Areté Market Review Q223: The Interest Rate Parlor Game

The second quarter was characterized by a debt ceiling showdown (which perversely provided a boost to liquidity) and by a big spurt in tech stocks. There were plenty of other things going on under the surface, but those were the big headline stories.

The outlook for the rest of the year depends heavily on one's view of monetary policy. One view is that over-tightening has already happened and the economy is on the cusp of a deep recession. Another view has it that the economy is fairly resilient and inflation remains a significant threat. How does one gain an advantage in this interest rate parlor game?

Monetary policy rules

One thing that often gets lost in this debate is that both outlooks depend on the assumption that the primary driver of economic growth is monetary policy. The trouble is that assumption has become increasingly tenuous.

While monetary policy has always had an important role in shaping the economy, it helps to remember its status got significantly elevated in the throes of the GFC. At the time, disorderly deleveraging and sharply partisan political divisions made any kind of cohesive public policy measures coming from Congress virtually impossible. Chuck Schumer perfectly captured the dearth of options for all to hear when he called the Fed "the only game in town". Thus heralded an era dominated by monetary policy.