1 to cut the federal funds rate by a quarter percent, setting the interest rate between 4 and 4.25 percent, and it projected two more cuts before the end of the year.

In its official statement, the committee expressed concern about the softening economy, noting that “economic activity moderated in the first half of the year,” and that “job gains have slowed.”

However, Federal Reserve Chairman Jerome Powell characterized the rate cut as a move to mitigate risk, not to rescue the economy.

Many market observers took this as a more hawkish sign, assuming the cutting program will be limited.

Metals markets have certainly responded well to the news. Gold is slightly below its highs from earlier in the week here on Friday, but is still up 0.8% since last week's close to come in at $3,686 an ounce.

Silver, meanwhile is seeing a big advance here today and is back up near the $43 an ounce level we saw a few days ago. The white metal currently checks in at $42.92, up 1.3% for the week. This will be the 5th straight week of gains for both gold and silver.

The PGMs are somewhat mixed with platinum up 0.5% to trade at $1,415, but palladium is off 4.3% to come in at $1,165 as of this Friday morning recording.

Although he didn’t use the word, Powell described a stagflationary setup, noting higher unemployment combined with rising inflation.

The only no vote on this week’s FOMC rate decision was recent President Trump appointee Governor Stephen Miran, who advocated for a half-point reduction. But Powell said there wasn’t widespread support for a bigger 50-basis point cut.

The FOMC released its dot plot, indicating two more rate cuts this year. However, the committee now only anticipates one cut next year.

While analysts tend to get all excited about these dot-plot forecasts, they are virtually meaningless.

Fed members are notoriously bad at projecting the trajectory of interest rates, even though they're the ones literally setting the rates.

How bad is their track record?

Well, Fund manager David Hay analyzed past dot plots and found the FOMC only got interest rate projections right 37 percent of the time. And as Hay humorously pointed out, “They control interest rates!”

For instance, in March 2021, the FOMC projected the interest rate would still be zero in 2022. The actual 2022 rate was 1.75 percent. And in 2023, the vast majority of FOMC members thought the rate would still be at zero. The actual rate was over 5 percent.

The FOMC would probably get much better results by flipping coins or throwing darts at the wall.

While the rate cut may provide some relief for an economy buried in debt, it will also ramp up inflation.

The cut will incentivize more borrowing. The downside is that in a fractional reserve banking system, an increase in lending grows the money supply.

Powell said the rate cut put monetary policy in “a more neutral” position. After the June meeting, he characterized policy as “moderately restrictive.” In fact, policy is historically loose and wasn’t even tight at the height of the tightening cycle.

After contracting during the hiking cycle, the money supply has been expanding for well over a year.

This is, by definition, inflation.

Looking at the historical data also reveals that the current interest rate level isn’t high at all.

So, why cut rates? Especially given the CPI data, which indicates inflation is alive and well.

The economy is showing cracks, and Powell acknowledged that he didn’t want to see any further deterioration in the job market.

This underscores the Catch-22 facing the Fed.

Price inflation is clearly alive and well based on the CPI, and monetary inflation is expanding. This would indicate the need to hold rates higher for longer.

However, the debt-riddled bubble economy is addicted to easy money. It simply can’t function in a tighter monetary policy environment.

In other words, the Fed needs to cut rates and hold them higher at the same time.

It appears the central bankers have chosen to try to keep the air in the bubble economy at the risk of unleashing more inflation.

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