Fed’s about to make a huge mistake, warns Cathie Wood

Kathy Wood, the founder of ARC Investment Management said any decision by the Federal Reserve to raise interest rates as the yield curve inverts would be a mistake. The US government bond yields reached new levels of inversion on Friday after a solid jobs report bolstered bets that the Central Bank will increase the size of its next rate hike. A 2-year rate exceeded the 3-year for the first time since 2007, while other parts of the curve, including the 5-year and 30-year segments, are already inverted. 

‘The Fed seems to be playing with fire’ she wrote in a series of tweets on Saturday. 

‘Yesterday, the yield curve – as measured by the difference between the 10 year Treasury and 2-year Treasury yields –inverted, suggesting that the fed is going to raise interest rates as growth and/or inflation surprise on the low side of expectations… which would be a mistake’ she wrote. 

Economists have learned over many cycles that the 10-2 year measure of the yield curve leads to another one: the difference between the 10 year Treasury yield and the 3 month Treasury rate. I have no idea why many strategists and economists are reverting to the latter one now.’

The 10-year to 3 month yield curve is steep because the fed is telegraphing aggressive interest rate hikes in the face of inflation that has been stoked by supply shocks. Inflation is a highly aggressive tax that is killing purchasing power and consumer sentiment.’ 

‘U.S. consumer sentiment, as measured by the University of Michigan, is lower today than it was at the depths of the coronavirus crisis. It has entered 2008-09 territory and is not far from the all time lows in the 80s when inflation and interest rates hit double digits.’ 

‘The economy succumbed to recession in each of those periods. Europe and China are also in difficult straights. The Fed appears to be plying with fire’ she concluded. 

The Federal Reserve raised interest rates for the first time since the pandemic last month, was signaling far more hikes and a warning that inflation would remain high through the rest of the year. The quarter-point interest rate hike was expected and considered modest, but the Fed more than doubled the number of rate hikes anticipated this year to a total of seven to help reign in the highest inflation in 40 years. Last month marked the first rate hike since 2018.

The Fed board has faced criticism that it has underestimated inflation over the past year, and now even more uncertainty lurks. Energy prices are spiking because of the war in Ukraine and court IRS surges that are shutting down major Chinese manufacturing hubs, worsening global supply chain snarls that are pushing prices higher. Inflation has a long way to fall before it comes close to normal levels, but the Fed has to avoid intervening too forcefully or abruptly, which could cause a recession. The Fed expect inflation will remain high hitting 4.3% at the end of the year even taking into account according to new projections released at the end of the Fed’s two-day policy meeting last month. Any further interest rate hike will likely have a big impact on consumers’ lives, from loans and investments to savings and job prospects and prices for goods and services. 

American households will feel that policy impact in many ways, both positive and negative, according to financial advisors. Raising interest rates has a cooling effect on the economy because it increases the cost associated with a wide range of lending, from mortgages and auto loans to business investments. 

The Fed’s tools are limited when it comes to lowering prices. Monetary policy is not intended to respond to short-term blips in the economy such as an energy shock, yet such shocks have the potential to weigh on the economy, especially the longer they last, forcing the Fed to consider more aggressive moves and coming rate hikes. To address surging energy prices, the White House, for its part, has explored a third release from the strategic petroleum reserve and is considering a pause in the federal gas tax. The administration is also warning oil and gas companies not to keep prices artificially high for American consumers. Inflation has cast a shadow over the economy recovery. Early looks at consumer sentiment and March showed it had fallen to its lowest level since 2011. According to University of Michigan survey data, the incomes took a beating from rising fuel prices. Consumers said they had very negative prospects for the economy aside from the job market. The Fed’s rate increase is considered a moderate move, and Republican critics have maintained that the Fed’s rate hike is too little, too late; rate hikes also tend to operate with a lag. 

Larry Summers, treasury secretary under President Bill Clinton, warned in a Washington Post column last month that the rate hike was not enough and would lead to stagflation and recession. However, Kathy Wood has warned the Fed that further hiking interest rates would be a huge mistake. For much of the past year, Fed officials have said inflation would be a temporary feature of the recovery and limited to parts of the economy hit hardest by the pandemic. Over time as higher costs spread to rent, groceries, and everything in between that message contrasted with what was actually unfolding in the economy and in people’s lives. That’s especially the case for families scraping by to cover the basics, for whom rent, groceries, and gas make up a huge share of daily costs. Inflation has hit lower income workers harder, even though they have seen some of the fastest wage growth during the pandemic, those gains are being eroded by rising prices. 

Meanwhile, wealthier Americans have stronger protections against rising prices and can cushion inflation’s bite by dipping into savings, tapping home equity, or cutting extra spending. We agree with Kathy Wood that further interest hikes will hit Americans hard and will cause U.S. consumer sentiment to fall to an all-time low.

We would like to continue the discussion in the comments as we are interested in knowing what you esteemed viewers think on this issue. Will further interest rate hikes be a huge mistake by the Fed or will the economy fall into stagnation if the Feds fail to raise the interest rate further? Let’s hear your views in the comments.