The stock market is still “at loggerheads with the Fed” thinking the central bank will cut interest rates this year instead of hiking them in response to persistently high inflation, Breitbart Economics Editor John Carney said in a Friday interview with Fox Business host Larry Kudlow.
“Stocks are pricing in interest rate cuts as we get towards the year, but I don’t know,” Kudlow told Carney. “Inflation, money supply, things of that sort suggest that maybe interest rates are going to go up instead of down.”
The stock market’s attitude “doesn’t quite make sense,” Carney said. “They looked at the inflation numbers and they said, ‘Okay, it came down from January. So, maybe the Fed can cut,’ The Fed is not going to cut—inflation is way too high—unless we get into a serious economic calamity, in which case the stock market shouldn’t be booming right now.”
“So, there’s a contradiction in the thesis of the stock market,” he added. “I would be very skeptical of what I’ve been seeing not in just the stock market, but in the derivatives market right now that is pricing in around three or four [interest rate] cuts by the end of the year. And meanwhile we have Fed officials telling us every time we hear from them, ‘We’re definitely not going to cut. We’re holding the line. We’re probably going to raise one more time, and then we’re going to hold it through the end of the year and probably into next year.’ But the market has been at loggerheads with the Fed for most of the last year basically. And it got on the same page for about two months. But then we had Silicon Valley Bank, and they said, ‘That’s it, you know, financial crisis. They’re going to have to cut later this year.’”
The latest economic data doesn’t back up the market’s rosy projections, Kudlow noted, particularly if Federal Reserve officials maintain their two percent inflation target.
“Right now, the inflation rate is about two and a half times the target,” Kudlow said. “So, they’re going to have to tighten the screws more. But the market thinks what? That they’re going to raise the target to three or four percent?”
Carney speculated that the market thinks the Fed “won’t officially raise the target, but just chicken out and back off.”
All of this wishful thinking flies in the face of the latest inflation data. Carney pointed to the Cleveland Fed’s calculation of median inflation, which is currently at 0.4 percent, as it has been for five of the past six months.
“It’s been 0.4 percent more or less since August,” Carney said. “So, that’s no progress at all against inflation. And I think that’s really telling us that the Fed hasn’t gone far enough yet. And Fed officials are going to look at that number. They don’t talk about median inflation that often, but they can look at it. And they say they want to see several months of progress before they’ll think that they’re there. We haven’t seen several months.”
Federal Reserve Board Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, DC, on March 22, 2023. (OLIVIER DOULIERY/AFP via Getty Images)
Kudlow then turned the discussion to the Federal Reserve’s March revision of the M2 monetary aggregate—a broad measure of the money supply that includes currency in circulation, checking and savings deposits, and shares in retail money-market mutual funds.
“The March revisions to last year’s M2 money supply created reasons to significantly revise expectations on inflation and economic growth,” Carney wrote in Thursday’s Breitbart Business Digest. “Specifically, the revised numbers showed that the money supply had been higher than we previously thought through most of last year and that the peak of M2 happened later.”
This revision has serious implications for inflation forecasts. Carney highlighted a study by economists Steve Hanke and John Greenwood, which argues that inflation tends to lag changes in the money supply by 12 to 24 months. Because the March revision revealed that the money supply “stayed higher for longer,” we can expect that “inflation and economic growth are likely to stay higher for longer too,” Carney explained in Wednesday’s Breitbart Business Digest.
Kudlow, who cut his teeth successfully fighting inflation in the Reagan administration, has long been an advocate for paying attention to M2 as an inflation indicator, even though this has gone out of fashion among economists today.
“This is almost making a heretical sin for economics reporters or analysts or whatever. But you’re looking at the money supply—the M2 money supply. I confess, I do too. I was actually trained as a monetarist a million years ago,” Kudlow told Carney.
“We thought that M2 had peaked around March when the Fed first started raising rates,” Carney said. “That actually seemed a little improbable to me, just because why would it peak right when the Fed was starting to raise rates? You’d think there would be a lagged effect.”
The revised data, Carney explains, shows that the M2 money supply “stays high from March through July, peaks in July, and then starts to come down. The lesson from that is that inflation, therefore, if you think there’s a 12 to 24-month lag, should still be running high right now, which it is.”
The money supply was not coming down for nine months as we previously thought, Carney said. “It’s been coming down for five months. So, we still have a ways to go before we hit whatever the lagged effect from the peak was.”
Kudlow noted ruefully that for years no one paid attention to the money supply, including Federal Reserve Chairman Jerome Powell.
“Jay Powell says routinely that he never looks at M2, which is really a stupid thing for a Fed chairman to say. You don’t have to be a dogmatic monetarist, but it’s a key indicator,” Kudlow said.
“Look, I was a skeptic,” Carney replied. “I hadn’t looked at M2 for a while. But if you wanted to predict the inflation wave we had, M2 told you that was coming. And so, I do think there’s a lot to be said for the idea that M2 is probably going to give us an indicator of what inflation might be.”
Kudlow closed the segment by noting that the M2 money supply “has a lot to do with bank deposits and a lot to do with oversized federal spending.”
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