The Fed Funds Rate Is Too High – RIA

In this summary, we discuss the current state of the U.S. economy, focusing on unemployment and inflation rates, as well as the Fed Funds rate. As of May 2023, the unemployment rate is 4%, and the core PCE inflation rate is 2.6%, a slight increase from the 3.6% unemployment rate and 1.6% core PCE inflation rate in December 2019. Despite this growth, the Fed Funds rate stands at 4%, significantly higher than its 2019 level. While some may find this higher-than-expected rate concerning, given the Fed’s long-term objectives of full employment and stable prices, a 2.8% rate is more consistent with their economic forecasts for a natural long-term unemployment rate of 4.2% and core PCE inflation of 2.0%. Thus, while it may seem anomalous at first glance, these statistics might suggest that, given current economic conditions, modest rate cuts in the coming year are reasonable, especially if inflation stays in check and the economy remains healthy.

In addition, today’s market trading update outlines that we are approaching a new quarter, the end of the first half of the year, and the beginning of Q2 earnings season. Volatility in the markets could increase in response, as observed recently with sharp sell-offs in long-date Treasury bond ETFs. However, this sell-off presents an opportunity for traders, considering that economic data continues to exhibit economic deterioration, which is supportive for bonds.

Lastly, a word of caution regarding predictions of an imminent recession, such as those based on an underperforming Economic Surprise Index. The index indicates that economists’ forecasts are often overly optimistic and, as a result, should be interpreted with caution. Lower-than-expected economic data should be expected, but it’s important to remember that economists usually adjust their forecasts to reflect such trend changes, which can lead to improvements in the surprise index. In fact, historically, low readings from the surprise index do not always indicate a pending recession, making them a somewhat unreliable indicator. As the blog suggests, it is wise to manage one’s portfolio prudently and maintain a long-term focus, utilizing strategies such as adhering to 15 trading rules aimed at mitigating market risks.

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