The FOMC released its latest monetary policy statement.  As widely expected, the Fed left its target rate unchanged.  More specifically, it left the range the same for the federal funds rate at between 2.25% and 2.5%.

However, as has been the case for a while now, the news isn’t really with the federal funds rate. If you really want to find out what is going on, you have to look at the Implementation Note that accompanies the statement.

The Fed will actually lower the interest rate it pays to banks on their reserves by 0.05% to 2.35%.  The reason is to get the federal funds rate more in the middle of its target range.  The Fed has had a bit of a balancing act figuring out where the exact federal funds rate would settle as compared to the rate paid on bank reserves.

So even though the news says that the Fed kept rates the same, it actually just kept its target range the same.  It actually did lower the rate, albeit slightly, that it pays to banks for parking their deposits with the Fed.

The even bigger news – if you want to call it news since it seems to be more of a footnote from the financial media – is that the Fed is already tapering its balance sheet reduction.  Instead of allowing $30 billion per month in Treasury securities to expire, now it will only be $15 billion per month.  At least for right now, the mortgage-backed securities will continue to be drained off at $20 billion per month.

The Fed was supposed to have this policy of monetary deflation last for a while in order to drain down its bloated balance sheet from its unprecedented expansion from 2008 to 2014.  The Fed’s balance sheet barely got below $4 trillion, and it is already slowing down the deflation.

The crazy thing is that the market (i.e., stock investors) was actually slightly disappointed in the wording of the Fed’s stance on inflation because they used the word “transitory”.  Stocks went down supposedly because of this one word.  Since the Fed doesn’t see the supposed lack of inflation as persistent, investors now doubt whether there will be an official cut in rates before the end of the calendar year.

This is crazy because if you go back to 2018, the Fed was hiking rates, and it was expected the Fed would continue to hike rates through 2019.  Now the market is slightly disappointed because there may not be a rate cut this year.

Of course, that could change quickly.  The yield curve, as measured by the 3-month yield vs. the 10-year yield, inverted back in March for a brief time. It is now close to flat.  If the stock market starts to tank, or if there are any other signs of a possible recession on the horizon, it is obvious what the Fed will do.  It will start to lower its target rate, and it will quickly stop its policy of reducing its balance sheet.

In fact, it is a relatively safe bet that if a recession is happening, or even looks likely, that the Fed will start another round of digital money printing (also called quantitative easing).  This will be QE4, as QE3 ended back in 2014.

As to the whole discussion on inflation, meaning price inflation, it is unbelievable that the Fed sees this as low.  They say it is running below its 2% target.  This is based on the PCE measure that the Fed uses.  If you use the CPI or median CPI, it is near or above 2%.  If you look at housing or stocks, it is certainly above 2%.  If you look at health insurance premiums over the last 10 years, it is certainly above 2%.

You can get your flat screen television for less than what you would have paid 10 years ago, and it is a lot nicer too.  The bad news is that your health insurance premiums are like buying a couple of flat screen televisions every single month.

I don’t know what the next bubble will bring when the Fed starts QE4.  But we know that there is a lag effect.  The Fed will not be able to cover up the next bust with its money creation, just as it was unable to stop the financial crisis in 2008.