What I Read This Week…

The Federal Reserve is losing credibility with markets.

What's going on?

The Federal Reserve has reduced the Federal Funds Rate by 1% since September, justifying their rate-cutting cycle by claiming job gains were slowing and inflation was moving toward their 2% target.

However, recent data contradicts both claims: job gains remain solid (256,000 in December, though the reliability of this number is questionable), and inflation shows persistence rather than moving toward the 2% target.

Meanwhile, long-term bond markets have directly challenged the Fed's policy - the 10-year Treasury yield has risen from 3.6% to 4.77% despite rate cuts, a rare occurrence seen only twice since the 1980s, and Bank of America now predicts rate hikes may be more likely than cuts in 2025.

Why does Fed credibility matter?

The Fed's monetary policy works largely through market expectations - when the Fed says it will do something, markets need to believe it for its monetary policies to be effective.

When the Fed cuts rates, it's trying to make borrowing cheaper throughout the economy.

But if markets don't believe in the Fed's economic assessment or policy decisions, they can push back through higher long-term rates, essentially canceling out the Fed's intended effects.

This is exactly what we're seeing now - the unusual rise in Treasury yields despite Fed rate cuts suggests markets fundamentally disagree with the Fed's view of the economy, making their policy tools less effective at a time when they might need them most.