What The FOMC Did On The Day It Realized Hikes To The Fed Funds Rate Weren’t Slowing Inflation

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The FOMC is meeting today, but we have to wonder if they already achieved their goal of slowing down the economy just six weeks ago with a psychological play.

Prior to the August get-together, the FOMC had raised the Fed Funds Rate from 1.000% to 5.250% over a period of two years and a few months.

With each successive increase came a public statement that explained why the FOMC voted for the increase, something akin to "we want to make sure that prices don't run up out of control."

This is also known as inflation.

At their last meeting, though, the Fed decided to stay put.  No increase at all.  And this happened even as the economy was showing zero signs of slowing down.

Regardless, markets applauded the Fed Pause and thus began the long, slow conversion to the belief that FOMC is now done raising the FFR altogether. There is a 94% probability that the FFR would hold at 5.25% this afternoon, according to the Fed Funds Rate futures market.

Meanwhile, after the August meeting, economic indicators showed signs that the economy actually was cooling off:

• Oil prices came down
• CPI came down
• PPI came down
• Housing markets slowed

Looking back at the FOMC meeting in August, there are two well-debated points about what has happened since:

1. Prices and costs have dropped because markets are now expecting a general economic slowdown moving forward
2. Despite the inflationary data, the Fed saw a pattern that said inflation was no longer a threat

Most pundits are in one camp or the other.  I'm in neither.

I see it as the Fed elected to hold pat at 5.250% as a last-ditch effort to slow the inflation stampede.  This was a pure psychological play against the markets.  The FOMC was simply out of options.

See, the Fed kept telling us that the economy was spiraling out of control.  Hence, the hikes in the Fed Funds Rate.

But with each increase, markets took that future expectation and then traded on it.

In effect, inflation became a self-fulfilling prophecy.

So, at the August 8 meeting, the Fed may have recognized how their rate hikes were actually contributing to inflation -- traders were actually pushing markets forward in the form of futures, causing higher prices.

Remember how pricey copper was several months back, and other commodities, too?

Because the economy was not slowing down the "traditional way" (i.e. with hikes to the FFR), the FOMC decided to slow it down with a different tactic.

Mind games.

"If the Fed didn't raise rates," markets wondered, "they must know something.  Maybe we should stop playing for inflation."

And so they did.  And prices dropped.  And so did a bunch of key inflation indicators.

The economy was running at uncomfortable inflation levels August 8, but it is entirely possible that -- after 17 consecutive rate hikes -- that the Fed realized the only way to slow things down was to fake the markets into slowing themselves down.

It's a psychological play, but absolutely effective.  And today, expect another pause.