The Federal Open Market Committee (FOMC) issued its latest statement on monetary policy.  As was widely expected, the Fed has lowered its target federal funds rate by a quarter of a percent.  Meanwhile, in other news, the S&P 500 index hit new all-time highs on the same day.  I wonder if that has ever happened before.

It certainly seems contradictory.  Why would the Federal Reserve be reducing its target rate if stocks are at an all-time high?  Is the economy booming, or is the economy in trouble?

Maybe the answer to both of these questions is yes.  It is booming according to the stock market, but it is also in trouble. This also seems contradictory. Perhaps it is less contradictory to say that there is an artificial and unsustainable boom, and the economy is in trouble.

The people at the Fed know that something is wrong.  They wouldn’t just be lowering rates to please Donald Trump.  They are just not explicit about the problems that exist.  There are the weird happenings in the repo market.  And I think more importantly, they see the partially inverted yield curve.

The Fed is now indicating that they may stop reducing the target rate for now.  They are waiting to see the data, which is really what they always do.  Jerome Powell and company are also saying that a hike in rates is unlikely until they see a significant uptick in price inflation.  They obviously haven’t looked at my health insurance premiums.

There were two dissenting votes in the decision.  Esther George and Eric Rosengren “preferred at this meeting to maintain the target range at 1-3/4 percent to 2 percent.”

In the Implementation Note, it states that interest rate paid on required and excess reserve balances will be lowered to 1.55%. This was to be expected, as the Fed’s free money to banks (not for us) is helping to control the federal funds rate.

Monetary Inflation and a Stock Bubble

The bigger elephant in the room that does not get as much attention is the Fed’s balance sheet. The Implementation Note indicates a continued swapping of $20 billion per month of mortgage-backed securities to Treasury securities.  This is a wash in terms of the Fed’s balance sheet.

The key statement though was this:

“In light of recent and expected increases in the Federal Reserve’s non-reserve liabilities, the Committee directs the Desk to purchase Treasury bills at least into the second quarter of next year to maintain over time ample reserve balances at or above the level that prevailed in early September 2019.”

This is what Powell said is not QE.  This is a lot more vague than what we were told for the last 11 years, but it still looks like monetary inflation to me.  It was originally reported a few weeks ago that the Fed will buy $60 billion per month initially, extending at least into the second quarter of 2020.  But the official statement does not give a set amount for the Fed to purchase.

Regardless, I don’t think this is going to prevent the recession from coming.  I don’t even think it will slow it down. But when a recession does arrive, the Fed will at least be able to say that it had already started doing something.

I keep saying that the biggest bubble of all is this unsustainable boom in stocks.  I don’t understand how the S&P 500 is hitting new highs while the Fed’s actions are indicating practical panic.

I simply think that the bond market is smarter than the stock market.  I know this isn’t technically true.  A market can’t be smart.  It is made up of millions of individuals.  But the people buying stocks are making a huge mistake, unless they are counting on the greater fool theory and planning to unload them in the near future.

The low yields on long-term bonds are not indicating good times ahead.  There are many reasons that people are buying bonds, but the overall conclusion is that they are seeking some form of safety.

While the Fed members are not smart enough to centrally plan an economy of 325 million people (nobody is smart enough to do this), they do understand what the bond market is telling them.  They know that the booming stock market is an illusion.  They are acting now to fend off some of the criticism later.

The market is betting now that the Fed won’t touch rates in its December meeting.  But a lot can change in six weeks.