00:20:00 · Ed Elson
[00:20:00] S6: We're back with Prof G Markets. The Fed decided to hold rates steady yesterday as expected, but not everyone was on board. Two officials, governor Lisa Cook and Cleveland Fed president Beth Hammack, dissented in favor of a quarter point hike. It was Cook's first dissent since joining the Fed in 2022. Others said the Fed has time to wait and see. Chair Kevin Warsh said that financial and credit conditions have, quote, tightened for some businesses and households, but the Fed said that the economy is growing at a strong pace, an upgrade from solid in September. Warsh also announced a change to the Fed's meeting schedule. Starting next year, one of the Fed's eight meetings will focus on long term strategy with no rate decision. Traders now put the odds of a December hike at 80% on Cal Sheen. So joining us to discuss the Fed's decision, we've got Mike Gapen, chief US economist at Morgan Stanley. Mike, good to see you. It was a hold. People expected that. We did see these two descents. Did anything surprise you about this? Did anything jump out?
00:21:08 · Michael Gapen, Ed Elson
[00:21:08] S4: Well, I think what jumped out at for me and probably for others also is that I don't think we got a convincing explanation from the chair as to why the committee decided to stay on hold this month. We heard from many FOMC participants going into the meeting that for a variety of reasons, they didn't feel a sense of urgency to raise rates this month, but we didn't really hear the chair's explanation. Now that in some ways that's not a surprise. He doesn't like to provide a lot of information. But I do think kind of the lowest hanging fruit is to talk to markets and investors and individuals about why you did what you did, what decision you took today and why. So to me, that was the surprising part. There are a few other things that were surprising on the margin, but I think that was the most important one. If you're looking for a reason as to why the Fed stayed on hold despite strong growth, despite a stable labor market, despite inflation being above target, you didn't really get one today. [00:22:14] S6: What do we think the reason is? I mean, some have said... There has been conjecture at least that maybe there was a political motive. This is the week before the midterms. Maybe... I mean, we know that the president is not a fan of raising rates. Do you think that could be it? What do you think is the answer?
00:22:35 · Michael Gapen
[00:22:35] S4: The policy based answer, the real answer in my opinion, is that most everyone on the committee who do speak from time to time and give their views are I think saying, look, a lot of this inflation is driven by supply side forces that we can't really fix. In other words, the Fed raising rates doesn't bring more oil to markets. So monetary policy isn't well equipped to respond to every kind of inflation shock. But in this case, what you don't want or what you want to avoid is high energy prices spilling over into the prices of other goods. It's what economists call leaning against the second round effects of higher energy prices. So yes, gas prices go up and diesel goes up, but we want to prevent it from spilling over into other parts of the economy. What that means is you can raise rates, but what you tend to do is raise it less. You don't respond to the increase of headline inflation, you lean against the wind. In doing so, you're not hiking as much. And you probably do want to take some time to assess whether energy prices are flowing through into other parts of the economy through second round effects. So I think that's probably the main reason. That inflation, it's sticky, but it's come down. The labor market really isn't overheating. Yes, growth is solid. But the mix of all that says you can tighten policy, but there may not be a high degree of urgency. Again, that's roughly what I think 18 of the 19 participants are saying. Well, two, as you noted, voted in favor of a rate hike. Let's say, you know, the vast majority think this, We're not entirely sure what share wash thinks.
00:24:23 · Ed Elson
[00:24:23] S6: I guess the confusion then, because I have heard that argument, which is the reason that prices are up is because of what's happening in the Strait Of Hormuz and what's happening in Iran. I mean, also the tariffs. But those... I mean, the big one is the price of oil and therefore the price of gas and the price of diesel and the fact that those are inputs throughout the rest of the economy. I have heard the argument, which is like the Federal Reserve isn't gonna do much about that. I mean, if you raise rates, you're not you're not gonna bring down, oil prices. That is a function of what's happening in Iran. But they already did raise rates. And so they've already told us we think this is gonna be our strategy. So if now the position is, no. That's not gonna work because that's not gonna have an effect on oil prices, I guess I just... I I don't fully buy it, and it makes me think maybe this was a political decision. Like, there doesn't seem to be enough continuity there.
00:25:27 · Michael Gapen
[00:25:27] S4: So I would push back on that a little. Would say that, yes, you can imagine being faced with two choices. Inflation is high, it's driven by movements in energy prices that you can affect directly. What you could do is raise rates a lot, maybe weaken asset markets, weaken demand, and you could bring inflation down to two quickly, but you'd pay a pretty high economic cost for that. An alternative is to say that what we want to do is make financial conditions a little more restrictive, moderate some of the growth in the economy, kind of prevent second round effects, as you said, the energy effects from spilling through into other parts of the production process, and assume that over time those supply forces go away. So it's a strategy, it's not guaranteed, but I think doing nothing probably, you know, they view doing nothing as not the right answer. The question is how much do you want to do and how fast do you want to do it? And the committee is saying we need say a modest recalibration of policy. Rates should go higher, but it's not clear they have to go higher at consecutive meetings, and we do have some time to assess what's happening.
00:26:40 · Ed Elson
[00:26:40] S6: Yeah, that makes sense. Something he also, emphasized was this 2% target. He's like, I think he said, we doubled down on the 2% inflation target, which we have been quite a long way away from for several years now. I'm starting to think that that's just never gonna happen. I'm starting to think we just live in a in a world where inflation is never close to the target because I just don't see... I mean, they keep on saying it. I I keep on knowing, yeah, this 2% thing, it's apparently important, but we've been miles off for years. So I guess my question to you, do you think that the 2% target is realistic, feasible? Do you take it seriously?