The U.S. Interest Rate Problem Just Flipped (Jerome Powell Changes Stance)

If you've been paying attention to the stock market recently, you'll have noticed it's currently nose diving. It's nothing crazy yet; it's definitely not a stock market crash. But the S&P 500 is down around 5% since just last week. If you're wondering why, it has everything to do with this guy, Mr. Jerome Powell, and what he said recently at the Washington Forum on the Canadian economy.

It's interesting. As you guys know on the channel, I love to cover the biggest names in the world of business and investing. By doing that over the past few months, there's unintentionally been a bit of a theme shine through in my content that you've probably noticed. It's that all these big names in the world of investing and business do not think the Fed should be considering interest rate cuts anytime soon. As their plan suggested, Ray Dalio, Jamie Dimon, Steve Eisman, Howard Marks, just to name a few, have been saying this for months and months.

Well, the interesting thing is that it seems like the Federal Reserve has finally pivoted their viewpoint too, and it's sending the stock market south. This is what Jerome had to say just last week: "The performance of the U.S. economy over the past year has really been quite strong. We had growth of more than 3% last year as rebounding supply supported both robust growth and spending and also employment, alongside a considerable decline in inflation. The more recent data show solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal."

The reason this is such a big deal is because that is the first time that Jerome Powell has publicly stated that inflation is no longer trending in the direction the Federal Reserve wants for a grand plan of lowering interest rates. I know that's probably not shocking news to you; we probably knew this was going to happen, but a lot of everyday people did unfortunately get swept up in this idea of interest rates coming down around about now, and now they've unfortunately just got a bit of a rude shock.

This is what Jerome had to say: "Right now, given the strength of the labor market and progress on inflation so far, it's appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us. Come what may, we remain strongly committed to returning inflation over time sustainably to 2%."

So yes, I know that we probably could have seen that coming, but regardless, this is pretty big economic news, as the market was very much pricing in the idea of multiple rate cuts quite soon. Now, well, it looks like that ain't happening, and it probably won't happen until late this year or potentially even next year.

There is a fair bit more Jerome had to say on this topic, which I'm going to cover in just a second. However, one thing I did just want to quickly announce is that with the Berkshire Hathaway shareholder meeting coming up on the 4th of May, myself and my podcast co-host Tam Mot will once again be attending. So the Berkshire Bonanza is back for 2024! If you came to come along to Omaha, definitely please do so. We'll be going to the meeting itself, we'll be going to the ValueX conference, we'll be going to the Meryl brunch, and all the little side events that happen around the actual shareholder meeting. We'll be there!

So both myself and Tam would absolutely love to meet you guys, so if you see us, definitely come up and say hello. And if you can't make it to Omaha this year, never fear; we will of course be covering everything on our channels and on our socials. If you want to follow along for behind the scenes, my Instagram page will definitely be the place to be, but I'll also be making a few videos for posting here on the channel as well. We're really excited to announce this all in partnership with Morning Brew this year, so stay tuned for all of that content.

So that's something super exciting, but for now, let's get back to the interest rate situation. So yes, Jerome all but confirmed interest rates aren't going anywhere anytime soon, which is a big shift to their messaging. Earlier this year, the FOMC was on balance expecting to cut rates three times in 2024 and then four times in 2025. Now the news articles are reading very differently, seeing a possible scenario where rate cuts don't start until March 2025.

As I said in the intro to this video, the interesting thing is that if you really paid attention, there was a very strong contingent of the world's greatest business minds who were all very skeptical of this sudden plan to lower rates because inflation had supposedly been conquered. What's interesting is these big notable names all independently made the exact same argument: the argument is this: you lower interest rates to stimulate a weak economy. Right now, by the Fed's own admission, the economy is not weak, and it doesn't really need stimulating.

But one risk of lowering interest rates is that you can create an environment where inflation can occur. What is the one thing that the Fed has not got fully under control right now? It's inflation. So inflation has cooled, but recently it has stabilized around 3%, which is still 50% higher than the target rate. So why would you take the risk of lowering interest rates when the economy isn't struggling and when it could potentially cause inflation to spike again, which would result in the Fed needing to raise interest rates again down the track? That was the argument from the super investors, and that analysis turned out to be 100% correct—so much so that it's now the exact argument of Jerome Powell.

At the end of the day, the Federal Reserve has a dual mandate to achieve maximum employment and price stability, and if unemployment is currently not a big issue, yet lowering rates could disrupt price stability, should the Federal Reserve be entertaining that option? Probably not. This is Jerome Powell explaining exactly that point at the panel: "I'll say a little bit about our two mandate goals: maximum employment and price stability. As I mentioned, the labor market remains very strong. Payroll job gains have been strong over the first quarter, averaging just a tick above 275,000 per month. The unemployment rate has been below 4% for 26 consecutive months, which hasn't happened in more than a half a century—the longest streak of its kind. So the overall picture for the labor market is one of real strength."

Turning to price stability, Powell said: "Our inflation mandate—inflation, of course, declined quite significantly over the second half of last year, over the whole year but particularly in the second half. But 12-month core PCE inflation, which is one of the most important things we look at, is estimated to have been little changed in March over February at 2.8%, and the 3- and 6-month measures of inflation are actually above that level. We've said at the FOMC that we'll need greater confidence that inflation is moving sustainably toward 2% before it would be appropriate to ease policy."

As you can hear in that clip, Jerome touches on both aspects of the dual mandate: job gains are strong, unemployment is low, but inflation is still not down to their target of 2%. It's really leveled out over the past six months. The trend is no longer of consistent reductions.

But with that said, I do want to be fair to Jerome. It's very easy to hate on the Fed, especially when they keep raising rates, which makes our lives harder. To their credit, they have done a pretty good job overall, and what's really important is that they have clearly communicated their thoughts and intentions as the situation has unfolded. While it's true that late last year and early this year, the members of the FOMC did anticipate three rate cuts in 2024, they always said that this would be dependent on inflation continuing to lower. Jerome very commonly said that this three rate cut situation was not locked in just yet; the Fed needed to see some more evidence before that policy stance might become a reality.

A few videos ago, I played a bit of a montage of all the times that Jerome Powell told us that the Fed needed more evidence before pulling the trigger and lowering interest rates. Here's a little refresher: "Inflation is still too high. Ongoing progress in bringing it down is not assured and the path forward is uncertain. We want to see a little bit more data so that we can become confident and so that we can take that step of beginning to reduce policy rates. You know, we want to see more evidence that inflation is moving sustainably down to 2%. The lower inflation readings over the second half of last year are welcome, but we will need to see continuing evidence to build confidence that inflation is moving down sustainably toward our goal. We have some confidence in that; our confidence is rising. We just want some more confidence before we take that very important step of beginning to cut interest rates."

And then here is his explanation from the panel last week: "You know, we took that cautious approach and sought that greater confidence so as not to overreact to the string of low inflation readings that we had in the second half of last year. The recent data have clearly not given us greater confidence and instead indicate that it's likely to take longer than expected to achieve that confidence."

So no, I don't think Jerome or the Fed is to blame for this change in stance, but there's no doubt people will still get upset that they aren't getting their rate cuts now. Overall, I do think this is the smart course of action by the Fed, as it lowers the chances that we get that repeat bout of inflation. That was the real risk if the Fed decided to lower interest rates too soon, and that's the number one thing the Fed needs to avoid right now to achieve their dual mandate.

So I think holding back the rate cuts and essentially doing nothing for the time being is definitely the right call. It gives the Fed flexibility, as Jerome talks about here: "We think policy is well positioned to handle the risks that we face. If higher inflation does persist, we can maintain the current level of restriction for as long as needed. At the same time, we have significant space to ease should the labor market unexpectedly weaken."

It's a good spot to be, right? You've got room on either side. If the economy drifts into recession, you can cut rates. If inflation doesn't come down, you can always raise rates or keep them as they are. This is what Howard Marks talks about all the time. He wants to see interest rates eventually get to 2% to 4% and then stay there so that you create neither a stimulative nor overly restrictive environment, and you have the flexibility to raise or lower rates if something were to happen.

"What I said in the memo is that rates are likely to be between 2% and 4%, not between 0% and 2%. The Fed funds rate, you know, between 0% and 2% is an emergency measure. I would like to see the Fed get to a neutral position, which is neither stimulative nor restrictive, and I describe that as 2% to 4%."

So that's the idea: keep interest rates as they are for the time being, allow restrictive policy to continue to work, and then in the long term, once inflation has cooled, slowly reduce to neither a stimulative nor restrictive interest rate.

Overall, that's where we stand at the current point in time with interest rates. But there is one more important thing that I did just want to touch on in this video, and that is the question: how do macroeconomic changes affect us as investors? The reason I want to talk about this is because the answer is that it really shouldn't. It's certainly a predominant narrative in financial news at the moment, and a lot of people, I feel, don't quite understand how the system works.

I do like to stay in the know and cover it on my channel, but in terms of my own investing, I think it's important for me to acknowledge that this stuff really doesn't impact any investments that I make. There are two reasons for that.

The first is what happens with interest rates is completely unknowable. Nobody knows what's going to happen. Peter Lynch famously said, "If you spend 13 minutes a year on economics, you've wasted 10 minutes." As even this video has shown, the Federal Reserve themselves, that have their hand on the lever that moves interest rates, they don't even know where interest rates will be in just a few months from now. It's all unpredictable, so focusing on it too much is definitely a fool's errand.

Then from there, the second reason I don't worry about interest rates is because I'm much more focused on the quality of the business. Think about this: at the end of the day, if you're making a decision to invest in a company based on the most current Fed prediction on interest rates, well, that's a bad place to be. You don't want to be buying a business because interest rates might come down soon, right? You're going to be buying a business because the company you're analyzing has a competitive edge, it outshines all the competitors in the field, it's managed well, and it's priced at a fair level.

Particularly if you find businesses with a competitive advantage, you'll find that when the economy rains hell or shines, the business typically will do fine. I mean, take a company like Microsoft, for example. It's got a massive moat; it's probably one of the biggest moats in the world. Look at their profit over the last five years! In that five-year period, I'll say we've had that speculative mania of 2019, we've had the pandemic in 2020, we've had the zero rate recovery in 2021, we've had the rise of interest rates and the economic slowdown in 2022, we've had the geopolitical concerns of 2023, and we've had whatever you call 2024.

Yet in that extremely wide range of economic situations, Microsoft's profit has just kept going up steadily year after year. And through all of that volatility, this is the stock price. Yes, they did outperform the broader market in 2022, but even considering that, this isn't really a super volatile five-year chart. Right? Who would have guessed that all of that macro stuff happened when looking at Microsoft's net income or stock price chart?

That's the real secret: companies with intrinsic and durable competitive advantages—those businesses are much less impacted by general economic conditions. And if you want another metric that helps bypass the macro, look for low debts. At the end of the day, the Fed can do whatever it wants with interest rates if you don't owe anything to anyone.

So overall, guys, that is hopefully a balanced update on the Fed's pivot in messaging, but also a bit of a reminder that for us investors, it's probably best to for the most part look past it. It's interesting to stay up to date with and understand why things move the way they do, but for our investing, it probably doesn't matter all that much.

But anyway, hope you enjoyed the video. Please leave a like on it if you did; subscribe to the channel if you would like to see more. You can check out New Money Education if you want another way to further support the channel financially, and you can also learn about the Warren Buffett strategy or passive investing if that's something that you're interested in.

But guys, thanks very much for watching, and I'll see you guys in the next video.