The Federal Open Market Committee today announced a 50 bp hike in the Fed funds target rate and the commencement of QT June 1. This is pretty much as expected, which itself is expected since the Fed is notoriously ascared of surprising markets.
The lack of hawkish surprises in the post announcement press conference is apparently being taken as dovish by the markets, with Treasury prices up modestly and stocks up less modestly … at this writing we’re looking at nine hundred Dow points. Powell guided expectations towards another fifty basis points at each of the next couple meetings.
Powell did his best to channel Paul Volcker, even mentioning him by name, and actually marginally succeeding. The foaming-at-the-mouth, bug-fucking crazy Jay Powell of a year ago has been abducted by the pod people and replaced with a sane central banker anxious to earn back his dignity. He might not only succeed, but even rescue his legacy from the disastrous policy that underwrote this inflation in the first place.
We could quibble with the decision. We’d have preferred 75 bp but can live with 50. Wait … better we’d have preferred 150 bp, along with a clear statement to the effect of “that’s all, folks” … “we’ll review the rate at each subsequent point and either hike, cut or hold as the data warrant at the time”. Of course the committee has kind of made such things difficult by conditioning the markets for years to expect only the expected.
So as a practical matter our ideal move may be a bit of a fantasy. But as long as we’re going down that road, we have to reiterate that the best rate policy is none at all. In contrast to many Fed critics, I don’t have much of a problem with QE, confined to Treasuries and gold, and would prefer to see it completely replace rate targeting as the Fed’s marquee policy tool. Probably because it’s been done so long, rate targeting has become accepted as normal, but that overlooks the incalculable damage it has inflicted on the economy.
Powell continues to irrationally cling to the use of “forward guidance” as a policy tool, and equally irrationally to the “2% inflation target” as if it had been handed to him on stone tablets. But I believe Powell when he says he’s declared inflation Fed Enemy Number One and think we can be grateful for the progress we’ve seen to date.
The tricky part is that, as the Fed seems to increasingly recognize, it has to go through asset prices to get to consumer prices. Powell himself acknowledged that today, albeit in the fuzzy terms of “financial conditions”. So in an example of what we might call reflexivity, today’s big post-announcement rally in asset prices actually works at cross purposes with the progress the Fed seeks. If it continues, the Fed will find it must become more aggressive to achieve the victory it seeks, in which case the predictability it so cherishes may have to be the next thing to go.
5 thoughts on “FOMC 2022 0504”
Okay so we see yesterday’s rally across asset classes undone and then some. Some are seeing this as a criticism of the Fed … .i.e. the markets are expressing “disapproval” of its policy. No, that’s a simple minded reflex. As this post points out, this is just what the Fed wants. At long last it’s come around to the Financology point of view … policy will have to go through asset prices to get to consumer prices.
Looked at the other way around, more correctly today was all about a rally in the value of the dollar. Prices of just about everything fell … US stocks, foreign stocks, short term bonds, long term bonds, high quality bonds, low quality bonds, copper, gold … folks, there is no spooky metaphysical conspiracy going on here … these prices are all down in US dollars. Occam’s razor dictates that the US dollar went up.
It couldn’t be simpler. Years of dollar depreciation are now working their way into rising consumer prices. The remedy is to increase the value of the US dollar. That, just like it did on the way down, now shows up first in asset prices.
Contrary to superficial financial reporting, this market action is not repudiation of Fed policy, it’s affirmation.
What is the mechanism that is increasing the value of the Falderal Reserve Note? Just increasing rates?
Great question, Rick. The short answer is short covering. When the Fed cuts rates it induces borrowing. It’s effectively going short the currency. Like when you short a stock, you borrow it and then have to pay it back.
When you’re short something and have to pay it back, you’re a source of demand for it. As interest rates rise, the carrying cost of being short the currency rises, decreasing the number of people that want to borrow and increasing the number who want to pay it back. This net increase in demand for currency is what causes its value to rise.
So as with anything else when demand increases, all else being equal, the value rises. This is what happened in 2008. Due to the previous rate cuts, debt grew to unsustainable levels. Millions of people shorted FRNs (dollars) against their homes, certain that the dollars would continue to depreciate against these homes. This created the inflation (dollar depreciation) you see at the far left of the chart.
Then in an effort to fight the inflation, the Fed began to raise interest rates. This ultimately stopped the depreciation of dollars against houses. Some began to have trouble making payments, and had to exit their dollar shorts, stopping the dollar depreciation and ultimately reversing it. Magnified by massive Wall Street leverage, the whole thing picked up speed as people and institutions desperately sought dollars to cover their short positions. The dollar spiked in value, causing prices to crash.