The Federal Open Market Committee today announced no change in monetary policy. The Fed funds target remains at 5.00%-5.25% and the balance sheet rolloff continues apace. The FOMC balanced this dovish nonaction with firm, resolute, hawkish movement of dots.
In the context of the entire yield curve, Fed funds in this range is high. The Fed’s balance sheet meanwhile remains far out of whack with historical trends, leaving monetary policy in accommodative mode, as discussed more fully in Fed Preview. It’s hard to anticipate where this experiment in unbalanced policy will lead. For the time being, while trailing indicators of inflation like consumer prices are moderating, leading indicators like asset prices show a new wave of inflation entering the pipeline.
Forget the 1970s motto. Here in the 2020s, it’s Whip Inflation Tomorrow!
Maybe some patience is in order. The balance sheet is being trimmed, albeit at a pace that still leaves it massively larger than before the explosive expansion of 2020. At what point does it catch up sufficiently to actually provide the restrictive character Fed PR suggests? I don’t know, but would look for the balance sheet to return to somewhere in the neighborhood of its pre-2020 trend. We will know for sure when asset prices take another leg down. If the Fed is as serious about nipping inflation in the bud as it portrays, it should accelerate the runoff of non-treasury assets such as MBS. That seems unlikely given its predisposition for the drip drip drip of water torture tightening.
Is the Fed making a policy error? I believe so; just not the kind widely posited in the financial media. Rather its mistake is in assuming the financial system is a linear system – that if it implements policy sufficiently gradually, the economy will respond in kind. This is the same error it committed in the runup to 2008, and I expect a similarly nonlinear response.
Reaction
Stocks responded to the announcement with a mini-crash. Given the leading aspect of asset prices, I take this as a positive review. Analysts however are not at all in uniform agreement. Amid the erudite commentary on Bloomberg TV, for example, the word “dumbassed” wouldn’t have been substantively out of place. The question: If you’re so sure more hiking is in order, why didn’t you do any today? Some version of this is virtually assured to come up in the press conference. The dots imply at least 50 bp of further hiking. So indeed, if you think 50 bp is in order, why not even 25 now?
My take is it’s just plain weak. Try to present a strong image without being strong. They must realize that a lot can happen in the intervening weeks. and can project with impunity secure in the realization that they can find a rationale to fail to follow through. The projections are an empty threat. Although initial market reaction indicates the dots are being taken seriously, that can change tomorrow, if not the next tick.
Press Conference
Powell did nothing to mitigate the damage. Indeed he was pressed on the ‘why delay the inevitable’ question, and stumbled through a bunch of mumbo jumbo that really just added up an imitation of a certain barnyard fowl.
Stuff might happen. The perennial “uncertainty”. More data will become available. Okay, but that doesn’t explain why you couldn’t hike today and take it back if evidence later calls for it. But don’t hold your breath waiting for an explanation. The only one that would come even close to true would be hewing to market expectations. In other words, we’re letting Wall Street tell us what to do. Any connection with general economic welfare would be purely coincidental.
And our observation about the market reaction has been vindicated even sooner than we expected … the initial downdraft in stock prices has already been reversed.
So even as lagging inflation indicators show moderation, a new wave is developing. Marks for this Fed decision: F.
Look What They Do
Not what they say. Markets are. As we suspected, the ostensibly hawkish part of yesterday’s announcement – the outlook – has pretty much been forgotten. The dovish part – the action – is what counts.
Yet there is one narrative worth paying close attention to. Powell has repeatedly emphasized that it will “take some time” to get inflation back into its target range. Make no mistake … it’s not because the Fed can’t work more expeditiously, it’s because it won’t. Ignore the rhetoric about how important they think it is to get it down faster to provide relief for the average American. The Fed intends to take its time.
My pan of this FOMC decision is finding distinguished company. Among others, former Boston Fed President Charles Plosser and former Treasury Secretary Lawrence Summers have both appeared on Bloomberg television lampooning the decision in barely polite terms. Plosser for instance said it represented an ill-considered attempt to post a unanimous decision while placating both hawks and doves, and that the honest approach would simply be to have published a straightforward decision with dissent. Summers said it lacked “coherence”. Either way, going weak in the knees while trying to appear resolute is embarrassing.
To be clear, it’s not about whether the FOMC did or did not raise its rate target. It’s the pathetic attempt to do nothing while appearing tough on inflation. Markets rightfully didn’t take it seriously.