FOMC 2023 0503

The Federal Open Market Committee today announced a 25 bp hike to 5.00%-5.25% in the Fed funds target. 

FOMC 20230503

In the context of the entire yield curve, Fed funds in this range is high. The Fed’s balance sheet remains far out of whack with historical trends, as discussed more fully in Fed Preview, indicating the FOMC is putting too much reliance on its Fed funds target and not enough on trimming the balance sheet and raising reserve requirements. It’s hard to anticipate where this experiment in unbalanced policy will lead.

Meanwhile it’s abundantly clear that Financology’s criticism of the Fed’s attempts to rely on “forward guidance” is being further vindicated. It clearly did not foresee the recent spate of bank failures, which have made a mockery out of hawkish guidance just a couple weeks earlier. Can anyone seriously claim that the Fed could have known in January what monetary policy settings would be appropriate today? As I’ve said time and again, the only realistic option is to evaluate the data that are known at the time, respond appropriately, and stop talking about what you’re going to do in the future.

The Fed needs to take off the blinders and broaden its range of tools. It cut the required reserve ratio for depository institutions to zero on March 26, 2020, and left it there. Not possible this has weakened the banks? All through this banking crisis, I have not heard even one attempt in the financial media to defend this.

Markets are intensely focused short term. The rate decision itself is pretty much non-news. It’s widely expected that this will be the last rate hike of the cycle, and markets will seize upon any shred of evidence in today’s announcement as confirmation. History doesn’t support this view … you only know which was the last hike when the cutting cycle begins. But no matter … Wall Street wants to sell stocks and always shapes the narrative in its captive media to suit. Don’t count on the initial stock market reaction as an indicator of what lies ahead.

7 thoughts on “FOMC 2023 0503

  1. Bill Terrell says:

    Reaction to Chairman Powell’s press conference already seems to reflect a more sober assessment. As I expected, stock traders initially seized on ephemeral hints of dovishness to rally prices. While the statement was classic two handed economist jargon, a change in the language referring to additional tightening served the purpose. It shouldn’t have been needed, but Powell threw cold water on fevered stock bulls, saying essentially ‘we just don’t know’ what’s going to be needed going forward. They are retreating from forward guidance and will be “data dependent”. A step in the right direction, Mr Powell.

    Those looking for an authoritative, rational assessment would do better to look to the Treasury yield curve. By Friday it should have had a chance to thoroughly assimilate today’s policy action.

  2. shiny! says:

    Hi, Bill.
    You asked where this experiment in unbalanced policy will lead? It seems to be breaking the Regional banks for one thing. Two hours after Powell said the system was strong we have more regional banks crashing (to be absorbed by the TBTF):
    PacWest down 57% after announcing its seeking a buyer
    Western Alliance Bank down 30%
    Metropolitan Bank 20%
    (these numbers might have changed in the last few hours. H/T The Kobeissi Letter twitter)

    Also this afternoon, the US Treasury Dept announced plans to begin buying Gov’t debt in 2024 “for cash management and liquidity support purposes.”
    Somehow I don’t think it’ll take that long. I’d like very much to hear your thoughts on these developments.

    1. Bill Terrell says:

      Thanks, Shiny! A bit of a tongue-in-cheek rhetorical remark. In truth, bad policy can lead to different results. But suppose you wanted to design a policy to foment problems. What do you think of this strategy;

      1) Lower reserve requirements for all depository institutions to zero.
      2) Slash interest rates to zero.
      3) Stuff the banks with trillions of dollars of reserves.
      4) Raise interest rates on short term funding.
      5) Whenever your banking regulators discover a bank taking excessive risks, send a strongly worded letter.

      The first step was actually taken on March 26, 2020, the second around the same time. The fourth has been ongoing … it leaves banks with two choices: Either raise deposit rates to compete with those on alternatives like short term treasuries and money market funds, or lose deposits as depositors leave for greener pastures. So either the cost of capital you pay depositors rises dramatically or the capital walks. One way hammers profits. The other poses a risk of insolvency and a run on your bank.

      Most banks have left rates in savings deposits near where they were before the rate hikes even started, or grudgingly moved them higher. You get to preserve your profit margin, but become highly dependent on FDIC insurance to incentivize depositors to leave their deposits with you and rely on the potential for a bailout if it doesn’t work out.

      The third incentivized banks to lend indiscriminately. For more color on just how that happened, check out the Hussman piece I cited in Fed Preview. Here’s the direct link:

      Fabricated Fairy Tales and Section 2A

      Hussman points out that the excess reserves – including some eight trillion uninsured deposits – are in banks because “the Fed put them there”. He also traces the root of the problem to the Fed violating its prime directive; to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential…”. Was multiplying monetary and credit aggregate by several times in just three years “commensurate with the economy…”?

      No. In short, the seeds of crisis were sown a couple years ago, if not last decade. The only question was what form the crisis would take. It might be inflation, for example. But whatever the form, policy formulated to address it just forces it to emerge in another.

      The Fed is now playing whack-a-mole.

    2. Bill Terrell says:

      PS I have no idea what Treasury means by “buying government debt” … Treasury is broke … in the hole many trillions of dollars. I hope I’ve addressed your other question though.

    3. Bill Terrell says:

      So PACW last traded at $3.05, after spending the day session around $7, and most of the last few weeks around $10. What do you suppose S&P futures have done? They were initially sharply down, but are now up a few points. Markets smell another rescue. Wonder how many of pieces of the puzzle have to crumble before the big picture follows?

  3. jk says:

    1. you left out saying that you weren’t even thinking about thinking of raising rates. this certainly encouraged banks’moves into 3% paper.

    2. there was a really good interview with Jim Bianco posted on the blockworks macro you tube channel tonight. too much interesting stuff for me to summarize here

  4. Bill Terrell says:

    Haha for sure Powell & Co stuck to their ZIRP forever story long past its sell by date. That tempted bankers to load up on risk. But it’s not as if they blindsided them with hikes either … they were very well telegraphed in advance. But so were they in the runup to 2008. The common mistake the Fed seems stuck on repeating is behaving as if it implements policy sufficiently gradually, the financial system will respond in kind. It doesn’t work that way. It’s a non-linear system.

    They would actually be better off with a more symmetric approach … tighten as readily as you ease, or at least ease as reluctantly as you tighten. And get off this silly paradigm where policy can only move in extended unidirectional cycles. There’s nothing fundamentally wrong with hiking a bit one meeting, cutting the next, hiking the next … whatever is called for at the time. Real markets work that way. It’s ironic that the one place volatility is most easily coped with – short term interest rates – is the one place policymakers seem most obsessed with suppressing it.