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Why The Fed Should Not Stop Raising Rates

Why The Fed Should Not Stop Raising Rates

A very smart and wealthy friend always reminds me that you have to invest in the market landscape that exists today—not the one you wish for. That said, I like to think of myself as a pragmatist who views the capital markets through the lens of financial history. That history would imply that the Fed should keep hiking rates and ignore the yield curve. In fact, if I were the chair of the Fed, I’d have an emergency 50bps hike today; just to show that I’m serious about putting the economy back on a sound footing for future growth.

To start with, capital markets exist to finance businesses—they should not exist to drive economic growth through a distributed wealth effect that narrowly benefits the wealthy who have capital market assets. The state of affairs that exists today, is an anomaly historically—it isn’t sustainable and shouldn’t be supported by the Fed at the expense of the rest of the economy. Capital market bubbles are disruptive and destructive of long-term GDP growth. Today’s bubble is unparalleled by almost any historical standard—only made possible by abnormally cheap credit along with an implicit Federal Reserve put.

Since the Fed sets the cost of capital, they need to change priorities from supporting financial bubbles to supporting the actual economy. The cost of capital should be at a level that allows businesses to profitably re-invest in growth endeavors. If capital is so cheap that returns on capital investment are minimal, businesses instead focus on driving returns through financial engineering. This isn’t only because they’re obsessed with their stock options—it is because they now have no viable investment opportunities in a world where there is endless competition funded with almost free and limitless capital.

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