Before the meeting, the President told the man he had appointed how to vote. He wanted a cut. He has said the rate should be one percent, or less. What he said to Kevin Warsh was that he might as well vote with the board, because it was not going to matter.
It mattered. On Wednesday the committee raised the rate to a range of 3.75 to 4 percent. The vote was twelve to nothing. It was the first increase in three years.
Then the part worth stopping on.
The ten year Treasury yield had touched 5.016 percent that day, the highest in nineteen years. After the Fed raised its rate, the ten year fell. It closed the next session at 4.94, down six basis points.
The Fed pushed one rate up. The market pulled the other one down.
There are two rates, and only one of them is yours
Almost every argument about the Fed treats it as though there were a single dial. There are two, and they are not connected the way people assume.
The Fed sets one rate. It is an overnight rate, for banks lending to each other for a single night. Nobody has an overnight mortgage. Nobody finances a factory overnight.
The rates that reach a household are long. A thirty year mortgage. A car loan. A corporate bond that funds the plant where somebody works. Those are set in a market, not in a committee room, and the market is doing something specific when it sets them. It is forecasting inflation over the life of the loan.
That is why Wednesday looked backwards and was not. Warsh raised the overnight rate and said inflation is too high and has been for too long. The market heard a central bank that intends to finish the job. So it marked down its inflation forecast. And the long rate, which is mostly that forecast, came down with it.
Run it backwards
Now take the mechanism that worked on Wednesday and reverse it.
Suppose the Fed cuts. Not because inflation fell, because it has not. Consumer prices are up 3.4 percent over the year. Core inflation is 3.3. Suppose it cuts anyway, under public demand from the President, having just told the country that inflation is too high.
What does the market conclude?
It concludes that the central bank will tolerate more inflation than it said it would. That is the only available reading. And the long rate, which is that forecast written as a number, goes up.
So the mortgage rises. The car loan rises. The corporate bond that funds the plant rises. The overnight rate that almost nobody borrows at falls, and every rate that ordinary people actually pay moves the wrong way.
There is a second channel, and this year it bites harder than usual. A cut weakens the dollar. Oil is priced in dollars. Brent is trading near $104, up from about $91 a month ago, with transit through the Strait of Hormuz still selective. A weaker dollar makes an energy shock more expensive in exactly the currency Americans earn.
And a third. At one percent, with inflation at 3.4, the real interest rate would be about minus 2.4 percent. Money would be free and then some. That is a subsidy, but read carefully who collects it. It goes to whoever already holds assets and can borrow against them. It does not go to the household deciding whether it can afford a house. That household is quoted the long rate. Which just went up.
What the gauge says is actually scarce
All of that is plumbing. Underneath it sits a simpler question, and it is the one this site was built to ask.
Is money the scarce thing right now?
The Credit Counterfeit Index exists to answer exactly that. It reads minus 1.24 for the third quarter. The monetary side of it sits at minus 0.09, which is to say at nothing at all. Risky credit traded at 265 basis points earlier this month, among the calmest readings in the whole series. Banks are not tightening standards. Real money growth runs near 2.1 percent.
Money is not scarce in America. It is abundant and it is cheap.
The real bind is the one at 1.15, and it is a strait. It is a tanker that cannot get through without paying a toll to somebody with a navy. No interest rate reaches it.
This is the same finding the dividend checks dispatch reached by another road, and it is worth saying why the two are not the same argument. A check adds money to households. A rate cut lowers the price of money for everyone. Different instruments, different plumbing. Identical mistake.
Both are monetary answers. The binding scarcity is physical. Cheaper credit does not produce a barrel of oil, and it does not open a strait.
What it produces is more money chasing a quantity of goods that has not moved. The word for that is not stimulus.
The thing that is hard to buy back
There is one more cost, and it does not show up in any rate on the day.
Wednesday worked because the market believed him. That belief is why raising the short rate lowered the long one. It is an asset, it sits on no balance sheet, and it was not free.
A central bank that cuts when a president tells it to has told the market something permanent about how it will behave next time. After that, the long rate stops responding to what the Fed says and starts responding to what the politics require. The tool does not break loudly. It just stops working, and nobody can say precisely when it stopped.
Paul Volcker bought that credibility back once. The price was the recession of the early eighties. It is very cheap to spend and very expensive to rebuild. That is the worst possible combination for anything a four year political cycle can reach.
The case for cutting, stated fairly
There is one, and it deserves to be put properly rather than waved at.
Unemployment is 4.1 percent and near a four year high. If the labor market breaks, everything above changes. A genuine credit event would move the monetary bind up fast. The binding scarcity would rotate from real to monetary. A cut would become not merely defensible but urgent.
That is the whole point of keeping a gauge rather than an opinion. The index is built to catch that rotation. It is not catching it now. The monetary bind is at minus 0.09, which is about as far from a credit emergency as the series gets.
So the objection is not to cutting. It is to cutting now, into a real constraint, on political instruction, while spending the credibility that makes cutting work later.
What would prove this wrong
Three things, and the first is the sharpest test this site has published.
Say the Fed cuts, and the ten year yield falls with it. Then the argument here is wrong. The term structure does not work the way this dispatch says. Watch that specific number on that specific day.
If the monetary bind rises above zero while credit spreads widen past 400 basis points, the disease has changed and the medicine becomes correct. And say Brent falls back under $80 with open transit. Then the real bind recedes on its own. The inflation problem is largely solved without the Fed, and this whole question gets much less interesting.
One caution. The six basis point fall on Thursday is a single day in a noisy market, and single days are the weakest kind of evidence. The stronger version of the claim is the level, not the move. A ten year at 4.94 against an overnight rate of 3.875 is a market charging a premium for long horizons. That premium is where a credibility loss would show up first.