A humble Fed and policy slowdown

 

Is the Fed right with holding rates at the current level? Hard to say. They have gotten the inflation forecasts wrong for years, so it any argument based on an inflation forecast is likely to be wrong. Similarly, any policy change based on whether there will be a recession is also likely to be wrong. The Fed is not a good forecaster, so any action should be based on humility. Should the Fed provide liquidity in a crisis? Absolutely. However, will the size and timing likely to be wrong? Indeed.

The argument in response to these wrong forecasts is that the Fed should be gradual, and the Fed should be cautious; however, this means that the Fed will likely be late with any policy action and will likely overdo it when liquidity is needed and under act when policy excess needs to be curbed. 

The result is that investors should make two key assumptions with Fed modeling. One, the Fed will make wrong forecasts. Policy mistakes should be expected. Two, the Fed will also error on caution so it will always be slow to react. This means that asset markets will also be slow to react to any shock. The major surprise will occur when the Fed does decide to act and not follow a cautious policy.