Small Business Optimism Surges: Another Reason for the Fed to Pause
Today’s report from the National Federation of Independent Business shows that small business sentiment is riding high, with optimism reaching its highest level in over six years. A resilient labor market, the improving outlook among small businesses, and persistent inflation pressures are signals that the Fed’s September and October rate cuts may have been premature. Instead of preparing the market for further rate reductions, the central bank should rethink its approach and consider pausing.
Resilient Labor Market: The Tail Risk That Wasn’t
The Federal Reserve justified its rate cuts last fall by citing concerns about a potential sharp downturn in the labor market. But that risk has failed to materialize. After a brief slowdown in hiring over the summer, payroll growth has picked up, and unemployment remains steady. The December jobs report showed a robust gain of 256,000 jobs—far surpassing economists’ expectations of 150,000—and the unemployment rate ticked down to 4.1 percent.
In short, the Fed acted to head off a tail risk that no longer exists—and may never have existed. We have been arguing for months that the economy was stronger than it seemed (a position unpopular with conservatives who hated the Biden economy and liberals who wanted the Fed to ease) and would likely strengthen if Trump won. The prudent thing for the Fed to have done would have been to wait until after the election to start cutting since the election of Kamala Harris may well have brought on the weakness the Fed feared.
Regardless of whether that fear was ever justified, it no longer is. With the economy near full employment and interest rates already lowered by 100 basis points, the rationale for further cuts has evaporated.
Inflation is no longer cooling sustainably. While prices cooled briefly in the second quarter, the latest data suggests that inflation has become stuck at a level well above the Fed’s two percent target. Even today’s soft producer price index number—final demand prices rose 0.2 percent in December—didn’t budge the year-over-year figure off 3.3 percent.
With inflation running above the Fed’s two percent target and the labor market proving resilient, why should the central bank continue to cut rates? It risks stoking inflation further while doing little to spur already-strong employment.
Main Street Sends a Clear Signal: Confidence is Back
The surge in small business optimism underscores that Main Street is feeling confident about the future. What Larry Kudlow has been calling the “Blue Collar Boom” is already beginning. Expectations for sales and expansion have risen sharply, and uncertainty has fallen. The political climate, driven by the promise of low taxes and reduced regulation, has made businesses more willing to invest and grow.
This confidence is not the product of cheap money—it’s the result of a stable economy and pro-growth policies. Small businesses are less concerned about credit conditions and more focused on expanding their operations in response to stronger demand. That’s a sign that businesses don’t need lower interest rates to keep the economy humming—they need a Fed that stays out of the way.
No Justification for More Cuts
Both pillars of the Fed’s rationale for rate cuts—labor market weakness and soft inflation—have weakened, if not disappeared entirely. Instead of leaning toward additional cuts, policymakers should acknowledge the strength of the labor market and persistent inflation risks. Cutting rates further at this point risks over-stimulating the economy and creating new imbalances.
If anything, today’s data should encourage the Fed to hold rates steady at its next meeting. The case for insurance cuts has evaporated, and further easing could turn into a policy mistake. The Fed would be wise to take a cue from Main Street and let the economy grow without the unneeded stimulant of monetary easing.
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