Now It Begins, But How Will It End?

As expected, the Federal Reserve raised its target interest rate by 25 basis points last Wednesday, as Fed Chair Jerome Powell said two weeks ago that it would do. What was surprising was that the Fed also telegraphed that it plans to raise rates six more times this year, to at least 1.75% by the end of this year, and four times next year, with fed funds ending at around 2.75% by the end of 2023.

That was a lot more aggressive than some observers, including this one, had expected. Yet the market seemed happy with it. After a brief initial sell-off, stocks soon resumed their upward path, apparently because they liked the certainty it provided, at least for now, as well as the gradual nature of the Fed’s schedule.

But how certain can we be? Will the Fed really carry through with this, or will it revert to its easy-money ways? And even if it does do what it says it plans to do, will it be enough to get inflation under control while at the same time avoiding pushing the economy into recession?

We’ll have to wait and see. Continue reading "Now It Begins, But How Will It End?"

Interest Rates Are Going To Go Higher

Even while the Russian-Ukraine conflict continues to rage on, the fact of the matter is the US, and honestly, the majority of the world is dealing with higher-than-expected inflation. And the most direct way to bring that inflation back down to sustainable levels is for the Federal Reserve and other central banks around the world to take action and increase interest rates.

Prior to the Russian-Ukraine situation occurring, it was widely expected that the Federal Reserve would raise the benchmark interest rate by 0.5% in March. However, now that the war in Ukraine is occurring, many believe the Fed will only increase rates to 0.25% in March and reassess the situation at the following meeting.

However, even while most market participants expect a rate hike of just 0.25%, some Fed officials still believe that a 1.00% rate hike is justified in March. While there is talk of the 1% hike, very few believe it will occur in March, especially since the Russia-Ukraine situation.

Furthermore, market participants also need to consider when and how quickly the Federal Reserve decides to start winding down its balance sheet. Some believe when the Fed begins that process, it could have more of an effect on interest rates than when the Fed actually raises rates since the Fed was a huge buyer of bonds. Since the bond market and bond interest rates are essentially determined by supply and demand, if demand is weak due to limited buyers, the interest rates will increase until buyers step in. With the Fed no longer buying and potentially selling bonds, supply will be high, which will require much more attractive yields in order to entice investors to step in and buy bonds.

So as an investor, how can you profit from this information? Continue reading "Interest Rates Are Going To Go Higher"

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? Continue reading "Failure To launch"

Rescue Me

How transitory is transitory? Maybe inflation won’t turn out to be as “transitory” as we would like, but even the Federal Reserve thinks inflation will ease sometime in the not-too-distant future, likely this year. The bond market certainly doesn’t seem overly concerned about it, with the 10-year Treasury note trading late last week at about 1.75%, or about six percentage points below the current inflation rate. If inflation is such a big problem that must be addressed immediately, shouldn’t long-term bond rates be closer to 5% or 6% rather than less than 2%?

Then why is the Fed all of a sudden so worried about stamping out inflation when it’s also predicting that the inflation rate will come down fairly soon? What’s the rush?

According to its most recent economic projections released after its December 15 monetary policy meeting, the Fed said it expected inflation to fall to 2.6% this year, from 5.3% last year, then fall to 2.3% next year and 2.1% in 2024. Yet now the Fed can’t seem to stamp out inflation fast enough, even though it was Fed policy not too long ago to let inflation “burn hotter for longer.” What happened with that? Continue reading "Rescue Me"

What's Next For The Fed?

Now that the Federal Reserve has formally announced its taper plans, what can we expect next?

The Taper

First of all, let’s not go into panic mode because the Fed is suddenly reducing its asset purchases. In the statement following its November 2-3 meeting, the Fed said it would “begin reducing the monthly pace of its net asset purchases by $10 billion for Treasury securities and $5 billion for agency mortgage-backed securities.” In the scheme of Fed purchases, that’s practically nothing, you won’t even feel it. Indeed, in the very next sentence, the Fed also announced the converse of that, namely that starting this month, it “will increase its holdings of Treasury securities by at least $70 billion per month and of agency mortgage-backed securities by at least $35 billion per month. Beginning in December, the Committee will increase its holdings of Treasury securities by at least $60 billion per month and of agency mortgage-backed securities by at least $30 billion per month.”

Note the operative word, Increase. So yes, it’s accurate to say that the Fed is reducing its asset purchases, but it’s not going away, far from it. It’s still buying a ton of securities. Remember that the Fed’s balance sheet currently totals $8.5 trillion and still growing. Now, the Fed did add that “it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook,” which most market participants take to mean that the Fed is more likely to speed up, not slow down, the pace of purchases, given the current robust state of the economy. That’s a good thing and long overdue. Continue reading "What's Next For The Fed?"