The writer is chair of Rockefeller International. His latest book is ‘What Went Wrong With Capitalism’
As Donald Trump pressures the Federal Reserve to cut rates, the fear is that he is undermining the central bank’s independence, with potentially damaging consequences for the US economy. Yet most mainstream economists and investors seem convinced the Fed will cut rates anyway at its September 16-17 meeting, particularly after Friday’s employment report confirmed some signs of weakness in the labour market.
This is unfortunately the same alarmist reflex — rush to the rescue at the slightest hint of economic trouble — that has been undermining Fed credibility and fuelling financial bubbles for decades. And the timing could not be less opportune.
Financial conditions are very loose. The economy is still resilient. The basic Fed lending rate is not restrictive. Signs of job market weakness are minor compared with the evidence that inflation has become entrenched. And cutting rates with AI mania gripping US markets risks driving them to greater heights. All this makes it an odd moment to follow Team Trump, which includes past critics of easy money flip-flopping to please their boss.
While interest rates have moved up since the pandemic, financial conditions reflect much more than rates. And it’s the broader signs that show conditions are loose.
Capital pouring into the US stock market has driven valuations close to historic highs. Venture capital is pouring into profitless tech firms. Credit growth is surging, particularly in private markets. Junk firms can borrow at rates only marginally higher than solid ones or even the government; the premium they pay over Treasuries is as low as at any point in the last half century. And not once during that period has the central bank cut rates, much less launched a cutting cycle of the scale the market is now pricing in, based on Fed guidance.
Trump aides want to stimulate an economy that doesn’t need help. Despite the tariff shock, GDP is on track to expand by more than 2 per cent this quarter. Regardless, juicing up growth is not the central bank’s job. Its mandate is to control inflation while maximising employment. And standard guidelines on how to achieve this, such as the Taylor rule, show that the Fed’s basic lending rate is not currently restrictive.
If anything, there is an equally strong case for a rate increase. While the latest report showed disappointing job gains, that is unsurprising when labour supply is weak due to declining immigration. More tellingly, the unemployment rate is still just 4.3 per cent, close to historic lows. Meanwhile, consumer price inflation has exceeded the Fed’s 2 per cent target for five years running and is expected to remain stuck at an elevated pace for the foreseeable future.
It’s also a mistake to ignore prices for stocks, homes and other financial assets. Since failing to anticipate the 2008 financial crisis, the central bank has incorporated financial stability into its “mission.” Some argue that a rate cut will make homes affordable again, but easy money was one driver of the affordability crisis in the first place. The main factor was and is over-regulation limiting housing supply, and new rate cuts won’t address that problem.
By easing every time the markets falter — including as recently as last August — the Fed has been fuelling asset price inflation and wealth inequality. Now, it seems poised to go further, easing in a boom.
Tech investment is following the path of past bubbles: at nearly 6 per cent of GDP, it roughly matches investment in tech at the 2000 peak as well as investment in real estate at its 2007 peak, and greatly exceeds investment in oil at the 2013 commodity boom peak. Speculators focusing on the least profitable and most expensive stocks are amped up on AI too. Their share of US trading is now approaching the dotcom era high.
The “asymmetry” of Fed policy — always rescue but never restrain the markets — is tilting further towards promoting bubbles. Yet prominent Republican critics of easy money now call for more of it, in the name of “reform”. Stephen Miran, Trump’s appointee to the Fed board, is one of the enemies-turned-advocates of central bank dovishness.
Real reform would hold the Fed more accountable for errors of easy money. What’s needed is a return to symmetry, including periods of restraint. With the economy holding steady while AI mania is showing similarities to the dotcom boom, cutting rates now could push the market to crazier highs and set up a bust reminiscent of 2000. It would be exactly the wrong move at the wrong time.