The US Fed may kill the Biden presidency
t is no secret that one of President Biden’s key weaknesses in the upcoming presidential election is the economy. A USA TODAY/Suffolk University poll in March put Trump at 40pc, just ahead of Biden on 38pc. The same poll showed many Americans remain undecided; among those surveyed inflation and the economy were listed as the most important issues determining their vote.
As such, a core problem for Biden is the recent price rises and resultant cost of living crisis. In the past few months, political strategists have marvelled at the fact that the economy under Biden was growing (at 3.2pc in the fourth quarter of 2024) but polling on Biden’s performance on the economy was dismal.
A recent paper led by former treasury of the secretary Larry Summers has helped clear up the discrepancy. Summers and his co-authors show that if we adjust American inflation data to consider changes in methodology that have taken place over the past few decades, we see inflation not peaking at 9pc, as the official data indicates, but rather at 18pc. The paper also suggests that inflation measured in line with historical norms would have been 8pc at the end of 2023, not the 3pc shown in the official statistics.
This explains why the average American voter is angry at Biden about the economy: prices are still rising at a rapid clip and living standards have been substantially eroded under his administration. This puts the Federal Reserve in a very unusual position this electoral cycle, because what the central bank does in the coming months could have a huge impact on the outcome of the election.
As late as December of last year, the Fed remained concerned about inflation. The mantra that officials were feeding to markets at the time was “higher for longer”; the idea being that the Fed would maintain interest rates at a high level until there was ironclad evidence that inflation had been tamed.
Then, in mid-December, much to the surprise of market analysts who were naïve enough to simply follow the data, the Fed turned on a dime and started to signal that there would be rate cuts in 2024. This has led many Republicans, perhaps understandably, to start questioning whether the Fed has begun to play politics with monetary policy: lowering rates not because the inflation numbers justify it, but because it might help the incumbent at the White House.
Consider the basic facts. The Fed, like the Bank of England, has a target of 2pc for inflation. Yet US inflation has not been below 2pc since February 2021. As of February 2024, inflation stands at 3.2pc, higher than it was in June 2023 when it bottomed out at 3pc.
So-called “sticky price” inflation less food and energy – a key metric the Fed has been watching to make sure the inflationary vampire will stay in the grave – was at 4.4pc in February 2024. Back in February 2021, this measure was at 1.4pc.
This has been a dangerous game for the Fed. After all, its credibility is currently at an all-time low after it missed the inflation to begin with, and even once the threat was apparent members thought it was “transitory”. With the Fed signalling rate cuts for four months while the actual data continued to show inflation above target, the central bank was betting the farm that it would fall.
Now, however, it appears that the Fed will have to throw in the towel. Oil prices are rising sharply. Brent oil currently stands at over $90 a barrel, up from just over $73 a barrel in mid-December around the time the Fed started priming the market for rate cuts.
It should have been obvious that oil prices would rise, as the OPEC+ countries led by Russia and Saudi Arabia were signalling aggressive production cuts. But the Fed ignored oil producers and rode a downward market trend that was facilitated by hedge fund short sellers.
As a result, the Fed has succeeded in annoying almost everyone and looking very silly in the process. Biden looks like he will not get the rate cut that he effectively promised. Trump will not forget the chatter about the Fed playing politics with interest rates. And the markets will finally have to face the fact that the Fed’s inflation analysis, much less its signalling, is at times unreliable.
A credibility crisis has been building around America’s central bank for some time. Yet because markets have become so enamoured with Fed policy, it is in no one’s self-interest to call it out.
When the Fed asserted that inflation was transitory, for instance, the markets trusted the plan. After all, it was reasoned, the Fed sets the interest rate which in turn determines the value of bond portfolios in the markets.
Rather than question the rate-setter, the path of least resistance was to go with the flow. And when it turned out that the Fed was wrong about inflation, the rational move was for markets to shrug it off: after all, if everyone got it wrong, then it was obviously unforeseeable.
Two things are now becoming clear. First, that central bank independence in the US is looking less like independence from government and more like independence from serious economic analysis.
Second, that Joe Biden cannot rely on lower interest rates to boost his electoral prospects. If anything, they look more dire than ever before.
