OPINION:
After its June meeting, the Federal Open Market Committee is signaling a possible interest rate hike to address the inflation instigated by the Iran war and a stronger-than-expected economy.
It would be better to keep rates steady and let markets sort out inflation, employment and growth.
Since September 2024, the Fed has cut the overnight bank borrowing rate by 1.75%, but inflationary pressures from the tariffs, bulging federal deficits and other structural forces have kept inflation expectations elevated.
Just before the Iran war, the 10-year Treasury rate, which serves as a benchmark for mortgages and other consumer and business loans, was higher than when the Fed began its series of interest rate reductions. It has since moved higher.
This reflects lenders’ skepticism that inflation, even before gasoline and diesel prices rocketed, was on a glide path to the Fed’s 2% target.
Thirty-year mortgage rates are 3 percentage points higher than just before COVID-19 and have risen since the Fed started cutting rates 22 months ago.
Simply put, the Fed has proved impotent at lowering long-term interest rates.
After normalizing, fuel prices should rise again as oil inventories in storage tanks and in transit before the war run out.
We have a lot of pent-up inflation elsewhere.
Over the past year, real wages have fallen, but retail sales have outpaced the consumer price index. Consumers are saving less and borrowing to buy gas, but economizing where they can.
At grocery stores, consumers are cutting back on snack foods and beverages and turning more to store brands.
Dollar stores and fast-food restaurants are gaining business, but consumers are spending less on an inflation-adjusted basis on groceries overall, home furnishings and health and personal care items.
Lower- and middle-income households (but less so high-income households) have cut back on driving.
Even before the war, this two-tier pattern — wealthier households versus the rest of us — was challenging major food processors such as General Mills, Kraft Heinz and Conagra.
In this environment, importers, manufacturers and farmers cannot easily pass through the full impacts of tariffs, shortages of petroleum-based commodities or other structural factors that push up their costs.
That was why headline inflation rose from 2.4% just before the war to 4.2% in May, while core inflation (the CPI less food and energy) rose only from 2.5% to 2.9%.
Eventually, as fuel prices stabilize, core inflation must catch up with headline CPI for many businesses to remain solvent or achieve margins that justify their owners’ investments.
The global petroleum market will permanently change to reduce vulnerability to the Strait of Hormuz, but alternatives such as new pipelines, railroads and oil resources elsewhere will be expensive and keep prices from permanently falling back to prewar levels.
Meat prices will continue to rise because drought conditions have reduced the cattle herd to a 75-year low.
California, which produces almost half of our vegetables and more than three-quarters of our fruits and nuts, is enduring record heat, and roughly 60% of wheat, barley and rice farmers are in drought-stricken areas.
Extreme weather has damaged coffee supplies in Brazil and Vietnam, and El Niño will instigate additional severe weather events.
Along with tariffs, the closure of the Strait of Hormuz and the boom in data center construction and grid modernization are pushing up prices for copper, aluminum, diesel, lumber, semiconductors and electricity.
Several of those commodities are used to make just about everything we consume.
President Trump’s constantly changing tariffs make effective supply chain planning and investment difficult, compounding their effects on underlying inflationary pressures.
Raising interest rates would not appreciably limit those forces.
The Fed cannot change the weather, Middle East geopolitics or Mr. Trump’s trade policies.
As for lowering interest rates, the Fed had marginal success pushing down rates on short-term consumer loans.
Since September 2024, rates for auto loans have fallen from 6.18% to 6.08%, and on bank credit cards from 21.5% to 21.0%.
It would take a mighty jolt of liquidity to really move the needle on those and send folks rushing to car dealers and malls. That would cause enough inflation to impose real pain when the Fed had to tighten again.
The labor market appears to be recovering on its own, but cheaper money could accelerate the adoption of artificial intelligence. The cost of investing in new AI software would fall relative to wages, potentially throwing cold water on resurgent hiring in white-collar areas.
Monetary policy cannot much affect inevitable structural adjustments in the global economy. Nor can the breakneck pace of data center construction continue, because the major players in AI see building them as an existential challenge.
As my middle-school band director would say, a musician gets paid just as much for resting as for playing when the score calls for it.
Fed Chair Kevin Warsh should give interest rate policy some rest.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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