The Fed has a dependency problem that needs fixing

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Subscribe to enjoy similar stories. Investors have once again been head-faked by the Fed. After seven false alarms where markets priced in a dovish pivot by policymakers, the Federal Reserve finally turned dovish in a big way—only for bond yields to rise sharply and investors to price in fewer rate cuts than they had before.

What’s going on? The answer can be summed up in two words: Data dependency. The Fed says it sets policy based on incoming data, especially on inflation and jobs. And those data have been both unreliable and far more volatile than usual, confusing investors into a series of rapid reversals.

The data point first to economic weakness and then, sometimes after revisions, strength. Since the Fed cut last month, economic data have come in much stronger than expected. The economy also appears strong.

The weak jobs figures that spooked the Fed into a double cut of half a percentage point last month reversed in this month’s report, which was the third-strongest of the year. Live estimates of economic growth by the New York and Atlanta Feds are both above 3% for the third quarter, up from 2% in late August. The Fed should, of course, look at the data.

But “data dependency" has come to mean looking only at recent data, ignoring projections for the effects of interest rates on the economy in future. Data dependency has made bond markets unnecessarily volatile. In the summer, data suggested high rates (along with a global slowdown, troubles in China and wars in the Middle East and Eastern Europe) were hurting the economy as the jobs market slowed.