Fed Thoughts: Suspension of Disbelief

Chief Economist and Macro Strategist Vincent Reinhart answers key questions in the wake of the July 26-27 FOMC meeting.

We feel the interpretation of events was mostly shoe-horned to fit the prevailing policy narrative, both inside the Fed and apparently among market participants. Good news was good; bad news had the silver lining of foretelling a rebound. The result followed the storyline that the Fed would hew to its established policy path, slowing the growth of aggregate demand, perhaps at the risk of a shallow recession next year with few untoward consequences, and successfully return inflation to its longer-term goal. We believe this happy coincidence of events would allow the Fed to reverse course and ease next year. There is a glow about it, as in the opening pages of a fairy tale with a sunlit castle and a happy family.

Here, we provide a bracing reminder that summer romances do not usually last but, instead, are followed by a discontented Fall and cold Winter. For now, there is a mutual suspension of disbelief among officials and market participants of the old, hard logic of the business cycle. We think reality will set in, and a happy ending is only afforded to investors prepared for it now. We proceed first with the facts, next voice our doubts, and then pose three uncomfortable questions about the outlook.