5-14-24: The Fed Should Cut Rates Before a Credit Crisis Forces Their Hand

by Louis Navellier

May 14, 2024

The Fed seems determined to keep kicking the rate-cut can down the road. Last Tuesday, Minneapolis Fed President Neel Kashkari issued an essay saying that the recent inflation data raise questions about whether their monetary policy is restrictive enough to fully return price growth to the central bank’s 2% target rate.

Specifically, Kashkari singled out persistent housing inflation as a sign that the “neutral” interest rate – meaning a rate that neither restricts nor stimulates the economy – may be higher in the short term. Essentially, Kashkari implied that the Fed has more work yet to do to cool inflation when he said, “My colleagues and I are, of course, very happy that the labor market has proven resilient, but, with inflation in the most recent quarter moving sideways, it raises questions about how restrictive the policy really is.”

Kashkari emphasized that the Fed must set policy rates based on where the “neutral rate” is in the short run, saying, “The uncertainty about where ‘neutral’ is today creates a challenge for policymakers.”  Even though he is not a voting member on the FOMC, he has raised his long-term neutral rate forecast to 2.5%.

One major impediment to inflation meeting the Fed’s 2% target is high shelter costs (called “Owners’ Equivalent Rent” in the CPI). Ironically, our formerly hot housing markets – like Austin, Texas and much of Florida – were over-built and are now moderating, but that trend is not yet reflected in the monthly CPI.

Zillow Group reported last Tuesday that rents in most major metropolitan areas have risen 1.5 times faster than wages in the past four years. Specifically, according to Zillow, StreetEasy and the Department of Labor, rents rose 30.4% in a five-year period (2019 through 2023), while incomes rose 20.2% over the same period. Three Florida metro areas outpaced the national average, ranging from 36.7% in Jacksonville, to 52.6% in Miami, while wage growth severely lagged rental costs in those regions.

My Case for Cutting Interest Rates Sooner Rather than Later

I would humbly suggest that the Federal Reserve Governors get their nose out of the inflation data alone and take a closer look at the entire array of data – and lives impacted by “higher for longer” interest rates.

Here are five reasons why I think the Fed might want to consider cutting rates sooner – in June or July:

Reason #1: The Fed has a dual mandate – promoting jobs and controlling inflation. To date, they have focused almost 100% on inflation, but the Labor Department reported last week that weekly jobless claims rose to 231,000 in the latest week, up from a revised 209,000 in the previous week. Weekly jobless claims are now running at the highest rate since August 2023, which should concern the “data dependent” Fed, since their dual mandate includes a push toward low unemployment, as well as a low inflation rate.

Reason #2: On the wholesale level, prices are flat or falling. A strong U.S. dollar is deflationary, since it lowers the price of imports and commodities priced in U.S. dollars. Also, with its shrinking population and struggling economy, China’s deflation is spreading to the U.S. due to their overproduction of solar panels, batteries and EVs. As a result, wholesale goods prices have fallen in five of the last six months.

Reason #3: Interest service on the federal debt is too costly: Our soaring national debt – now over $34 trillion – costs nearly $1 trillion per year to finance, and that will grow as our old debt is refinanced. We simply can’t afford to keep paying 4% to 5% on a rising federal debt for an extended period of time.

Reason #4: China continues to export deflation and over-production: China’s exports of steel products have risen 27% this year, but Brazil, Europe and Turkey have started probes to verify if China is dumping low-cost steel. Over-production of many Chinese exports – like batteries, EVs, steel and solar panels – remains an acute problem, so China is expected to continue to export deflation. Within China, consumers are buying a record amount of gold, since there are restrictions on some bank withdrawals, sometimes including withdrawal limits or a longer liquidation schedule, due to their fragile real estate markets.

Reason #5: We could see a deflationary “credit crunch” in the private debt market. We are seeing soaring credit card debts, with credit scores at a four-year low, while the banking system overly relies on – even seems obsessed with – lending based on “credit scores,” without really knowing who their clients are.

As a result, a secondary debt market has boomed, and the private credit industry has soared, creating a second tier of lending for companies and consumers with less-than-ideal credit scores. Currently, the private credit industry is promising yields in excess of 11%, with quick payback rates over just two years.

The next crisis could be triggered by a private credit lender, like Blackstone, restricting redemptions due to defaults. Then, if there is any kind of “credit crunch” with forced asset sales, deflation could spread.

I should add that Blackstone has attracted billions of dollars for direct leveraged lending. This is a good time to remind everyone that the 2008 Financial Crisis was largely triggered by leveraged debt blowing up. This time around, the private credit industry is reportedly utilizing less leverage, but as the industry expands and competes with higher yields, the probability of another “Black Swan” meltdown increases.

Of course, the Fed can counteract the risk of any meltdown by cutting key interest rates, which would reap windfall profits for the private credit industry. So essentially, we are now at an interesting tipping point, and I for one, hope the Fed does not wait for the next credit crisis to begin cutting key interest rates.

Business Insider last Tuesday printed a less than flattering article (“Blackstone’s Big Gamble”) about Blackstone’s commercial real estate fund, BREIT, which buys warehouses, apartments and other commercial real estate assets. BREIT has $114 billion in assets and pays an annual dividend of about 4%. Business Insider cited Craig McCann, a financial analyst who served as an economist at the SEC, who wrote last year that, “Investors should not accept anything Blackstone and BREIT state as truthful.”

Essentially, Blackstone appraises the value of its commercial properties to determine a “net asset value,” or NAV. Since most funds calculate their NAV based on the last securities trade, and BREIT’s financial documents state that Blackstone “is ultimately and solely responsible for the determination of our NAV,” advisors are skeptical of any NAV not audited by an independent registered public accounting firm.

So, Fed Governors, please look at the whole picture – not just consumer inflation – and cut rates soon.