Why The Fed Rate Cuts Were A Mistake | Michael Kao

The Fed's rate cuts in late 2023 were a policy mistake, as argued by Michael Kao, due to a confluence of supply inelasticity factors and a strong US economy. Kao anticipates a potential pause in rate cuts as early as December, leading to a global 'bait and switch' where the US dollar strengthens, negatively impacting emerging markets like China. A stronger dollar and relatively high oil prices could cause a global recession.

Fed Rate Cuts

• 00:00:54 The Federal Reserve's decision to cut interest rates by 50 basis points in August 2023 was deemed a mistake by Michael Kao, who believed the move was premature given the absence of recessionary pressures. This decision was primarily driven by weak unemployment data that Kao considers an outlier.

Supply Inelasticity

• 00:03:39 Kao highlights several factors contributing to a supply-constrained environment, including oil price support by Saudi Arabia, geopolitical issues impacting freight rates and manufacturing, and the housing shortage. These factors limit supply flexibility and can lead to renewed inflation if aggregate demand rises, which was exacerbated by the Fed's actions.

Global Economic Impacts

• 00:11:57 The Fed's rate cuts spurred a global cycle of competitive rate cuts, initially leading to a weaker US dollar. Kao anticipates that this cycle will shift, with the Fed potentially pausing cuts and other countries continuing to ease, which will strengthen the US dollar. This creates a ‘wrecking ball’ scenario for other countries, particularly those with significant US dollar debt.

China's Economic Challenges

• 00:24:28 China faces significant economic pressure, notably from a burgeoning housing crisis and a reliance on exports to the US and EU. These pressures are amplified by the potential for increased US protectionism and tariffs, forcing China to consider a currency devaluation to stimulate its economy.

Future Macroeconomic Outlook

• 00:43:54 Kao forecasts a potential pause in Fed rate cuts in December, which could lead to a rally in long-term bonds. However, equity prices may remain resilient, particularly for large technology companies. He believes oil remains a key commodity to watch, as a potential deal between Trump and Saudi Arabia could significantly impact prices and global markets.