When cooking a steak, everyone has a preferred temperature and most people tend to be pretty picky. If it’s undercooked, it feels like bloody, raw meat. If it’s overcooked, you might as well use it as a dog biscuit. We like it just right.
The Federal Reserve has the challenging task of being the U.S. economy’s grill master. When the economy is at risk of being overcooked (inflation running too high), the Fed raises the fed funds rate to reduce the economy’s temperature. Higher rates reduce consumer and business spending thereby cooling economic growth and inflation. When the economy is at risk of being undercooked (growing too slowly), the Fed cuts the fed funds rate to raise the economy’s temperature. Lower rates stimulate spending, growth, and inflation.
Fed Meeting Last Week — After 10 consecutive rate increases, the Fed voted to keep rates the same last week. But they also indicated they expect to raise rates two more times this year, suggesting they’re not done raising rates to cool an over-heating economy.
Being a Critic Is Easy — Criticizing the Fed’s pace of raising or lowering rates is financial media’s favorite pastime. In December 2021, the Fed said they expected to raise rates by ¾% during 2022. Instead, they raised rates by 4.25% as inflation unexpectedly hit 40-year highs. It’s in vogue for pundits to criticize the Fed for raising rates too slowly. But go back and look at Wall Street’s 2022 predictions for any Fed predictions that came close to reality. I’ve looked and the next one I find will be the first. The firms I respect the most had predictions that looked a lot like the Fed’s expectations. But everyone’s always right in hindsight.
Harder Than It Looks — The primary job of the Fed is to help the economy achieve maximum employment and stable prices, aka moderate inflation. The problem is it takes about 6 months for the economy to feel the full impact of Fed rate changes. How hard is that? Imagine having to choose a set temperature to cook a steak for 6 hours and then hope it’s just right at the end. To increase the level of difficulty, there’re surprise economic hot spots (war) and cool spots (bank failures) on the grill that the Fed can’t foresee when setting its rate.
Like men standing around their neighbor’s grill, financial media will continue to opine on whether the Fed’s actions are cooking the economy’s steak just right, or not. However, for long-term investors, it’s crucial to focus on what you can control. By making sure your portfolio is well-diversified and assuming a level of risk that aligns with your tolerance for risk and time horizon, you can set your financial plan at the optimal temperature.
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