Economist: The Federal Reserve cut interest rates too early, inflation may rebound next year!

Economist and honorary business professor Peter Morici from the University of Maryland recently pointed out in an article that premature rate cuts often lead to inflation rebound, but in the short term, if the United States can avoid an economic recession, rate cuts should boost stock prices. Here are his views.

Federal Reserve Chairman Powell believes that inflation has almost disappeared, which stock market investors should cheer about.

The Federal Reserve recently cut the federal funds rate by 50 basis points, a move typically taken to address economic crises, such as the global financial crisis.

At the moment, such a disaster does not seem imminent. By historical standards, the U.S. unemployment rate of 4.1% is low; the ratio of job vacancies to unemployed persons has normalized, and Powell expects the U.S. GDP growth rate to continue at 2.2%.

Powell stated, "Inflation is moving steadily towards 2%," and inflation expectations are currently "well under control." However, surveys conducted by the University of Michigan, the New York Fed, and the Business Roundtable show that consumers expect prices to rise by 3% or more next year.

This is not surprising. Rising prices of rent, housing, car insurance, and other services have increased the cost of living for Americans. Vice President Harris, a Democratic presidential candidate, has pledged that the federal government will take action to address price gouging at grocery stores and severe housing shortages.

Progress in inflation is mainly reflected in commodity prices.

In August, the Consumer Price Index (CPI) rose by 2.5% year-on-year, but the core inflation rate excluding energy and food prices was 3.2%. Meanwhile, rent rose by 5% year-on-year, overall housing costs increased by 5.2%, and builders faced shortages of land and labor as well as rising regulatory costs. Most concerning is that service prices excluding housing and energy rose by 4.5% year-on-year.

Over the past year, the U.S. economy has added an average of 203,000 jobs per month, significantly exceeding the 80,000 new jobs that population growth and legal immigration could create. New arrivals who have obtained temporary asylum or entered the country through other means are also working.

Despite President Biden's efforts to strengthen border management, the number of immigrants remains much higher than pre-pandemic levels. The surge in immigration may be a major reason for the rise in the unemployment rate to 3.4% last year, casting doubt on warnings of an economic recession based on the unemployment rate.

There is a shift in job demand. For example, tech giants like Microsoft, Alphabet, Apple, and Meta are laying off employees but investing more in developing artificial intelligence products.

Layoffs have not reached the point of causing a vicious cycle of layoffs - unpaid leave - decreased consumer spending.

Powell said in 2021 that the surge in inflation would be temporary, but he was wrong. Powell attributed this collapse to the COVID-19 pandemic and supply chain disruptions, but the Federal Reserve provided trillions of dollars in federal spending during the pandemic by printing $4.8 trillion to purchase U.S. Treasury bonds Now, Powell's bold rate cut has received widespread support. A significant rate cut will enable banks to borrow and finance at lower costs, reducing the costs of credit card balances, car loans, home equity loans, and mortgages, thereby stimulating financial liquidity. Small businesses relying on revolving credit lines should also benefit from lower rates.

Don't be surprised if the inflation rate rises next year—just like former Fed Chairman Arthur Burns abandoned monetary discipline to boost the economy during the Nixon administration.

Since the 1970s, experiences of inflation in more than 100 instances across 56 countries have shown that premature rate cuts often lead to inflation rebounds, resulting in more unemployment and greater macroeconomic instability.

On average, tightening monetary policy takes over 3 years to eliminate inflation, but the Fed abandoned this policy after raising rates for 30 months.

However, even if inflation heats up again, stock market investors should benefit. In the 40 years before the global financial crisis of 2008, the average inflation rate in the U.S. was 4.0%, the 10-year U.S. Treasury bond yield was 7.4%, the home yield was 5.6%, and the average annual return of the S&P 500 index was 10.5%. In the short term, if the U.S. can avoid an economic recession, low rates should boost stock prices.