Interest Rates: Predicting the Unpredictable

Everyone wants to ask me where I think rates are going, and everyone wants to tell me where they see them going. I’ve had chats with really, truly smart people. We’re talking finance gurus, real estate moguls, physicists, chief executives, you name it. 

And the conversation shocks me. It’s always about near-term changes to interest rates. Earlier this year, it was about where rates are going in 2024. Now that’s evolved to where rates are going next year.

What shocks me about these conversations is the certainty.

In January, for example, one smart guy I spoke to said there’ll be three, four, maybe even five rate cuts this year. 

Not long ago, another guy I know comes to me. He’s so incredibly smart — he has all the models and has worked out the probabilities, and he says, you know, there’s a 25% chance of this, and a 12% chance of that, and rates are going to go here and then there.

Well, here’s my perspective: We control way, way, way less than we think or would like to believe. So what are we even talking about? We have no idea!

It’s insanely complicated

The global economy — of which the U.S. is just one part — is ridiculously complex. There used to be this profession called econometrics where kids would go to school just to build models of the economy. The thing is, it never actually worked. It’s just too complex: There are too many moving parts, too many interdependent nodes.

Consider all the various tiny things that can affect the economy and the price of goods: the cost of a carrot in Boca Raton, the cost of cabbage in Siberia, where NVIDIA is relative to Google, even the color of Powell’s briefcase. It all plays into this complex web that makes up the global economy. These billions of tiny, interrelated nodes all come together to make the economy unpredictable.

Human emotion is the current that drives so much. You can’t predictably guess, at scale, how billions will react to anything. Hindsight, of course, makes everything look easy. After COVID, the market ripped because we pumped money into the economy. But before that? Everyone thought the world was ending. Nobody saw the rebound coming, except maybe a few lucky ones.

My point is: It’s all about how we interpret things. The Fed’s most powerful tool in their toolkit is not interest rates nor is it all those PhDs they’ve got trying to figure out what’s going to happen next. It’s rhetoric. When the Fed talks, people listen. Not because they know what’s going to happen, but because their rhetoric shapes expectations. Whether interest rates go up, go down, or stay the same — it’s all just educated (or uneducated) guesswork. And anyone claiming certainty is kidding themselves.

When you (or anyone else) say there are going to be two, or three, or four rate hikes or cuts this year — what are you talking about? There are full-scale wars happening on two continents. When you make your rate predictions, you’re saying you understand all of the repercussions of those. You’re saying you understand the full, entire repercussions of this year’s elections — not just in America but around the world. You’re saying you understand how that’s going to affect the basket of goods measured in an obscure way by the CPI against this make-believe 2% target.

The Fed doesn’t know any of this either. If the Fed knew, everything would be easy peasy. There would never need to be a Paul Volcker. These things are unknowable in the short term. In the long term, sure, these things are much more measurable, but that’s still not enough.

When you think about the worst that could happen, what do you do? You look at extreme events that have happened in finance. The Great Depression, Black Monday, the COVID crash. The thing is, these extreme events? Before they happened, they’d never happened. You can’t benchmark against them. The worst that’s happened so far isn’t the worst that can happen. The unforeseen is what matters the most. It’s always coming out of left field.

Looking longer term

In the long term, the Fed is going to manage to get towards lower inflation using the tools they have: their rhetoric, interest rates, and money supply. The short term’s more like a soap opera. We don’t know what everything happening today means in the tapestry that’s the U.S. economy. We can’t possibly predict where all those little, individual, interconnected nodes will take us.

The Fed’s most powerful tool isn’t rates; it’s what they say. They’ve got their rhetoric and their interest rates, but they’re up against forces beyond their control. 

There’s this great expression that always gets attributed to Mark Twain: “History doesn’t repeat itself, but it often rhymes.” And with that, I wish you lower interest rates and all the things we think come with them.