The Fed Should Invade Kharg Island

The Fed held rates steady and the statement was unchanged. Incredibly, three members dissented in favor of a rate increase. The reason that those dissents are complexly wrong is that all of the current inflation increase is coming from the rise in oil prices. An increase in rates will have zero impact on energy inflation and will only make the current recession in interest sensitive sectors such as housing and construction worse. The Federal Funds rate is 75bp above the neutral rate and the money supply is shrinking by over 5% resulting in a rise in the 30-year mortgage to 6.8%.

In the first quarter of 2021, the policy rate was 3% below neutral, the money supply had grown 70% and the 30-year mortgage was at 3%. This ultra loose monetary policy caused a 20% increase in home prices and a 10% rise in rents. This is a perfect example of when a central bank should raise rates, but we had an incompetent Federal Reserve that waited a year to raise rates. Today we have nearly the exact opposite situation which is a perfect example of when the Fed should not raise rates, but we still have 3 incompetent Fed members.

The dissenting members incorrectly believe that the rise in energy prices will create an increase in inflationary expectations, so a rate increase is needed. They are 100% wrong about this theory as there is no longer significant unionization that can force wages increases and more importantly now rising inflationary expectations actually reduce inflation due to rising 10-year interest rates which further slow the interest sensitive sectors of the economy.

If the Fed is serious about obtaining their 2% target in the short run, it should immediately raid Kharg Island and reopen the Strait of Hormuz. Unfortunately, this Fed seems woefully inadequate to accomplish this task so should remain on hold until the situation in the Middle East is resolved.