Macroeconomics- "Fed is behind the curve".

[Arnab_Biswas]

Hey, In news channels I am suddenly hearing- Fed is behind the curve a lot. Can someone briefly explain what it means? Using AI I have got the answer that it is- When the Fed is too slow to raise interest rates & you end up in a hyperinflationary environment which is bad for the health of the economy.
I want to know why we call it behind the curve? By curve, like yield curve or does it mean some other thing?
Can someone please clarify? I am finding it hard to gather information about this from the internet.

[Pai]

Hi Arnab,

While there are tons of nuances and technicalities to go through. In simple terms, the Fed (or any central bank for that matter) being behind the curve can be in the context of both raising or cutting the policy rate, which can either slow down or add momentum to the economic activity of the US (or any other country).

In the current context, with all that happened,

1. Japan after Bank of Japan raised interest rates (Nikkei 225 Index dropped a remarkable 12.4% overnight – its sharpest decline since 1987. The Nikkei was also off by a very sharp 24% at one point). Mostly due to leveraged carry trades being wound down - meaning, people borrowing in Japan to invest in foreign assets suddenly realised borrowing isn’t cheap, and would sell off foreign assets to return the borrowed capital.

2. In point 1, we spoke about foreign assets, the impact was also felt on US stock markets. Sell-off plus the unexpected jobs report in the US (which suggested the economy slowing down more than expected), and the hint from the Fed for rate cuts through the year all added to the frenzy. It is really difficult to put a finger on a few things and say for sure. Am relying mostly on the analyst reports I have seen.

The unemployment data we were speaking about also triggered something called a Sahm rule, which is a recession indicator based on how much job additions are slowing down, here is Shubh from our team explaining how it works,

@ShubhS9

Last week, the US jobs data came in, and it was disappointing. The US unemployment report hit a high last seen in October 2021. This bad jobs report sparked fears that the US is at a high risk of recession if it’s not already in one.

This bad jobs report also triggered something called the “Sahm Rule.”

The Sahm rule is a recession indicator that was created by Claudia Sahm (Saam), a former economist at the Federal Reserve. The indicators say that the US economy will be in a recession when the three-month moving average of the national unemployment rate rises by 0.5 percentage points or more above its low during the previous 12 months.

Sahm used the unemployment rate because once it starts rising, it tends to keep rising because bad economic momentum feeds on itself. If the unemployment rate keeps going that means the economy is in bad shape and probably in or entering a recession.

All of these prompted analysts to start saying the Fed funds rate is too high, too restrictive for businesses to borrow, and too high for economic activity to catch up, and hence rate cuts should have been done already. Hence behind the curve.

[SG_13]

@Pai has explained it perfectly from the macroeconomic perspective of what it means to be behind the curve.

@Arnab_Biswas

I want to know why we call it behind the curve? By curve, like yield curve or does it mean some other thing?

No, the curve here, doesn’t refer to the yield curve.

Here the word Curve refers to the trend in the economy and is used in an idiomatic tone.

Being ahead or behind the curve refers to leading or lagging the existing trend or latest developments.

In the U.S. context right now, it would probably mean that Fed is not cutting the interest rate fast enough as the inflation is down for now (Late to react)

[Arnab_Biswas]

Thank you so much! For this very detailed & well written explanation.

[Arnab_Biswas]

Thank you so much for the explanation