FOMC 2023 0920

The Federal Open Market Committee today announced nothing of substance. Its Fed funds target rate remains 5.25%%-5.50%. The balance sheet rolloff continues apace.

FOMC 20230920

The media are sound-biting this as a “hawkish pause”, its absurd doublespeak for all talk and no action. In the context of the entire yield curve, Fed funds in this range is high. The Fed’s balance sheet meanwhile remains obese with MBS at a time when the Fed claims to be on a mission to control inflation, which the data say has bottomed out and is re-accelerating, both in lagging indicators like wages and in leading indicators like asset prices.

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.

“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 upshot is that the Fed erred by easing up on the brakes late last year. It should have maintained the 75 bp pace or accelerated the balance sheet rolloff. In the December minutes it noted the risk that markets would react bullishly but did it anyway, and asset price inflation took off again. This new inflationary impulse is now being registered in resurgent goods and services inflation. No mere Monday morning quarterbacking; we said so at the time. And then it compounded the error by failing to stem the asset price inflation once it was apparent.

So the Fed continues to add insult to injury. In fairness, there is no way to fully compensate for being too slow in responding to the 2020-2021 surge in inflation. Rates may yet reach 6% (ht jk). But had the Fed begun to renormalize in late 2020 – early 2021, it would not have had to hike even as high as it already has.

At a more general level, we also see a clear case of policy error … the same as the Fed committed in 2006-2008. The Fed behaves as if it tightens gradually enough, the economy and financial system will respond in kind. But they are nonlinear systems. It’s like adding snow to the top of a mountain slope one flake at a time. The snow doesn’t gradually ease down the slope, it builds up until it collapses in an avalanche.

The safer, saner approach is to agitate the system, deliver small shocks as the snow falls, so that small avalanches occur while the snow pack is small. The choice is not between avalanche or no avalanche, it’s between multiple small ones or one big one.

So the Fed and most of the financial media are missing the big issue. The combination of gradualism and telegraphing moves ahead of time is a systematically failed policy. It has before and will again result in the opposite, a large adjustment that is widely unexpected. There will be no “soft landing”. Inflation will build until it collapses precipitously in a deflationary crash.

Then, some time in 2024, the Fed will show us how fast it can act as it frantically slashes its rate target and prints trillions.

8 thoughts on “FOMC 2023 0920

  1. Bill Terrell says:

    Jay Powell is now telling us again that the FOMC is data dependent, making its decisions meeting by meeting. This minutes after having delivered a decision that was apparently made weeks ago and bang in line with market expectations. No regard for the reacceleration of final inflation, resurgent oil prices or other recent data. Their “policy stance” is chronically to put off for tomorrow what it should do today.

    “We need to get to a place where we’re confident” inflation is on track to reach our 2% target.

    But not now.

    Powell seems to desperately cling to the hope that the Fed can talk inflation down without taking any decisive action that would scare the horses. The horses on Wall Street that is. But the only path to lower consumer inflation cuts through lower asset prices. Tangible progress will be seen first in another leg down in stocks. If you want to strengthen the purchasing power of the dollar for goods and services, you have to first strengthen it in real time markets.

    What might best accomplish that without undue damage to the real economy? A surprise hike today could have. If the Fed were determined to leave rates alone, it could have announced an acceleration in the balance sheet rolloff. Conditioning markets in advance overlooks how markets work … the expected can be hedged for and even leveraged for … predictability is itself a form of ease. But it only adds to the mountain of snow that must eventually fall.

  2. Bill Terrell says:

    One thing that appears to have impeded policymaking is the Fed’s aversion to reversing a policy move soon after it’s been implemented. It doesn’t want to hike this month and cut the next.

    Why? Appearances? It might be interpreted as an admission that the first move was a mistake. But there are multiple problems with that. First, it’s the epitome of being data dependent, something the Fed claims to be anyway. If the data call for a hike now, and a cut six weeks later, then that’s what they call for. Second, it subordinates its actual policymaking to image, something that appears nowhere in its mandates. Third, it turns policymaking into an absurd discussion about what policy will be months in the future, which would depend on one knowing what the future holds, a pretense proven folly time and again. The Fed has no effing idea what appropriate policy will be in the middle of 2024. It denies reality, that circumstances can change a lot in an even shorter period of time. Just one example is those few weeks in early 2020 when shutdowns triggered a deflationary crash. Then, the Fed demonstrated it can act quickly and decisively. That it doesn’t consider inflation an equally pressing emergency only betrays a greater concern for the comfort of the Wall Street wealthy than for the average American struggling to get by.

  3. jk says:

    just listened to an interview with Harold malmgen. his sources say funding needs in the new fiscal year will be much greater than expected. this will raise rates across the curve and trigger the dollar milkshake (not his words).

    1. Bill Terrell says:

      I don’t know what a dollar milkshake is, but this one won’t taste good. I read somewhere this week the federal debt has risen on the order of $1.5T just since the debt ceiling was lifted.

      These are crisis level deficits … in a period of multi-decade highs in employment. The economy isn’t exactly poised to accelerate from here, so Malmgen’s claim seems more than credible.

      I can’t imagine how this ends well. Inflation is picking up, even as the Fed pursues putatively restrictive policy. Powell dreams of quelling inflation while achieving a “soft landing”; his words in the post meeting presser. Maybe he has to say that, but it just sounds like he’s smoking something. It’s too late to subdue inflation with a soft landing. That ship has sailed.

      In my terms, a deflationary crash is baked in. This prompts the Fed to reopen the spigots, leading to another, more severe, round of inflation.

      The Fed can either save the bond market or the dollar, but not both. It will try to thread the needle but wind up alternately trashing both.

  4. jk says:

    the “dollar milkshake theory” is a creation of brent johnson of santiago capital. it refers to a scene in “there will be blood” in which the nasty protagonist bullies his neighbor to sell his property which has oil under it. the threat is that he’ll drill a slant well to tap the same pool, and “i’ll drink your milkshake.” johnson posits that liquidity will be pumped all around the world but whatever its source it will tend to flow into dollar assets, causing the dollar to spike. high interest rates and loose monetary policy recreates the early 80’s, which eventually necessitated the plaza accord. but in the meantime it’s bond negative, dollar positive.

    1. Bill Terrell says:

      Roughly what I suspected … in my lexicon a “spiking dollar” is the same as a “deflationary crash”.

      Which, incidentally, is what we’re getting a whiff of today. Twenty four hours hardly makes a trend, but more days like this would go a long way towards justifying an inflation victory lap. The dollar is up against just about everything under the sun … stocks, bonds, commodities, foreign currencies … this is a deflationary impulse entering the pipeline en route to consumer goods and services.

      This is the focal point of my “no soft landing” thesis … the financial markets and asset prices. It’s not absolutely necessary that there be mass unemployment, although it’s unlikely there would be a major decline in stock prices without at least some rise in unemployment.

      Though the media are laying today’s market action wholly at the feet of the Fed, I demur. Unless the laws of supply and demand have been repealed, the torrent of Treasury supply is at least partly, likely mostly, responsible. Also late September is an infamously seasonally apropos period for this kind of market action.

      1. Finster says:

        Indeed … which pings a point to ponder. Keynesian dogma calls for increasing deficit spending in recessionary times (presumably running surpluses in expansions, but that part has long ago been discarded). So we’ve grown these monster deficits while having overheated economy.

        What happens when the recession hits?

        The bond market is already buckling under the weight of trillion dollar deficits. Throw a few more trillion on that pile and it will snap. Then the Fed prints out the wazoo trying to bring yields under control? Destroying the dollar? Can you say hyperinflation?

        Got gold?