When the FOMC meets every 6 to 8 weeks, it gets some media attention, at least as far as the financial media goes.  You probably won’t hear much on CNN or Fox News, but you will hear about it on CNBC and Bloomberg television.

Aside from key statements from the Federal Reserve chair, the most common news reported is whether or not the Federal Reserve has decided to raise or lower interest rates.  These days, at least for now, it is whether or not the Fed raised interest rates.

But the Fed isn’t directly raising interest rates.  Its implicit guarantee to buy U.S. debt, if needed, is always there, which tends to keep interest rates lower than they otherwise would be.  There is no way we could have a $21 trillion national debt and a 10-year yield on U.S. government debt under 3% without a backing from the central bank.

The one rate that the Fed directly controls is the federal funds rate.  Prior to the fall of 2008, this rate was controlled by increasing (buying debt) or decreasing (selling debt or not reinvesting maturing debt) its balance sheet.  Since the major commercial banks now have trillions in excess reserves, the Fed can no longer easily control the federal funds target rate by buying and selling securities.

The Fed now controls the federal funds rate by setting the interest rate paid to banks for their reserves.  In the last FOMC statement, the rate paid to banks was increased to 1.75%.  This sets something of a floor on the federal funds rate.  By doing this, the Fed is subsidizing the banks at the expense of the taxpayer.

When the Fed subsidizes things, it usually does so at the expense of those holding U.S. dollars.  But in this case, it really is more the American taxpayer subsidizing the banks.  The Fed is paying higher interest rates to the banks instead of returning this portion of money to the Treasury each year.

While interest rates are an important subject, you can consider them manipulated forever, at least for as long as the central bank exists and has any power.  Again, if the Fed went away tomorrow, you could be sure that interest rates on U.S. debt would instantly spike.  There is a reason that cities and states are far more limited in the amount of debt they can issue.  They do not have the digital printing press.

The biggest issue that most everyone is missing right now is the Fed’s very gradual reduction in its balance sheet.  According to the FOMC, it is basically baked into the cake for now.  Of course, if the stock market were to crash next week and a recession all of a sudden appeared, you could be sure that the Fed’s tightening would be stopped rather quickly.

Since late 2015, the FOMC statements have been accompanied with implementation notes.  In the March statement, the implementation note stated (in part) the following:

“The Committee directs the Desk to continue rolling over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during March that exceeds $12 billion, and to continue reinvesting in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during March that exceeds $8 billion. Effective in April, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $18 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $12 billion. Small deviations from these amounts for operational reasons are acceptable.”

In other words, the Fed, starting in April, will be draining off $30 billion per month from its balance sheet ($18 billion plus $12 billion).  By the 4th quarter of 2018, it will be up to $50 billion per month, if things stay on track.

If you look at the adjusted monetary base, you can’t even see it yet.  There are several variables that go into the monetary base, so the Fed’s tightening can’t really be seen at this time.  When the monetary base is near $4 trillion, a $30 billion runoff in one month is less than 1%.

But by the end of 2018, if the Fed does not change course, you will see a difference.  There will be a visible reduction in the balance sheet.  So while the tightening is very gradual, it is happening.

I can’t emphasize this point enough because the stock market boom was largely a result of the Fed’s ultra-loose policy from 2008 to 2014.  It takes time for things to shake out, but this easy money led to malinvestments and unsustainable bubbles.  I believe stocks are the biggest bubble (not counting small things like cryptocurrencies).

Now that the easy money is being taken away, it should not be surprising that the propped up stock market goes down with it.

I don’t know if the increased volatility is the start of the bear market or if we will still have another run to new all-time highs.  But at some point, the Fed’s tightening is going to impact the financial markets.  You should prepare accordingly.