FOMC 2023 0726

The Federal Open Market Committee today announced a 25 bp hike in its Fed funds target rate to 5.25%%-5.50%. The balance sheet rolloff continues apace.

FOMC 20230726

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.

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.

So it appears that despite the Fed demur, and the media monomania over rate policy, the balance sheet is where policy is at. Interest rate policy has lost a lot of its punch due to the payment of interest on reserves. For most of history, raising the Fed funds target was done by restricting money … a rising rate was effect, not cause. In the QE era there is abundant money; the Fed has to actually pay interest on reserves to support its rate target from below. It creates the money to do so, so this program is expansionary.

This is only offset if the Fed is shrinking its balance sheet by other means. But the net effect is that a given increase in the Fed funds target is much less than it would appear based on history. This explains the unimpressive effect of what has been billed as one of the most aggressive hiking campaigns ever.

So even as the lagging effects of the last monetary expansion are being worked off, asset prices say a new impulse is in progress. Despite the Fed’s tough talk, money is not yet tight.

As to why we can only speculate. It may be that the Fed is unable or unwilling to resist pressure from Wall Street to keep money easy. One clue is that after repeatedly emphasizing the importance of tightening financial conditions last year, it has gone quiet on the subject since last December. The meeting minutes note concern that stepping down the size of hikes from 75 to 50 bp might reignite asset price inflation. That’s just what happened, but the Fed seems no longer concerned.

Long and variable lags has become the market mantra. This is a transparently disingenuous plea for easier money. If it were an objective, neutral concern, where was it when the Fed was printing by the trillions and promising ZIRP forever? AWOL. Not a peep of caution, even after inflation had begun to filter into consumer prices. It’s so simple a child could do it. Watch the data that don’t lag. Real time markets respond instantaneously. When the Fed hit Print on March 23, 2020, the dollar tanked and real time prices soared. Lag: 0.

The Fed takes months, quarters and years to tighten. But it can ease in a New York Fed minute. Forget all the rhetoric about fighting inflation. The Fed is an inflation creation machine.

The arsonist posing as the fire brigade.

Forget the 1970s Whip Inflation Now slogan. Here in the 2020s, it’s Whip Inflation Tomorrow!

8 thoughts on “FOMC 2023 0726

  1. Bill Terrell says:

    I wrote this post this morning … that’s how tiresomely predictable this Fed has become. The Chairman’s press conference is usually a bit more interesting. So far in this one though, no surprises. Powell continues on his transformation from hawk to dove. At least that’s how markets interpret it early on … the dollar is tanking relative to most everything else … bonds, stocks, commodities and foreign currencies. Likely markets had anticipated a tougher tone and are a bit surprised by its absence.

    This despite Powell having opened with his now-boilerplate expression of concern for the burden inflation poses on average Americans. With this backdrop, the Wall Street celebration is a bit embarrassing.

  2. Finster says:

    The press conference has now concluded and I’m beginning to come to. What a snoozer. I’m waking up to markets having basically returned to the flattish levels where they started, and Bloomberg anchors struggling to find anything interesting or consequential to comment on. Evidently our two handed economist didn’t say anything to surprise. This is regrettable, given the missed opportunity to check this latest inflationary impulse while it’s still in the pipeline, but not surprising.

    The one weakly notable takeaway is that Powell refused to commit to anything going forward. When quizzed at the outset about his view for subsequent meetings, Powell said simply we don’t know. We’ll look at the data and take each meeting as it comes.

    This is worth an upgrade for his performance from C to C+.

  3. Milton Kuo says:

    It seems the quantitative tightening of the Fed is analogous to stock buy backs in the private sector: any balance sheet run off (stock bought back) is negated by the interest being paid out on all the money the Fed has created (dilution from stock grants). I just don’t know if the entities holding Treasuries are holding on to the interest or if they’re using the interest to further speculate in the market.

    On another note, I just saw this headline on Bloomberg: “Powell Says Fed’s Staff Is No Longer Forecasting a Recession.” 😀 Given the Fed’s and Powell’s track record, that’s one of the funniest jokes I’ve heard in years.

    Here’s the direct link to the Bloomberg article:

    Here’s a link to the article for those who cannot read it:

    1. Finster says:

      Thanks for mentioning that no recession call. I saw that on Bloomberg’s live coverage but didn’t comment. What the F does that mean? The Fed is throwing in the towel on tightening? The Fed sees a green light to tighten further?

      It sure as heck doesn’t mean there’s not going to be a recession!

      1. Milton Kuo says:

        I suspect that like various other U.S. government organizations, the Federal Reserve will just change the definition of what a recession is. Maybe something will only be called a recession if unemployment hits 90%. Anything beneath that will be considered “not a recession” and just a transitory slowdown in the economy.

        I still remember reading that prior to the Great Depression, recessions were called depressions. Maybe it’s time to relegate the “harsh” term recession to the dust bin of history and come up with a new term. I cannot even imagine what kind of New Speak terms our Ministries of Truth will coin.

        I’m expecting a recession and, unfortunately for me, I exited this bubble far too early and have been waiting years for a mean reversion. 🙂

        1. Bill Terrell says:

          Aye … the Great Depression was so traumatic they retired the term “depression” because of the negative connotations. Now that we’ve had the “Great Recession”, maybe recessions will be defined out of existence too.

          Next up … the elimination of inflation by fiat. By the time they’re done, even Orwell would be impressed.

  4. jk says:

    with hedonics and goods substitution they have already defined a good deal of inflation out of existence. we just need another gimmick or two. a cbdc, if we get one, should provide opportunities.

  5. Bill Terrell says:

    One other item from Powell’s appearance of potential interest. He said he could imagine at some point cutting rates while continuing QT. This may be a tacit admission that relatively too much is being done on rates and not enough on the balance sheet. This would be consistent with my observations. At a more fundamental level though it is a crack in the Fed’s canon to date that quantitative policy is only appropriate when rate policy is maxed out.

    Powell quickly followed up by reemphasizing the long held view that rates are the Fed’s primary policy tool, but it still helps validate the notion the balance sheet is still just too big. Not that they’re in any hurry to do anything about it … I just think they think so too but just want to keep the balance sheet in the background.

    The extent to which the Fed prioritizes dogma over results nevertheless continues to be baffling. The only explanation I can think of is a priority to cater to Wall Street.