The Fed Has Misread the Economy
The Federal Reserve’s insistence that monetary policy is restrictive is looking more and more ridiculous.
The “flash” U.S. purchasing managers index (PMI) survey data from S&P Global released Monday indicated that economic output is rising at the steepest rate in 33 months. Growth is accelerating from an already robust pace, and both business and consumer expectations are surging.
The S&P Global PMI headline composite output index rose from 54.9 in November to 56.6 in December, signaling the fastest expansion of business activity since March 2022. This index has been indicating growth since early last year, but it has been showing growth accelerating since the Fed began indicating that it was entering an easing cycle this summer. New orders rose at the sharpest rate since April 2022.
The services side of the economy is booming. Excluding the pandemic rebound, the latest service sector expansion was the strongest recorded since March 2015.
“Business is booming in the US services economy, where output is growing at the sharpest rate since the reopening of the economy from COVID lockdowns in 2021. The service sector expansion is helping drive overall growth in the economy to its fastest for nearly three years, consistent with GDP rising at an annualized rate of just over 3 percent in December,” S&P’s Chris Williamson said.
Consumer and Business Confidence Is Rising
The Atlanta Fed agrees. It reads the economic data on the fourth quarter as indicating the economy expanding at a 3.3 percent annual rate, up from 2.8 percent in the third quarter and 3.0 in the second. That’s far above the 1.8 percent that the Fed thinks is the longterm trend for the U.S. economy and even above the three percent growth that Donald Trump’s economic team says it is aiming for.
The National Federation of Independent Business’s small business optimism index rose eight points in November to 101.7, climbing above the long-term average of 98 for the first time in 34 months. This was the highest reading since June of 2021, when Joe Biden’s inflation began to ravage the economy. Nine of the index’s 10 components increased, one stayed flat, and none fell. The share of business owners believing it is a good time to expand rose to the best reading since June of 2021. The balance of owners expecting higher real sales rose to the highest since February 2020—that is, since before we were hit by the pandemic.
Meanwhile, the New York Fed’s survey of consumer expectations improved considerably in the aftermath of Trump’s win. The share of households expecting a better financial situation one year from now rose to its highest level since February 2020. And the share expecting things to get worse fell to its lowest level since May 2021.
The manufacturing sector is still struggling, highlighting how Biden’s industrial policy—weighed down by a command-and-control, subsidy-riddled DEI and ESG approach—has been not only ineffective but counter-productive. The latest S&P Global survey shows that output is falling sharply, in part because of weakness in exports.
Even in manufacturing, however, there are signs of optimism. “Confidence in the 12-month outlook has lifted to a two-and-a-half year high, suggesting the robust economic upturn will persist into the new year and could also become more broad-based by sector,” Williamson reports.
The Fed, however, got itself into a trap. If it stopped cutting now, that would be tantamount to admitting that the earlier cuts—especially the super-sized cut in September—were mistakes. It would also require the Fed to surprise the market, which is pricing in a better than 95 percent chance of a cut this week, something the Fed has shown zero willingness to do.
Fortunately, the incoming Trump administration is aware of the risks these Fed cuts pose to the economy and their agenda. They’re likely to welcome a Fed that backs off from cuts as we enter the new year.