"Don't Fight the Fed" Has Been "Retired". The New Saying Is, "Don't Believe The Fed"

The old saying, "Don't Fight the Fed," has been "retired" and replaced by "Don't Believe the Fed." Fed Chair Jerome Powell and other policymakers say that it is essential for monetary policy to "normalize." Yet, the last time they attempted to "normalize" monetary policy (2018), policymakers caved to the pressure from the financial markets and politics. I bet they will bend again.

It is unclear what policymakers mean by "normalize." A balanced policy is not too tight or too loose. But it also changes or adapts based on underlying economic and financial conditions. What was perceived as a balanced policy stance last year is no longer appropriate because the Fed lives in a different world nowadays.

In March 2022, the civilian unemployment rate of 3.6% compared to 6% one year earlier. Wage growth for non-supervisory workers of 6.8% is 200 basis points higher, and consumer price inflation of 8.5% is nearly 600 basis points higher. Normalization of policy can't mean the same thing in 2022 as in 2021 because underlying economic conditions are markedly different.

Policymakers are telegraphing that they plan to raise the fed funds rate in May, and the two more 50 basis point hikes over the next two meetings will bring the Fed funds rate to 2% by July. But that is not "front-loading" rate hikes, as Fed Powell said in an interview, or is it moving "expeditiously," as others say. Instead, the Fed is playing catch-up and has a long way before normalizing policy in today's world.

If the equity market buckles as it should as the Fed raises rates and shrinks its balance sheet, the Fed will face pressure to stop. But, at that time, I bet they would not have the Volcker-fortitude to stay with the fight against inflation. So the trade-off will be a higher trend rate of inflation for a lower level of fed funds.