The FOMC released its latest statement on monetary policy.  As was widely expected, the Federal Reserve will maintain its current federal funds target rate between 5.25% and 5.50%.  The market is expecting two rate cuts later this year, but that can change easily depending on what happens with the economy.

Jerome Powell had a press conference afterwards.  It is mostly bureaucratic talk.  Powell generally plays it safe and parses his words.  During the small part of his press conference I heard, Powell was asked a question about how the upcoming election impacts the Fed’s decisions.

Powell assured us that the Fed doesn’t look at politics and only is concerned about the economy and how it impacts the American people.  He said you can look at the transcripts of past meetings, and it is clear that the Fed does not make decisions based on politics.  But why does this mean anything?  Of course they aren’t going to outwardly say anything in a recorded meeting about playing politics.  It doesn’t mean there aren’t conversations off the record, and it doesn’t mean that individuals aren’t factoring politics into their decisions inside their heads.

Powell is one who shows very little emotion.  Yet, when he was answering the question and assuring the reporter that the Fed doesn’t make decisions based on political elections, he seemed to have a smirk on his face.  This doesn’t automatically mean that he was lying, but it was interesting to note.

While the media tends to focus on the direction of interest rates, there was an interesting part of the policy statement where things changed.

Decelerating Monetary Deflation

Up until now, the Fed had been reducing its balance sheet by $95 billion per month, at least according to previous meeting notes.  That was $60 billion in Treasury securities and $35 billion in mortgage-backed securities (MBSs).  Despite what anyone was saying, the Fed was in a mode of monetary deflation going back to 2022 when price inflation became a major problem.

Maybe some of the words of Fed officials are dovish.  Maybe interest rates in a free market would be higher than what the Fed is currently allowing.  But in terms of the base money supply, the Fed has been engaging in deflation.

This isn’t stopping yet, but it is slowing.  It is kind of like price inflation.  Price inflation hasn’t stopped, despite what anyone says.  Prices in general are still going up.  They are just going up at a slower pace compared to before.

And so it is with the money supply.  Monetary deflation hasn’t stopped, but the Fed has slowed it down.

According to the Implementation Note with the FOMC statement, beginning on June 1, 2024, the Fed will roll over maturing Treasury securities that exceed $25 billion per month.  In other words, the Fed will allow a $25 billion per month reduction in Treasury securities instead of $60 billion.  The MBSs will continue to roll off at $35 billion per month.

To sum it up, that means the Fed will reduce the base money supply by up to $60 billion per month in total instead of $95 billion per month.  It could be less if there isn’t that much maturing debt in a given month.

To any individual, these are massive amounts of money.  They are relatively small compared to the Fed’s balance sheet that currently sits near $7.4 trillion.  It has come down from a peak just below $9 trillion.

It is doubtful that the Fed’s balance sheet will get much below $7 trillion at this point.  Even though markets have generally been booming (not counting recent weeks), a deliberate policy of monetary deflation eventually brings the party to an end.

I think the central planners know this.  It doesn’t matter what rosy things Powell has to say.  They know that there is a significant risk for a deep recession and some kind of financial crisis.

Why else would they begin to reduce the rate of monetary deflation?  They are admitting that price inflation is still stubbornly above their 2% target rate.  Wouldn’t they keep draining the balance sheet at the previous pace if inflation is still a problem?

The reason is because they are scared of a massive recession.  They are scared that the bubble will burst.  They don’t care if the stock market goes down 10%.  They do care if the stock market goes down by 70% accompanied by a major financial crisis.

Conclusion

The Fed is finally in a tough position.  They were able to get away with massive monetary inflation after the 2008 financial crisis.  Price inflation never got out of control until 2022.

Now the Fed has to play a balancing act of not allowing price inflation to spike back up while also not allowing a major financial crisis.  The only reason they are in this position is because of previous Fed policy.

Even though monetary deflation will be slowed down, it is still monetary deflation.  Mises taught that even a reduced rate of monetary inflation can bring on a bust.  In this case, we still have monetary deflation.  The Everything Bubble could go bust at any time.  And in spite of what Powell says, he would probably prefer that to happen after the election in November.