Failure To launch

Can everybody just chill a little? Yes, the Fed is “indicating” it’s moving to a less accommodative stance, no more government bond purchases, higher interest rates, maybe a decrease in its massive $9 trillion balance sheet, but it’s decidedly not going away. It simply can’t. Tightening? Hardly.

Indeed, as the results of its January 25-26 monetary policy meeting show, the Fed is basically being dragged kicking and screaming into stopping its asset purchases and raising interest rates to fight inflation, neither of which it actually announced at the conclusion of the meeting. Rather, it said it would buy “at least” another $20 billion of Treasury securities and $10 billion of mortgage-backed securities before ending the purchases “in early March.” It also didn’t raise interest rates, instead saying, “it will soon be appropriate to raise the target range for the federal funds rate.” Whenever that is, although everyone seems to believe it means its next meeting, which is set for March 15-16 (there’s no meeting in February). But again, the Fed didn’t say that.

If inflation is so darn dangerous to our nation’s economic health, why is the Fed willing to let it run another month or two before it starts acting instead of, to use Jerome Powell’s famous phrase, simply “talking about talking about” it?

As I argued in my previous column, the supposed “tightening” of Fed monetary policy is more a temporary political expedient to try to save the current ruling party from disaster in November than a belated panic move to stave off rising inflation. The recent spike in inflation to above 5%, the highest in decades, the media tells us, may very well be short-term. While the Fed has backed off using the word “transitory” to describe this phenomenon, it still seems to believe that it is, in fact, temporary, although a little longer lasting than it previously believed.

The market’s recent selloff, the major stock market indexes in correction territory, bond yields higher by about 40-50 basis points—therefore seems a bit overdone. Why should the market take the Fed seriously this time when it just can’t pull the trigger on ending asset purchases and raising rates? After all, this is the second meeting in the past two months where the Fed merely indicated what it was thinking about doing but didn’t actually do anything at all.

But let’s just say for the sake of argument that the Fed really is going to finally start ending accommodation. It would lose a lot of credibility, not to mention possibly throw the markets into a lot more turmoil, if it didn’t eventually follow through on its warnings. I guess we’ll have to wait and see how serious it is.

You do have to ask yourself, though, how “hawkish” is the Fed really going to be going forward? Yes, it probably is going to reduce if not stop its asset purchases, and yes, it’s probably going to raise interest rates. It may even start to reduce the size of its balance sheet someday; no mention of that at all in its post-meeting press release, you’ll notice. But there are limits in how much it can retreat from the economy. It’s simply too big a factor in how the American government and global financial markets operate to back off too much.

The government continues to run massive deficits proposes more bills to spend even more, but you hear next to nothing about how all of this is going to be funded. When was the last time you heard anything from Washington about a potential tax increase? It’s an election year, so forget about it for now.

That leaves the Fed, which has financed all the trillions that the government has spent over the past two years to fight Covid-19. It simply can’t back away now, at least not in any meaningful way.

If anything, the new members of the Fed recently nominated by President Biden are likely to make the Fed even more dovish, not less. Lael Brainard, his nominee to be vice-chair, is much more dovish than Powell himself, which is saying a lot. Biden also named two other people to fill vacancies on the Fed board. Do you really believe that he would name inflation-fighting hawks to the board in this or any other environment?

Another thing to remember is that the Fed’s natural inclination is to be dovish because that is how it exerts most of its power by controlling a huge supply of government bonds, of which it now owns almost 20% of the total. By reducing its balance sheet, it gives up power and influence, something large government bureaucracies, and make no mistake; the Fed is one of the biggest in terms of dollars, never do. It would be institutional suicide.

So let’s relax. The Fed will be here for a long time to come.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.