The Federal Open Market Committee (FOMC) released its latest policy statement to finish out 2024.  The Fed reduced its target federal funds rate by 25 basis points.  It now sits between 4.25 and 4.50 percent.  This move was widely expected.

What wasn’t expected was Jerome Powell saying that inflation is still a challenge and the Fed’s so-called “dot plot” indicating that we should expect fewer rate cuts next year than what was previously anticipated.

This sent markets in a tumble, with the Dow losing over 1,100 points and the Nasdaq down over 700 points on the day.  Gold was also down considerably, as the U.S. dollar rose.  The euro is getting quite close to being on par with the U.S. dollar.

So, even though the Fed cut rates like stock investors wanted, we should now expect two more rate cuts next year instead of four.  What’s to say it can’t go back to four at the next Fed meeting?

A Contradictory Policy

While the Fed continues to cut its target rate, and nearly everyone commenting on it assumes a looser monetary policy, the Fed actually has a tight monetary policy right now.

In the FOMC’s Implementation Note, it clearly states that the Fed will continue to reduce its holdings of Treasury securities by $25 billion per month and mortgage-backed securities by $35 billion per month.  If you look at the Fed’s balance sheet, this is indeed what is happening.  Approximately $60 billion is coming off the balance sheet each month.  This is monetary deflation.

This is the whacky world we have been living in since 2008, where the Fed controls the short-term interest rates by paying banks interest on their reserves.  The interest rate function has become somewhat independent, at least for now, of the money supply.

As the Fed’s right hand is lowering interest rates, the left hand is doing something else.  The left hand is sending us into a recession.

Of course, the recession is baked into the cake because of prior monetary inflation, but the push for deflation now will make a recession more inevitable in the near future.

The Yield Curve

After about two years of inversion, the yield curve is finally returning to “normal”.  It is still very flat, but the long-term rates are now slightly higher than the short-term rates.  The yield on a 30-year bond is about 30 basis points higher than the yield on a 3-month Treasury bill.

The inverted yield curve has been an accurate predictor of recessions.  Yet, every time it happens, we hear that this time is somehow different.

Before you think we have escaped recession, it is important to know that the recession comes after the yield curve has been inverted and then returns to normal.  In other words, the recession should be coming very soon if we aren’t already in it now.

Meanwhile, the Fed is deflating the money supply in the face of this.

The Fed could reverse course quickly, but it would be too late at this point, unless they plan to go wild like 2020.  Even then, it might not be enough to stop the oncoming recession.

Once the recession comes, Jerome Powell’s words from today will be meaningless.  The dot plot will be meaningless.  We could see the equivalent of four rate cuts in one meeting if things get bad enough.

If you think the plunge in stocks was bad on Wednesday, wait until a recession becomes evident.  There are going to be staggering losses.  Depending on how aggressive the Fed’s initial response is, we could see a stock market plunge of 75% in the next few years.