My grandpa was a heavy equipment mechanic who was known to improvise tools when needed. Once, he was working on a carburetor, and the space was too small for his wrench, so he cut the closed end off and used it with a hammer and screwdriver.
We need the Federal Reserve to be equally creative with its tools.
The Fed kept rates steady on Wednesday because of stubbornly high inflation. The Fed rate remains at the highest level in 23 years and has been unchanged since the Fed’s July 2023 meeting.
Inflation is decreasing, but not fast enough. Also on Wednesday, the consumer-price index said inflation rose 3.3% in May, more than a percentage point above the 2% target. The delay in cutting rates hurts lower- and middle-income renters.
The effects of inflation are treating renters and homeowners differently. Several million homeowners refinanced mortgages a few years ago when rates were extremely low, helping them tolerate the high cost of living.
The tool isn’t working
The Fed’s biggest inflation-fighting tool is raising the federal funds rate, which affects bank loans, CD rates and mortgage rates. In the past, when rates were raised, loans became more expensive, causing consumers to spend less, leading businesses to lower prices and entice consumers to spend more, which lowered inflation. That isn’t working this time around.
The Fed inflation tool is hurting renters
In March, the national average monthly rent was almost $2,000, increasing pressure on renters who have watched rents increase more than 20% since 2020. Because of inflation, renters are paying an average of $370 more each month, while payments of homeowners who refinanced lowered an average of $220 per month from refinancing. That means renters have $570 less per month to spend than homeowners, all the while paying higher prices for everything else they need to live.
That wasn’t how the inflation tool was supposed to work. The Fed needed everyone to slow their spending so prices and inflation would fall, but it’s not working that way. The wealthy have more monthly cash available to them and continue to spend, keeping inflation rising. High-income earners can’t be faulted for making good financial decisions. It was a miscalculation on behalf of the Fed. They used the same tool as always, despite changing circumstances. This miscalculation has made lower-income families suffer longer than they should have in the inflationary period.
Multiple reports have shown that consumers are slowing their spending, which will continue to bring inflation down as the year progresses. I am keeping a neutral allocation to the consumer discretionary sector, but I am closer to a downgrade than an upgrade.
The world is changing, and we need creative leaders who can adapt to it. My Grandpa didn’t know much about monetary policy, but he knew in mechanics, the problem dictates the tool, and the tool never dictates the problem. Problems change, and tools sometimes need to be adjusted to fix them.
Have a blessed week.
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