The Federal Open Market Committee (FOMC) released its latest statement on monetary policy. As was widely expected, the federal funds target range will remain at 1.5% to 1.75%.
For over a decade now (since the 2008 financial crisis), the Fed maintains the federal funds rate by paying interest on bank reserves. Since the banks piled up massive excess reserves from the start of QE1, they no longer needed to borrow overnight funds. Therefore, the Fed couldn’t control the federal funds rate by buying or selling assets as it had typically done before.
The FOMC statement, in the Implementation Note, states that the rate paid on bank reserves will be raised by 5 basis points, which is .05%, to 1.6%. It seems this was done in order to keep the federal funds rate within the target range.
The bigger story out of the Fed is not the federal funds rate. It really hasn’t been for over a decade now. This may be the story that gets the attention from the corporate media, but it isn’t the most important. The bigger factor is the Fed’s balance sheet. After a massive and unprecedented expansion from 2008 to 2014, the Fed tightened its stance. It actually started to allow some of its maturing debt to not be rolled over, which slowly decreased its balance sheet.
This all got reversed in 2019. By the end of the year, the Fed was once again increasing its balance sheet while intervening in the repo market.
It looks like the Fed will keep increasing its balance sheet, but don’t call it QE according to Jerome Powell.
Perhaps the most interesting thing that came out of the FOMC statement is a slight change in language regarding inflation. The Fed appears willing to be more aggressive in its quest for 2% or higher inflation. The Fed may even go a little over that number if necessary.
The old statement said its stance is appropriate to support “inflation near the Committee’s symmetric 2 percent objective.” The new statement says its stance is appropriate to support “inflation returning to the Committee’s symmetric 2 percent objective.” See, they swapped out the word “near” for “returning”, which makes a big story for the financial media.
Of course, the Fed isn’t following the median CPI, which has been well over 2% per annum for quite a while. Maybe Powell and company don’t think price inflation is high enough, but middle class America struggling to pay the bills is feeling it.
They Can’t Stop the Bust
I will keep returning to the theme of 2020, which is the unprecedented stock market bubble. The returns have been astronomical, and most of it isn’t because of great corporate profits. It is built on monetary inflation.
But here is a key point. The stock bubble will eventually go bust, regardless of what the Fed does. Maybe if the Fed goes to hyperinflation (which I am not predicting), then nominal prices of stocks will go higher. But that would, of course, be disastrous.
The Fed could possibly delay the bust (and make it worse) by being really aggressive with its digital printing of money. But even that is not clear.
As Ludwig von Mises pointed out a long time ago, the correction has to eventually arrive, unless the central bank is willing to continually provide ever-greater stimulus in the form of monetary inflation. But this will eventually end in what Mises called the crack-up boom, which is hyperinflation.
My point is that you shouldn’t think that stocks are safe because the Fed is trying to keep them propped up. The Fed can cause massive distortions and manipulate many things, but once the fear and panic set in, it will be mostly helpless. The bust in stocks will happen.
Remember, the Fed was already lowering its target rate before the 2008 recession. It didn’t prevent it from happening.
The 10-year yield sank more after the FOMC announcement. It is nearing the 3-month yield again. But it already inverted in 2019. Another inversion won’t tell us much at this point except that investors are seeking safety in long-term U.S. government bonds.
There is a disconnect between the stock market and the bond market. I think the bond market will ultimately be proven more correct. When stocks come crashing down, I expect long-term yields to go down further. I expect short-term yields to go lower as well, as the Fed lowers its target rate back to near zero.
It is a waiting game at this point. It is amazing how long and how big this stock bubble has gone on. It comes to a point where people think it will always be this way. But I am here to warn you, it can’t keep going, and it doesn’t matter what the Fed does to try and stop the crash from happening.