The latest FOMC statement came out on July 27, 2022.  As expected, the Federal Reserve is hiking its target federal funds rate by 75 basis points.  It now sits in the range of 2.25% to 2.5%.  It was a unanimous decision by the members.

Let’s say you had isolated each FOMC member since the previous meeting and prohibited them from seeing market expectations of the next rate change.  They were given all of the inflation and other economic data, but couldn’t listen to what the financial analysts were predicting for the next FOMC meeting.  What are the chances that they would have all agreed on a 75 basis point rate hike without talking to anyone about it first?

We have now seen back-to-back meetings of a 75 basis point rate hike.  So the Fed is getting aggressive in fighting the inflation that it created.  But short-term rates are still just above 2% while consumer price inflation stands above 9%. Enjoy that negative 7% return on your money.

In the Implementation Note, it states that the balance sheet will be reduced as previously planned by $47.5 billion per month.  In September, it will increase to $95 billion per month if the plan doesn’t change.

This may seem like a lot, but it is more like a blip when compared to the $5 trillion that has been added over the last 2 and a half years to the balance sheet.

You can also see in the Implementation Note that the Fed directs the payment of 2.4% interest to commercial banks on their reserves.  Since 2008, this is how the Fed has controlled its target federal funds rate.  Paying interest on reserves essentially sets a floor for the federal funds rate.

Because of this, another thing has changed since 2008.  The Fed doesn’t necessarily have to drain its balance sheet in order to raise its target rate, and it doesn’t need to raise its target rate to drain the balance sheet.  The two things still go hand-in-hand, but they aren’t as connected as they once were.

Paying interest on bank reserves may be a rip-off for us.  It may be a subsidy to the banks.  It may increase the deficit higher than it would have been otherwise.  But it does make it possible for the Fed to “raise rates” while not necessarily engaging in monetary deflation.

Still, even if the balance sheet remained the same, there will still eventually be a recession.  If you read Mises or anything about the Austrian Business Cycle Theory, it becomes apparent that just a slowdown in monetary inflation will eventually lead to a correction of the previous malinvestment.

Before the FOMC statement was released, there was approximately a 30 basis point difference between the 2-year yield and the 10-year yield.  The 2-year yield is higher, which doesn’t make much sense unless the bond investors are expecting a major downturn.

The gap between the 3-month yield and the 10-year yield has narrowed significantly over the last several weeks, and I expect an inversion there within a short period of time.

Jerome Powell said that he doesn’t think we are in a recession.  He also said it isn’t up to him to define when we are in a recession.  And he is probably technically correct on both points, even though we are getting the second straight quarter of negative GDP.

Powell is hoping for a “soft landing”.  He doesn’t want to admit that we are likely to have a recession.  I don’t think he’s a total idiot.  I think he knows that the Fed is in a bind.

Whether or not we are technically in a recession right now is actually not that relevant because this isn’t the big one.  The Fed would be happy if this were deemed a mild recession and that’s the end of it.

If we hit a major recession and stocks crash, what will the Fed do?  I’m really not sure, and I don’t think Jerome Powell is sure either.  They will try to continue to walk a tightrope, but the rope is getting thinner.

If consumer price inflation is still raging at 9% and we hit a big recession, it is going to be tough for the Fed to start lowering rates and printing money again.

Stocks have had a rough year so far, but I believe this is only the beginning.  The bond market and the gold market are telling us that we should be more worried about a major recession than higher price inflation in the future.  It’s not to say that the gold market and bond market have to be right, but I have more trust in the prediction ability of these two markets as compared to the stock market.