Despite scars of 2022, Fed decision doesn’t mean a new bear market says economist

Markets moving without Fed guidance

At various points in his press conference following the announcement, governor Warsh emphasized that he does not like to provide forward guidance. Moreover he described the idea of a neutral rate more as an intellectual exercise than a meaningful or substantive target for the Fed. Shankar accepts that this style of communication makes it harder to understand the Fed’s medium-term policy reaction function.

Despite some speculation that the Fed raised rates to reverse the rise in bond yields we’ve seen in recent days and weeks, those bond yields did not fall in the wake of the decision. While certain durations stabilized, Shankar still sees wider risks to the US and global economies stemming from high borrowing costs in the United States. He notes that Fed policy is only one factor in those high rates, however, which appear to be driven by significant levels of fiscal debt in the US and much of the developed world, as well as significant private sector debt issuances, largely connected to AI capital expenditures. There is a chance, though Shankar believes we’re not there yet, that the slowdown in economic activity proves more significant than the Fed intends.

US economic resilience, supply-side inflation

At the moment, however, Shankar says that the US economy is still quite resilient and that relatively strong GDP growth and hiring should support the economy through some interest rate increases. Growth is relatively narrowly driven, however, largely coming down to US consumers and the ongoing AI buildout.

The inflation that Warsh and the Fed want to tame, it should be noted, is largely supply driven. High energy prices tied to conflict in the middle east sit at the core of US inflation, and monetary policy can do little to curtail that. “Higher interest rates don’t, produce more oil, or build more semiconductors, or lower tariffs,” Shankar says.

Warsh, when asked about this during his press conference, said that the Fed hopes higher rates will prevent that supply-side inflation from spreading into the wider economy. Shankar says that if we see high energy prices driving demands for higher wages or increasing inflation expectations, then we are seeing that contagion. He says that monetary policy has only a limited impact on this supply-driven inflation.