The Federal Open Market Committee (FOMC) released its latest monetary policy statement.  It had become widely thought that the FOMC would lower its target of the federal funds rate by one-quarter percent.  This is what the Fed delivered.

The markets were rather tame after the announcement, which is almost an event in itself. There is typically a parsing of words that leads to a market overreaction one way or another. With this recent announcement, stocks were down a bit at first, but ended up little changed for the day. Gold did fall a bit.

While nearly everyone focuses on the statement itself and whether the Fed is “lowering rates”, I like to look at the detail found in the Implementation Note.

There wasn’t a lot that was interesting this time around.  The Fed will now pay a rate of 1.8 percent on bank reserves. In other words, there is still free (for them) money for the banks, but a little less of it than before.

The 1.8% interest is just above the bottom of the target rate.  The target rate is now set between 1.75% and 2.00%.  The Fed is actually dropping this rate by 30 basis points (0.3%) from its previous 2.1% announced in the July meeting.

The most important takeaway is the statement on the balance sheet.  All holdings of Treasury securities will continue to be rolled over.  Meanwhile, up to $20 billion per month of mortgage-backed securities will be reinvested in Treasury securities.  On net, the balance sheet should stay about the same.  But the Fed will be shifting some of its holdings from mortgage-backed securities to U.S. Treasury securities (government debt).

The Fed’s short period of monetary deflation ended with the previous meeting in July.  So even though the Fed is lowering its target rate, its overall stance on monetary policy is neutral.  In other words, the Fed is not inflating or deflating the money supply at this time.

This doesn’t mean that prices won’t change.  It just means that the base money supply is relatively neutral.  I think it will stay this way until there is more evidence of an economic downturn.  When things get bad, we can expect monetary inflation again.

How Bad Are Things Going to Get?

Trump says that the economy is booming, yet he wants the Fed to lower rates to zero or negative. He wants the boom to keep going until November 2020.  If things get bad before then, his chances of winning reelection will be reduced significantly.

While the establishment media is mostly very unfavorable towards Trump, and in an obvious way, there is more silence in regards to the economy.

Even though the establishment media wants to see Trump lose the election in 2020, they are mostly keeping with past trends in not talking down the economy.  There have been a few warnings about the inverted yield curve, but most pundits are not screaming that a bad recession is coming right at us.

But if the economy is doing well, then why is the Fed lowering its target interest rate? Why did the Fed abandon its balance sheet reduction so quickly?

The unemployment rate is near an all-time low.  Stocks are near all-time highs.  Price inflation, as measured by the CPI, is around 2%.  It is just below 3% if you use the median CPI.

We are supposedly 10 years into the recovery, yet the Fed is lowering its target rate.  And consider that rates are still historically low.  Even short-term rates, being at 2%, are very low.

The Fed is saying that there are “implications of global developments” and “muted inflation pressures”.  Is this the best they can do for giving a reason to lower rates?

I think the Fed members are worried.  They are just not showing their hand.  They see the inverted yield curve.  They see that you can buy a 20-year bond for close to the same interest rate as a one-month Treasury bill.  They know something bad is brewing.

They aren’t going to come right out and say that a recession is likely in the near future.  They would be accused of talking down the economy, and not just by Trump.

They also want to be seen as doing something.  If the economy tanks 6 months from now, they can say that they had already started dropping rates in anticipation of trouble ahead.  Meanwhile, Trump will continue to blame the Fed for not being aggressive enough.

It doesn’t really matter what the Fed does at this point, barring some kind of massive monetary inflation as never seen before.  They can lower short-term interest rates all they want at this point, but it isn’t going to stop the massive correction that is coming.

The Fed was lowering interest rates in 2007 before the official recession began.  The financial crisis didn’t become evident until late summer of 2008.  In other words, the Fed’s tinkering had no impact in stopping the recession that was coming.  It won’t be any different this time around.

I am still expecting a recession in 2020.  We’ll see if it hits with full force prior to the election.

I think everyone should prepare for what is coming.  Unemployment is going to go up.  Nominal wages will go down.  The good news is that consumer prices will likely go down too.

While I expect housing prices to go down in most areas, I don’t think it will be as severe as what we saw a decade ago.  The biggest bubble now is in stocks.  I will not be surprised to see a major drop of 50%, or 60%, or even more.  It will eventually depend on how fast and furious the Fed reacts to the situation.

We could end up seeing a return to QE like never before.  It was astounding what the Fed did from 2008 to 2014, more than quadrupling its balance sheet.  If we hit a deep recession, we could see the Fed creating $100 billion per month.  Maybe it will be $200 billion per month.  That will be the time to buy gold and silver and other hard assets.

We could also see our first $2 trillion annual deficit.  It was amazing to see it hit $1 trillion.  It is amazing that it is close to $1 trillion now, and that is with a supposedly booming economy.

It is impossible to say how all of this plays out.  But with the Fed lowering short-term rates during a supposed economic boom, we know something is up.  It is wise to prepare for what is to come.