Quit Playing the Fed’s Dull Waiting Game

Consumer prices didn’t change Wednesday, and neither did Fed rates. Yes, hours after May’s US Consumer Price Index (CPI) report showed prices were unchanged from April (and slowed to 3.3% y/y from 3.4%), the Fed kept the fed-funds target range at 5.25% - 5.5%.^[i] Yet expectations took a ride: After the CPI report raised rate cut hopes, the Fed’s infamous forecast “dot plot” projected just one rate cut by yearend. Cue the renewed speculation and high-rate handwringing, which we think investors should tune out. Monetary policy still isn’t predictable or make-or-break for stocks.

The Fed’s own dot plots prove the point. December’s dot plot projected three rate cuts this year, four next year and three in 2026. March’s kept 2024’s three, but trimmed future expectations to three each in 2025 and 2026. Now? Fed people backed up projections of a rate cut flurry. They collectively project just one cut this year (eek!), with four each in 2025 and 2026.

All these shifts followed changes in the inflation rate, which reaccelerated earlier this year. Fed moves are data-dependent. So if the Fed got caught out by unanticipated inflation wiggles and changed its forecasts, then why would its forecasts—or forecasting—suddenly be so prescient now?

In our view, the Fed will handle this as it always does: Policymakers will vote for whatever they judge best at the time, based on the available data and their interpretations of it. Those interpretations will reflect each of their biases and opinions. With 12 people voting on the Federal Open Market Committee (FOMC), this is a hodge podge of subjectivity and opacity.

The Fed’s squishy inflation targeting doesn’t help. As every FOMC statement notes, “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run.” Maximum employment has no numerical definition, and the Fed weighs a range of metrics beyond the headline unemployment rate.

The inflation target pretends to be clearer, as we all should know the Fed uses the headline Personal Consumption Expenditure (PCE) price index. That has run below the CPI throughout this inflationary episode, due largely to shelter’s lower weighting in PCE (more on this in a sec). It currently sits at 2.70% as of April.^[ii] But what does “longer run” mean? Is it three years? Five? The three-year moving average is 4.8%, way off target.^[iii] The five-year average is 3.5%.^[iv] But if we arbitrarily select 15 years and 6 months as long-term, PCE inflation is bang-on the target. Sooooo, is this mission accomplished? Time to cut?

The Fed, of course, thinks not. Today’s policy statement notes the Fed needs “greater confidence that inflation is moving sustainably toward 2 percent” before it cuts. We won’t know for sure for another five years, when the transcripts come out, but it seems fair to say the FOMC discussed May’s CPI report when weighing what to do. Yes, they target PCE, but CPI is timelier, and the same trends tend to influence both.

Therefore, we wonder, what do they remain unsure about? Goods prices, excluding food and energy, are in deflation at -1.7% y/y.^[v] Services prices are running hotter, at 5.3% y/y excluding energy services, but a lot of that comes from shelter, car repair and auto insurance.^[vi] Shelter is primarily this weird thing called owner’s equivalent rent (OER), which is the Labor Department’s attempt to factor in home ownership as a living cost instead of an investment.

Philosophically, we get it—we think it is better to view the home you own as a roof over your head rather than an appreciating investment, too! But OER is the hypothetical amount a homeowner would pay to rent their own house, and it is based on surveys and stale market data. It is also a cost no one pays. In our view, it is therefore a little weird that OER comprises over one-fourth of CPI.

As for the other outlying components, we daresay the amount of auto mechanics and technicians available to fix cars isn’t something the Fed can fine tune with interest rates. Nor is the availability and price of parts, many of which are imported. And nor are spiraling auto insurance costs, which derive from those high repair costs and the fact that, with all the bells and whistles that live in car bumpers, even a minor fender bender can do thousands of dollars’ worth of damage. 

Excluding shelter, CPI is down to 2.1% y/y.^[vii] Excluding food, energy and shelter, it is at 1.9% y/y.^[viii] The averages are elevated, but that is backward-looking. Money supply growth is forward-looking, and it is crawling at a snail’s pace.

But clearly the Fed needs to see more, and it isn’t clear more of what. Hence, it is 100% impossible to predict when they will cut. Or how often they will cut after they break the ice. Again, if even the Fed doesn’t know what it will do, how can mere non-Fed mortals have the faintest clue?

Not that anyone needs to know. Monetary policy doesn’t have a preset impact. Rate cuts aren’t automatically good (or bad), and hikes aren’t automatically bad (or good). This bull market was born in rate hikes and grew on high rates. Stocks have risen through shifting interest rate expectations. Markets look about 3 – 30 months out, and they are smart enough to see that a rate cut or three likely doesn’t much impact corporate earnings over this stretch.

So give yourself a break. Markets aren’t hyper focused on interest rates, so you don’t need to be either. Which is good, because the Fed is boring! There, we said it. We are sure, or at least we presume, they are nice people. But the documentation, the press releases, the speeches … they are all verbose and boring. Spend your time on more fun things.