The Fed is political. Stop pretending otherwise

Is the Fed a political institution? The answer is a resounding yes. And if you needed proof, the FOMC just delivered it, gift-wrapped, a few days before the mid-term elections.

Let's review the record. In September, the Fed hiked the overnight rate by 25 basis points after learning that inflation was running at 3.4% y/y. It wasn't brave, and it wasn't nearly enough, but at least it pointed in the right direction. Then the CPI report landed in October: 3.7% y/y. Inflation didn't cool off. It accelerated.

So, what should a central bank that claims to care about price stability do? Hike again. Twenty-five basis points. Two meetings in a row. This is not complicated.

Instead, the FOMC wrapped up its meeting today and took a pass. Apparently, 5.5 years of missing its 2% target is not enough to spur these people into raising rates by a measly quarter point twice in a row. Five and a half years! That's not an overshoot anymore. That's a lifestyle.

This is especially disturbing for anyone who wanted to believe that the Fed, under new Chair Kevin Warsh, finally cares about supplying consumers with stable prices. Credit must be given where it's due, though. The new Chair learned the unwritten rule of the Eccles Building in record time: never rock the boat in an election season. Never mind that CPI is accelerating further and faster away from the target. The Fed's mandate says price stability. The Fed's behavior is political.

Now, let's talk about where all of this is headed, because the stock market is without a doubt in uncharted bubble territory.

A key valuation metric, the ratio of total market capitalization to the money supply, has surged to a record 270%. Read that again. A record. Which means it's higher than the dot-com peak and higher than the 2021 mania. It is a disturbing, mind-blowing number that shows just how far equity prices have floated above the actual liquidity available to support them.

Think about what that means. The value of the entire US stock market is now 2.7 times the money supply. The market isn't priced on cash flows anymore. It's priced on faith, and on the belief that the Fed will always ride to the rescue. But a central bank that can't bring itself to hike twice in a row with CPI at 3.7% isn't a rescuer. It's a bystander with a conflict of interest.

And the stock market isn't the only bubble. We have massive bubbles in real estate, and credit as well, and they are slamming into rising interest rates. Rising, mind you, even with the Fed dragging its feet. The bond market doesn't take its cues from the FOMC's election-year timidity. It prices inflation and credit risks. Bondholders don't care about polls.

Consider where this leaves us in 2027. Consumers and corporations will have been battered by six years of inflation and much higher borrowing costs. Six years! Household and corporate balance sheets don't absorb that much punishment without cracking. And that's before we get to the next problem.

The next problem is the end of the wealth effect. A small cohort of Americans have been spending like they're rich because their brokerage statements said they were. But when earnings decline, stock prices come under pressure, and the paper wealth that was funding all that consumption starts to evaporate. People who feel poorer spend less. And consumer spending is roughly two-thirds of GDP. It's not exactly a theory that requires a Nobel Prize.

Then there's the AI investment bubble, which is running out of fuel. Trillions of dollars have been poured into data centers, chips, and promises. Where are the revenues and returns to justify it? They aren't there. Not in anything close to the size required. And the one thing that kept this party going, cheap credit, is drying up. Lower returns plus a declining supply of cheap money is a recipe that, in my view, virtually guarantees a sharp slowdown in economic growth next year.

So, here's the picture. A Fed that blinks when it should hike. A stock market priced at 2.7 times the money supply. Real estate, credit, and equity bubbles colliding with higher borrowing costs. A wealth effect on the verge of reversing. And an AI boom that can't fund itself on its own returns.

Would you like to know who's going to fix it? Don't look at the inhabitants of the Eccles Building. They'll be too busy checking the polls and watching the health of the stock market. And with the Federal Government carrying $40 trillion in debt and the Fed’s balance sheet close to $7 trillion, do not expect another debt monetization spree to help bring interest rates lower. More inflation and deeper insolvency will not bring solace to the Treasury market. Expect the bond vigilantes to vote no on that.