Issues & Insights

The Fed’s Mis-Step

Stefan Fussan

The Fed’s half-point interest rate move at an emergency meeting was supposed to set the stage for further financial market and economic gains. Instead, just one day after a near-record stock market jump, shares plunged. What went wrong?

Unfortunately, the Fed doesn’t have a great track record of reading market psychology — or even the economy, for that matter. That’s why Fed policy mistakes preceded nearly all 11 postwar U.S. recessions.

So why did the stock market tank, despite the surprise big rate cut? Lots of answers are possible. Certainly, the widening COVID-19 pandemic weights heavily on financial markets, and will continue to until it’s contained. But that was true yesterday, too, and markets then had a near-record gain.

A more likely reason is that the smart folks who control literally trillions of dollars of investments see the Fed’s big cut as a sign that the bank has lost confidence and is panicking. And we’re not the only ones to think so.

“Historically, the FOMC is reluctant to do an inter-meeting move on the fears that it looks like it’s panicking, that it conveys concerns about the economy from some insider knowledge, it feeds suspicions that it’s responding to equity moves, and lastly that it feeds suspicions that it was influenced by political actors,” Mellon Chief Economist Vincent Reinhart told Yahoo Finance.

Not exactly the soothing, confident message you want to hear.

The bank’s rate-cutting move wasn’t helped by the fact that Fed Chairman Jay Powell met with Treasury Secretary Steve Mnuchin shortly before cutting rates. It suggests either Powell feels politically vulnerable, or knows something that the rest of us don’t. Either is scary.

This isn’t the first time. When the Fed surprised markets with a quarter-point rate hike in late 2018, just five days before Christmas, it took a political beating from Congress and President Trump. Markets plunged then, too, before again taking off in early 2019.

This time, underscoring those concerns, the Fed made its surprise rate cut during an unscheduled meeting Tuesday — the first since the 2008 financial meltdown. You can almost smell the fear.

A big problem is that Fed policy-makers, despite supposedly being independent, regularly get buffeted by powerful political forces. Being human, that makes them prone to error.

Wall Street, Main Street, Congress, the president, regulators, bankers, all yell for the Fed to do something when markets or the economy seize up.  All have their own agendas. And sometimes those agendas clash.

An equally large problem is that the Fed’s top officials seem to believe they can fine-tune the economy.

Well, it hasn’t worked.

The Fed has for years tried to push inflation to 2%, to no effect. Nor has more than a decade of abnormally low interest rates and experimental money printing returned GDP growth to normal levels of 3%. For that, fiscal policy — taxes, spending, regulation — is the best tool.

Officially, the Fed’s main jobs are to keep overall inflation low — what’s called price stability — and to maximize employment. Yet our politicians often pressure the Fed to do what it shouldn’t or can’t do, and then blames the central bank when it inevitably fails.

For the record, the Fed doesn’t create jobs, and it can’t cure diseases. It can and should do one thing and one thing only: Keep inflation under control.

If the economy tanks due to the growing impact of COVID-19 virus, it’s unlikely Fed rate cuts will help much. Even Powell, in comments after Tuesday’s Fed meeting, seemed to suggest this, citing softening trade and travel as reasons for the rate cut — while calling the U.S. economy “strong.”

“I don’t think anybody knows how long it (the COVID-19 virus outbreak) will be. I do know the U.S. economy is strong and we will get to the other side of this,” Powell said.

Here’s what we know: The Fed can’t cure the COVID-19 virus, anymore than King Canute could halt the tide. Nor will any economic damage to the economy from the pandemic be halted by the Fed. That will take responsible government policies to keep the virus from spreading.

But at the very least, the Fed’s move took markets by surprise and was badly communicated. Another lesson the central bank should have learned long ago.

— Written by the I&I Editorial Board


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Issues & Insights is run by the seasoned journalists behind the legendary IBD Editorials page. Our goal is to bring our decades of combined journalism experience to help readers understand the top issues of the day. We’re doing this on a voluntary basis, because we believe the nation needs the kind of cogent, rational, data-driven, fact-based commentary that we can provide. 

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