The Fed is betting that inflation is easing. Don't fight the Fed.

By Peter Morici

This rate-cutting cycle will create a surge of financial-market liquidity

U.S. Federal Reserve Chair Jerome Powell is betting that inflation is nearly dead - and stock investors should cheer.

The Fed's recent half-point cut in the federal funds rate is a move usually is reserved for economic crises, such as the surge in mortgage foreclosures at the onset of the Global Financial Crisis.

No such calamity appears imminent now. U.S. unemployment at 4.1% is low by historical standards; the ratio of job openings to unemployed has normalized, and Powell expects GDP growth to continue at a 2.2%.

Consistent with the Fed's mandate to maintain price stability and maximize employment, Powell says "inflation is moving sustainably toward 2 percent," and inflation expectations currently are "well-anchored".

Yet the average of University of Michigan, New York Federal Reserve Bank and Conference Board surveys indicates consumers expect prices will rise 3% or more over the next year.

That's no surprise. Rising rents, homeowners and automobile insurance and other services are pushing up Americans' cost of living. U.S. Vice President and Democratic presidential candidate Kamala Harris promises federal action to remedy alleged price gouging at grocery stores and acute housing shortages.

Most progress on inflation has been in goods prices - China's economic malaise is pushing down the demand for oil and flooding global markets with excess manufactures.

In August, the Consumer Price Index was up 2.5%, but core inflation-prices less energy and food - was 3.2%. Meanwhile, rents are up 5%, the broader cost of shelter was up 5.2%, and builders face land and labor shortages and rising regulatory costs. Most troubling, service prices, less housing and energy, are rising 4.5% annually.

Over the past year, the U.S. economy has added 203 000 jobs per month, significantly more new jobs than the 80,000 possible based on population growth and legal immigration. New entrants receiving temporary asylum and just otherwise entering the country are working too.

Though U.S. President Joe Biden has tightened the border, immigration remains well-above pre-COVID levels. This surge of immigrants likely accounts for much of the increase in unemployment from 3.4% last year and makes questionable the warnings of a pending recession premised on the joblessness rate.

Employment needs are shifting. For example, tech giants Microsoft (MSFT), Alphabet (GOOGL), Apple (AAPL) and Meta Platforms (META) all have laid off workers in some activities, but spend more on developing artificial intelligence products.

Layoffs have not elevated to the level that would create a self-feeding cycle of job cuts, work furloughs and lower consumer spending. Powell got it wrong in 2021 when he said the surge in inflation would be transitory, but notes "the good ship Transitory was a crowded one, with most mainstream analysts and advanced-economy central bankers on board."

He attributes the debacle to COVID and other supply disruptions, but the Fed enabled trillions in pandemic-era federal spending by printing $4.8 trillion to purchase Treasury securities.

In taking bold action now, Powell has broad support. Large rate cuts will create a surge of financial liquidity by permitting banks to borrow and raise money more cheaply and charge less for credit cards balances, auto loans, home equity loans and mortgages. Small businesses relying on revolving credit lines should get lower rates too.

Don't be surprised if next year inflation picks up - as happened to former Chair Arthur Burns when he abandoned monetary discipline to boost the Nixon economy and to Chair Paul Volcker when he first raised interest rates, only to pull back too soon to combat a recession.

More than 100 experiences with inflation across 56 countries since the1970s suggest that premature interest-rate cuts generally cause inflation to rebound and bring more unemployment and greater macroeconomic instability.

On average, it takes more than three years of tight money to lick inflation - the Fed quit after 30 months.

Yet even if inflation reheats, stock investors should benefit. Over the 40-years prior to the 2008 Global Financial Crisis, U.S. inflation averaged 4.0%, the 10-year U.S. Treasury BX:TMUBMUSD10Y yielded 7.4%, appreciation on existing homes was 5.6%, and the S&P 500 SPX returned an average 10.5% annually. Near term, if the U.S. can avoid a recession, lower interest rates should boost stock prices.

Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

More: Small-cap stocks rally after Fed rate cuts start. Here's how to find winners.

Also read: The bull market is nearing its second birthday. Here's why it will likely continue.

-Peter Morici

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10-08-24 0705ET

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