Why the Fed keeps getting it wrong

The Fed’s shifting stance on interest rates is driving markets again, with politics and policy mistakes now shaping how investors react.

One of the biggest drivers in the market, if you didn’t know, is interest rates, and it is all to do with global liquidity. If interest rates drop, money comes into the system, comes into the stock market, and the trend in interest rates is one of the biggest drivers for stock markets. If there’s a change in attitude towards interest rates, it can turn the stock market.

What we’re seeing at the moment is a bit of a sell-off thanks to concerns about an AI bubble, but we’ve got the US market starting to bottom again. And the expectation is that interest rates are going to come down.

Rate-cut expectations are swinging again

Just three weeks ago, after the last Fed meeting, we saw Jerome Powell tell us that a rate cut in December is by no means guaranteed. And the odds of a rate cut in December in the US dropped from 100% down to 30%. It’s now back up over 80%.

There are a few things driving that. There has been a lot of Fed speak – Fed governors talking – in the last week about rate cuts. We know Stephen Miran, who is a Trump stooge on the Fed board, wants a 50-basis-point rate cut. And now suddenly we have a White House official being favoured as the next Fed chair, taking over from Powell next year. Scott Bessent, who is obviously a Trump-aligned official, is interviewing people for Powell’s job at the moment.

And he’s interviewing someone called Hassett, who is very much in the Trump camp. The feeling is Trump is going to say something before Christmas about who the next Fed governor is, and it could be Hassett. He has already talked about a 50-basis-point cut in December.

Does the Fed need a shake-up?

I know everyone’s upset about Fed independence and how terrible it would be if the Fed got touched by Trump. But let me just tell you, the way the market sees it at the moment, it is probably a good thing.

The most obvious point is that if Trump gets his people onto the Fed board, then interest rates are more likely to come down quickly, which the market likes – and it might actually be appropriate, inflation aside.

The other thing we all have to think about is whether the Fed needs a shake-up. Yes, it does.

Just go back and have a look at why the GFC happened. It happened because, as Greenspan admitted in the 2000s, they kept interest rates too low for too long. They created a housing bubble, which turned into a mortgage-backed security crisis, turned into a global financial crisis. They then printed money and, by their own admission, didn’t tighten up fast enough.

That money went to large investment banks in the US, which were supposed to make it available to the economy to refloat things. Instead, they were buying asset classes that were going up in price and making billions out of printed money. And the Fed didn’t tighten up fast enough. That created another bubble.

How past Fed errors hit Australian households

Then in COVID, they printed money again. Inflation picked up, and they called it transitory. So interest rates were sitting at 1% for far too long again. Suddenly they woke up in January 2022 to realise inflation wasn’t transitory, and interest rates had to go from 1% to 5% in the US – which doesn’t really matter in the US because 90% of mortgages are on fixed rates based on the 30-year bond yield.

So you can raise rates in the US, and it doesn’t affect consumer spending. It’s the other way around here. We’re all on variable mortgages, or anyone with a mortgage is. Put rates up here and the consumer gets affected.

If you know somebody who took out a $1 million mortgage in the year 2000 and thought interest rates were going to stay at 1% because the Fed was telling them that – they quintupled. And everybody got nailed because the Fed got it wrong.

Let me be clear: if you’ve struggled because interest rates went up in the last four or five years because the Fed got it wrong, it’s the Fed’s fault. It affected you. It didn’t affect US consumers. Australians have been nailed by the Fed as well.

Why markets may actually prefer a Trump-aligned Fed

The point being: the Fed is not the Messiah. It has actually been a rather pathetically run, badly managed institution. And if it has to get touched by Trump, let it get touched by Trump, because it needs a bit of a sort-out.

The bottom line to all this is that I think the market will like the Fed being touched by Trump because it will mean lower rates. And it won’t dump because of the Fed independence worries that were around six months ago.

Let’s see who’s appointed before Christmas. If it’s a Trump appointment, and if Stephen Miran is also reappointed next year, we’re going to see lower interest rates in the US. And that’s probably a good thing. And if the Fed gets shaken up, that’s probably a good thing too.