The Federal Open Market Committee (FOMC) released its latest monetary policy statement. As had become widely expected over the last several weeks, the Fed is lowering its federal funds target rate by 0.25%. Its target range is now between 2% and 2.25%.
Remember, the Fed raised its target rate back in December 2018, which is less than 8 months ago. Things change fast.
The market was expecting this news, so it didn’t send stocks soaring. Instead, Jerome Powell made a statement in his press conference that implied more rate cuts were not necessarily coming any time soon. He said that the rate move was a “midcycle adjustment”.
Stocks fell on this news, with the Dow closing the day down over 330 points. The price of gold also fell. Yields on longer-term U.S. bonds fell.
Powell said that the Fed does not take into account political considerations and does not conduct monetary policy to prove its independence. He is essentially saying that they didn’t lower the target rate just because Trump has been calling for them to do so. He may be being truthful in saying that the people at the Fed are not following Trump’s orders. However, to say that the Fed is not political is a joke.
The Federal Reserve has a legal monopoly over the U.S. dollar, as granted by Congress. If you or I tried to do what the Fed does, then we would be put in jail for counterfeiting.
Also, maybe someone could point out to Powell that he was appointed by Donald Trump. If that doesn’t fit the definition of a political institution, I am not sure if anything would.
The Implementation Note
Almost nobody in the financial press or anywhere else actually highlights the implementation note in the FOMC press release. This is really what counts. This shows what the Fed will actually be doing.
While everyone focuses on “rates”, the Fed is only directly controlling the federal funds rate, which is the rate for overnight borrowing by banks. Since most banks are flush with excess reserves, they don’t have to borrow overnight to meet reserve requirements.
The Fed has been controlling its target rate by paying interest on bank reserves. It is just another free lunch for the banks at taxpayer expense. It means less money is returned to the Treasury each year, thus making the deficit even bigger.
In the implementation note, it states that the interest paid on required and excess reserve balances will be 2.1%, effective August 1, 2019.
Even more interestingly, the Fed will start reinvesting all principal payments for Treasury securities. Here is what the note actually reads:
Effective August 1, 2019, the Committee directs the Desk to roll over at auction all principal payments from the Federal Reserve’s holdings of Treasury securities and to reinvest all principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month. Principal payments from agency debt and agency mortgage-backed securities up to $20 billion per month will be reinvested in Treasury securities to roughly match the maturity composition of Treasury securities outstanding; principal payments in excess of $20 billion per month will continue to be reinvested in agency mortgage-backed securities. Small deviations from these amounts for operational reasons are acceptable.
This means that the Fed is trying to get mortgage-backed securities reduced on its balance sheet, but Treasury securities will replace them. It’s no wonder now why long-term yields fell. The Fed will actually be a net buyer of Treasury securities.
The Fed has put a halt to reducing its balance sheet, which is two months earlier than previously expected. It is no longer in a mild deflationary mode.
The stock market is near all-time highs. Unemployment is near all-time lows. So why would the Fed be going to a looser monetary policy?
Again, I don’t think this has much, if anything, to do with Trump. I think the Fed recognizes the partial inversion of the yield curve. Most of the Fed members are not going to come right out and say that a recession is imminent. They don’t want to be held directly responsible when the downturn hits.
I don’t think they can prevent the downturn with this tinkering. I don’t even think it will delay it much, if at all. When the crash finally hits, the Fed will be able to say they did something preemptively. They certainly didn’t want to be in a situation where they were raising rates and deflating the money supply when a crash occurs.
Overall, I think Powell’s press conference was mostly meaningless. The Fed is going to decide things in the future based on the yield curve and the overall economy.
If and when things get bad, you can be sure that the Fed will start expanding its balance sheet again. Rates are already low. The only thing they will have to fight a massive economic downturn will be massive monetary inflation.