The Federal Reserve is repeating a critical error that dates back to 1929. In an effort to control inflation, the Fed has maintained a restrictive stance on interest rates for far too long. This delay in adjusting rates has led to concerns that the U.S. economy may face severe consequences, much like in 2008 and even as far back as the Great Depression.
A Brief Historical Context
Over the past 12 months, the Fed has held steady on interest rates, mirroring a similar pattern seen before the 2008 Financial Crisis. At that time, Fed Chair Ben Bernanke admitted that not cutting rates earlier contributed to the economic downturn. The Fed kept short-term interest rates above the economyâs neutral rate â the rate at which economic activity neither accelerates nor decelerates â signaling tight monetary policy. This restrictive environment persisted until the recession officially began in December 2007.
But this wasnât the first time the Fed had made such a mistake. In the late 1920s, it held rates too high for too long, inadvertently contributing to the Great Depression. It wasnât until after the financial collapse that the Fed acknowledged it should have cut rates sooner to stimulate economic activity.
Echoes of 1929 and 2008 in Todayâs Economy
Fast forward to today, and the situation appears eerily similar. For the past two years, the Fed funds rate has remained above the neutral rate, maintaining a tight monetary policy. While this was necessary during the inflationary surges of 2022 and 2023, recent data shows that inflation is now stabilizing. However, the Fed continues to hold a restrictive stance, elevating the risk of another policy mistake.
At the recent Jackson Hole meeting, Fed Chair Jerome Powell indicated that rate cuts could begin as early as this month. But even with these cuts, the Fed wonât reach non-restrictive levels until April 2025. With several economic indicators already showing signs of deterioration, this delayed response may prove to be costly.
Warning Signs in the Labor Market
The U.S. labor market, a key indicator of economic health, is starting to flash warning signs:
đ· Layoffs are increasing: Businesses have begun to lay off workers in anticipation of economic slowdown.
đ· Hiring has slowed: Job creation has reached its lowest level since 2020, raising concerns about future growth.
đ· Wage growth is stagnating: Employees are seeing fewer pay raises as businesses cut back on expenses.
With both employment and inflation data suggesting that the Fed should ease its policies sooner rather than later, the continued delay raises concerns about the sustainability of the current economic trajectory.
The Stock Market's Disconnect
Despite these economic warning signs, the stock market has continued to rise. However, history teaches us that the stock market isnât always a rational predictor of the future. For example:
đ· The 1920s stock boom: In the years leading up to the Great Depression, stocks soared, even as the economy weakened.
đ· The 2008 crisis: Stocks plummeted as the financial crisis took hold, only to rebound once the recession ended.
Todayâs market behavior could be following a similar pattern. Absent a major economic shock, the stock market could remain irrational for a few more months. But once the reality of the economic situation sets in, a downturn may be inevitable.
Navigating Uncertainty
At Game of Trades, we are guiding our members through this unpredictable economic environment. While there are still opportunities to profit from the current market upswing, we are also preparing for the downside when the recession finally hits. We remain on the lookout for attractive long and short opportunities, enabling our members to navigate the markets, no matter what comes next.
The Fed's delayed response to cutting interest rates could have long-lasting consequences, and as history has shown, these policy mistakes often come at a great cost. Whether or not the Fed will act in time to avoid another major economic downturn remains to be seen.