The Federal Open Market Committee (FOMC) released its latest statement on monetary policy. The target federal funds rate remains unchanged in a range between 4.25% and 4.5%.
One thing that typically doesn’t get much attention from the financial media is the actual balance sheet of the Fed. While we usually hear about “rates”, we don’t hear much, if anything, about whether the Fed is inflating or deflating the base money supply.
The Fed had been draining its bloated balance sheet that reached a high of nearly $9 trillion in 2022. For many FOMC meetings now, they had maintained a runoff each month of $25 billion in Treasury securities and $35 billion in mortgage-backed securities (a total of $60 billion).
The Fed is maintaining its runoff of $35 billion per month in mortgage-backed securities, but it is reducing its runoff of Treasury securities to just $5 billion per month. Overall, starting in April, we will be at $40 billion per month instead of $60 billion per month.
To be clear, the Fed isn’t actually selling anything. It is allowing some of its debt to mature without rolling it over.
This was seen as good news by stock investors. It means less monetary deflation and one step closer to no monetary deflation at all. Given the size of the Fed’s balance sheet (still around $6.75 trillion), $40 billion per month isn’t a huge sum.
Economic Uncertainty and Inflation Expectations
The Fed is acknowledging economic uncertainty, and its growth projections have gone down. But they are stuck between a rock and a hard place as price inflation keeps coming in higher than what they would like.
Jerome Powell was asked about inflation and tariffs enacted by Trump. Powell said it is impossible to measure how much tariffs account for inflation but that they do account for some of it.
What is his excuse for the 3 years before Trump came into office?
It is certainly true that tariffs will make things more expensive than they otherwise would have been, but you can also see where Powell and the Fed are using this as a get out of jail free card. The Fed is primarily responsible for the price inflation.
A new or increased tariff will likely increase consumer prices, but it should be a one-time effect if it doesn’t change after that. It isn’t like monetary inflation that can keep prices going up over time, one year after another, and compounding on itself. Trump is giving Powell a convenient excuse for not bringing price inflation under control.
The Yield Curve and the Fed
The inverted yield curve, which we had for 2023 and much of 2024, serves as a recession warning. It will typically normalize before the recession actually becomes evident.
It will often “normalize” because the Fed is pushing short-term rates down in response to an economic slowdown. It actually is a legitimate question to ask if the Fed is driving the yield curve or if the yield curve is driving the Fed. It is probably both.
In this case, the Fed is not lowering rates at the moment. Maybe it is to make trouble for Trump. Maybe it is because they are truly concerned about price inflation.
Either way, this doesn’t change the fact that the yield curve is still somewhat normalizing even without the Fed sharply cutting its target rate. If anything, they will just seem late to the game when recession hits and the Fed hasn’t been doing much of anything (which is what it should have done in the first place).
The Fed can’t stop the oncoming recession unless it wants to turn to massive monetary inflation. Right now, they are sticking with a policy of monetary deflation, even if it isn’t much.