Image Credit: Steve Jurvetson

Will the Fed Bring Down Skyrocketing Inflation and Hit its Employment Targets?

Fed Chairman Powell, who was just reappointed this week, is making no promises as to the results of his attempt at a soft landing. He told Marketplace that he couldn’t assure there won’t be bumps on the ride to inflation getting back to the 2% range while the labor market stays strong. “It’s quite challenging to accomplish that right now,” he said.

The current situation is often compared to the stagflation of the 1970s, but in reality, the last time the country was challenged by high employment coupled with high inflation was 1951.

The Challenge

It has been 70 years since the U.S. last had low unemployment with rapidly rising prices. Today inflation is more than a data point or a CPI headline, at an 8%-9% pace, most in America are feeling the numbers each time they make a purchase. Meanwhile, the job market is historically strong. As of April, only 3.6% of the labor force was jobless and looking for work, the lowest since the last time the Fed considered tightening.

Low unemployment is mostly a positive social and economic measure, but with inflation already climbing to its highest rate in more than 40 years, a tight labor market will lead to wage pressures and more costs for businesses that will be handed down to consumers.

Aggressive monetary tightening is often the medicine for rising inflation; just as low interest rates and quantitative easing stimulates activity, more expensive, and less money in the system reduces activity and that raises unemployment. The person or team of people at the controls are targeting two competing priorities, one is usually sacrificed.

History as a Measure of Success

Before March 2022, you would have to be 71 years old or older to have experienced inflation above 8% while the unemployment rate sat below 4% (Fed Chair Powell is 69). The cause in the early 1950s was the economy experienced a burst of inflation during the Korean War as government spending on national security increased. 

Since 1948, the unemployment rate (monthly) has dropped below the 4% level 146 times. Of those months, inflation registered above 8% only 15 times. So statistically, the combination has occurred less than 2% of the time in three-quarters of a century.

There are bankers and investors like Jamie Dimon of JPMorgan Chase and Bill Ackman of Pershing Square Capital that believe the Fed is behind in its rate-hiking efforts and needs to act more aggressively in order to keep the explosive inflation under control. But the criticism is not without understanding. In April, Jamie Dimon was quoted as saying, “The Fed needs to deal with things it has never dealt with before and are impossible to model.”

Is the Fed Behind?

Former U.S. Treasury Secretary Larry Summers has noted, each time inflation has exceeded 4% while unemployment was below 5% over the past 75 years, which has happened in 70 months, the U.S. has fallen into a recession within two years.

The first quarter of 2022 has already shown negative growth for the economy. A recession is defined as two consecutive quarters of negative growth, we may already be in a recession. It should be noted that the negative 1.5% growth rate followed a quarter of above-average growth.

Investment Portfolio Impact

Stocks tend to do well during tightening cycles. Since 1972 there have been eight of these cycles. Only in the 1972-1974 period did the S&P 500 produce negative results. In the seven periods that followed, with the most recent being 2015-2018, the market returned positive results to investors.

Higher material prices and increased cost of labor both raise the cost of doing business, which could reduce corporate net earnings. This is why inflation is an ugly word in the markets. But stock market results on a total return basis exceed cash or bonds. This makes them attractive and often leads to assets moving into stocks and pushing the market up. At the same time stocks can be a hedge against rising prices.

Different assets react differently to inflation, both within stocks and across other markets. Previously an allocation to value stocks generally performed better than others when inflation grew. Read quality research on the companies you’re considering, a company may have a pricing power advantage. Companies with large inventories or that own advantageous futures contracts may grow profits while their competition’s earnings falter. Making prudent adjustments to an allocation helps position portfolios for a changing environment, stock selection becomes more important, and understanding what is under the hood of an individual company can increaseyour probability of success.

Research provided on Channelchek is by the top-tier equity analysts at Noble Capital Markets. Timely reports are sent daily to your email inbox before the bell, and at no cost. Sign-up here.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.marketplace.org/2022/05/12/fed-chair-jerome-powell-controlling-inflation-will-include-some-pain/

https://www.marketplace.org/collection/unemployment-2020/

https://qz.com/2150562/jamie-dimon-wishes-the-fed-all-the-best-on-slowing-inflation/

https://www.bea.gov/data/gdp/gross-domestic-product

https://blog.nationwidefinancial.com/wp-content/uploads/2022/03/Picture1-1.png

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Image: World Economic Forum (May 24, 2022)

Cryptocurrencies in the Hot Seat at World Economic Forum

Considered by some to be controversial, the annual World Economic Forum (WEF) in Davos, Switzerland, each year impacts thinking on everything from economics, health care, environmental actions, and currencies, including cryptocurrency. This year’s summit is full of crypto-related companies seeking attention and a say. Its been over two years since the last meeting because of the pandemic, since then crypto has gained a strong foothold in many of the subjects covered at the WEF. Many crypto-related stakeholders bought exhibitor space and are attending the event. Their plans to be at this Swiss ski resort were made before the recent selloff and problems with the stablecoin TerraUSD.

The Establishment Speaks

Change will always be fought off by whatever is currently in place until or unless it can become a part of it. Cryptocurrencies and stablecoin fall solidly in this category, and it was made loud and clear at the World Economic Forum. Below are some topics discussed and what was said:

Is Bitcoin money? “Bitcoin may be called a coin but it’s not money. It’s not a stable store of value,” said Kristalina Georgieva, managing director of the International Monetary Fund.

Is crypto a good payment system? “Cryptocurrencies are not a reliable means of payment. Someone must be responsible for the value, and it must be accepted universally as a means of exchange. It’s not,” Villeroy said, noting that some “citizens have lost trust in crypto” because of the massive volatility.

How likely is it that cryptocurrencies and stablecoins
will be used as currency? In a panel discussion, central bankers and regulators were in more or less agreement that the recent plunge of Bitcoin, Ethereum, Luna, and TerraUSD is not behavior desired in a currency.

Are Central Bank Digital Currencies likely? Some cryptocurrencies are more akin to a pyramid scheme for the digital age because they aren’t backed by real assets, explained Kristalina Georgieva. She does however believe Central Bank Digital Currencies (CBDCs) supported by governments can be stable.

François Villeroy de Galhau, a governor of the Central Bank of France, concurred, adding that governments looking to adopt digital currencies must do so in partnership with large commercial banks.

What is the real role of cryptos? Sethaput Suthiwartnarueput, a governor of the Bank of Thailand, said that Thailand has been experimenting in the world of digital currencies. But he said it “has to be clear what problem you want to solve.”

“We don’t want to see it as a means of payment,” Suthiwartnarueput said, adding that cryptos are more of an investment than a medium of exchange.

Do they see private crypto benefits? Francois Villeroy mentioned that the experiment by El Salvador to use bitcoin as legal currency shows how risky it can be to embrace cryptocurrencies.

Georgieva noted that digital money could be a “global public good” that can help people send remittances across borders. The key is for interoperability so that it is just as easy to transfer digital currencies as it is paper-backed currencies like the dollar and euro.

Timeline? Panelists wanted to be clear that it will take time for digital currencies to evolve and become mainstream for consumers, major financial institutions, and governments.

Take-Away

While firms involved in digital currencies were out in force during the World Economic Forum, the recent selloff in crypto values provided less strength and enthusiasm. Particularly unenthusiastic were regulators and bankers. Their presentations and forum discussions show it may be a tougher sell than many private crypto advocates may hope for.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.weforum.org/agenda/2022/05/can-cryptocurrencies-become-environmentally-friendly/

https://www.cnn.com/2022/05/23/investing/davos-central-bank-digital-currencies-crypto/index.html

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Federal Reserve Board Issues Economic Well-Being of U.S. Households Report

The Federal Reserve Board on Monday issued its Economic Well-Being of U.S. Households in 2021 report, which examines the financial lives of U.S. adults and their families. The report draws from the Board’s ninth annual Survey of Household Economics and Decisionmaking, or SHED, which was conducted in October and November of last year before the increase in COVID-19 cases from the Omicron variant and other changes to the economic landscape in recent months. The report, fact sheet, downloadable data, data visualizations, and a video summarizing the survey’s findings may be found here.

The report indicates that self-reported financial well-being reached its highest level since the SHED began in 2013. In the fourth quarter of 2021, 78 percent of adults reported either doing okay or living comfortably financially. Financial well-being also increased among all the racial and ethnic groups measured in the survey, with a particularly large increase among Hispanic adults. Parents were one group who reported large gains in financial well-being with three-fourths saying they were doing at least okay financially, up 8 percentage points from 2020.

“The SHED results provide valuable insight into Americans’ financial conditions during the late fall of 2021. This important perspective helps the Federal Reserve better understand the economic challenges that existed during that phase of the pandemic recovery,” said Federal Reserve Board Governor Michelle W. Bowman.

The share of adults who reported that they would cover a $400 emergency expense using cash or its equivalent similarly increased to the highest level since the start of the survey—68 percent—and was up from 50 percent when the survey began in 2013. Eleven percent of adults could not pay the expense by any method.

In addition, the survey presents insight into the experiences of workers through the pandemic. Fifteen percent of workers said they were in a different job than 12 months earlier. Most who changed jobs said the job change was an improvement. Remote work also continued to evolve in 2021. During the week of the survey in late 2021, 22 percent of employees worked entirely from home, down from 29 percent in late 2020, but well above the 7 percent who worked entirely from home before the pandemic. Most employees who worked from home preferred to do so, often citing work-life balance and less time commuting. Those working from home indicated that they would be about as likely to look for a new job if required to return to the office as if their employer instituted a pay freeze.

In addition, the
report explores families’ experiences related to banking and credit, income, housing, retirement, student loans, and retirement alongside several new topics, such as the use of emerging financial products including cryptocurrencies and “Buy Now, Pay Later” services.

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Sources

https://www.federalreserve.gov/publications/report-economic-well-being-us-households.htm

https://www.federalreserve.gov/newsevents/pressreleases/other20220523a.htm

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Inflation, War, and Oil: How Today’s Crises Are Rehashing the 1970s

Consumer price inflation has risen to 8.3 percent in April 2022 in the United States and 7.5 percent in the euro area. This raises the question of who is responsible. In the US, President Joe Biden has argued that 70 percent of inflation in March is attributable to Russian president Vladimir Putin. The European Central Bank has suggested that the high inflation should be seen in the context of the pandemic and the Ukraine war. ECB president Christine Lagarde sees steeply rising energy prices as unrelated to the monetary policy of the ECB. But is inflation only due to the war and the pandemic?

According to Milton Friedman, inflation is “always and everywhere a monetary phenomenon” and thereby the responsibility of central banks. Given that in all industrialized countries money supply has for a long time grown much faster than output, the resulting huge monetary overhang should be at the root of rising inflation. Whereas since the turn of the millennium stock and real estate prices have grown fast, consumer price inflation only started picking up in mid-2021, boosted by energy prices. There are five reasons why rising energy prices are linked to the global monetary overhang, which was further strongly increased during the pandemic.

First, because of eroding trust in the dollar and the euro, a flight to real assets has set in. Tangible assets include not only real estate and stocks, but also shares in commodity mines and raw materials, including oil and gas. Secondly, the ultraloose monetary policy of the major central banks has—together with expansionary fiscal policies—fueled aggregate demand and thus also demand for energy and raw materials. When corporations—thirdly—assume that the price increases will be permanent, they hoard raw materials, which further increases demand and prices.

Fourth, energy- and commodity-exporting countries hold large dollar and euro reserves, which are devalued by inflation in the US and the euro area. Since they are often oligopolists, energy- and commodity-exporting countries can hedge against this depreciation by raising prices. Recently, some Arab countries have refused to expand the production of oil and natural gas to lower world market prices. Fifth, energy and commodities are predominantly traded in dollars. If the euro depreciates due to the ECB’s ongoing loose monetary policy, prices of raw materials and energy rise in the euro area.

This leads to the question of the extent to which there are parallels with the 1970s, when high and persistent inflation was accompanied by war in the oil-rich Middle East. Global inflationary pressures emerged even before the first oil crisis in 1971, as they are today. Since the second half of the 1960s, the US had financed the Vietnam War and growing social spending partly through the printing press. Inflation was exported to the many countries whose currency was pegged to the dollar. Then as now, energy- and commodity-exporting countries had an incentive to compensate for real losses in the value of their dollar reserves through price increases. This can be seen as the origin of the cartel policy of the Organization of the Petroleum Exporting Countries and the first oil crisis in 1971.

Persistently loose monetary policies always have negative growth and distributional effects that impair political stability. In extreme cases, there are civil wars, as evidenced by the Arab Spring, or there are armed conflicts between countries. The Yom Kippur War in 1971 was—inter alia—triggered by the Egyptian president Anwar el-Sadat’s desire to distract from domestic political tensions. Since 2014, falling oil prices have been depressing growth in Russia. It cannot be ruled out that one of Putin’s major motivations to go to war was securing his power in Russia. Finally, as in the 1970s, the growing international political instability has further increased global inflationary pressure via rising oil and commodity prices.

In the 1970s, inflation only came to an end when, starting in 1979, the new US Federal Reserve chairman Paul Volcker rigorously raised interest rates to 20 percent (Volcker shock). As a result, oil prices started to fall. Both the Fed and the ECB are still far from taking similar steps. The Fed has decisively announced interest rate hikes, but a rise in interest rates above the inflation rate is still a long way off. In the euro area, President Lagarde has kept all options open despite high inflation.

A decisive defense of price stability looks different. This implies that inflationary pressure will persist for longer, particularly in the euro area, as the high level of government debt can be melted down by inflation, helping to financially stabilize the heavily indebted euro area countries. As this process is likely to come along with persistent economic instability, however, the Ukraine crisis may not be the last political crisis in Europe.

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Wholesale Prices are Still Hot and Passing the Cost Increases on to Final Goods

Last Thursday, while the markets were transfixed on watching a so-called stablecoin on its rapid path down to almost $0.00, the Bureau of Labor Statistics (BLS) released the Producer Price Index Report (PPI). If not for the cryptocurrency distraction, the BLS report may have been the most market impactful data made available so far this May. PPI measures the inputs to manufacturing and services and calculates the average change over time of these production costs. It’s often an indicator of where consumer prices are headed.

For April 2022, year-over-year growth in the producer price inflation data came in at 11%. It has been over 10 percent for five consecutive months. PPI experienced a small drop from March’s year-over-year rate of 11.5 percent but continues to scream that costs are rising at a double-digit pace, at least for those manufacturing goods. The monthly figure was a deceleration from March, but the increase is on a growing base.

Year-over-year changes in the PPI have been over 7 percent for 11 months.

Producer Price Index (PPI)

As with the Consumer Price Index (CPI), the expectations just a few months ago were overly optimistic. Analysts forecast that PPI would moderate significantly in April and signal a downward turn. Instead, the April number disappointed those that were looking for signs of a more transitory rise in prices that then quickly moderate.

The report included some signs that price increases have reduced acceleration, but from a surprisingly high level. Despite the tapered increase, prices are still rising at a historically quick pace. Wholesale food costs rose 1.5% during April from March, this one-month increase is extreme. Even more extreme are shipping and warehousing price increases for the month of 3.6%.

What it Could Mean

There are still no indications that inflationary pressures have reached a peak and will move more toward the Fed’s target of 2% to 3%. And from a policy standpoint, there are concerns that neither the Federal Reserve (US Central Bank), Congress, nor the White House have decided to show plans that decisively wage a battle against the purchasing power erosion of US dollars. So the trend may endure for an extended period.

The Federal Reserve which embraced the stimulative position back in 2008 of adding significant liquidity to the US economy and then expanded its efforts during the government’s reaction to the pandemic starting in 2020 has been a significant catalyst to rising prices. Some analysts fear that its tepid steps do little to extinguish the raging price increases.

After nearly a year of historically relevant elevated inflation rates, the Fed has more or less assured us it will decrease its balance sheet. This would take money out of the system of at least $47.5 billion each month. As compared to the size of the overall economy, these Fed held maturities of US Treasuries and Mortgaged Backed Securities reduce money in the system by a like amount and require non-Fed investors to participate in the rolling of this debt. With consumer inflation running above 8% and 10-year US Treasuries only at 3%, history suggests either interest rates will gravitate upward to compensate investors, or inflation needs to come down. The PPI number on Thursday made it clear that the pipeline of costs that lead to consumer prices has not pulled back by much.

Take-Away

The Fed has raised interest rates twice this year. Word is they will continue to move 50 bp for at least one, probably the next two meetings. In the meantime, the pipeline of rising price inputs to consumer goods hasn’t backed off much. Equity investors view stocks as a natural hedge against inflation. What they do however need to watch is the notion that higher interest rates could cause some money that never wanted to take on risk, may leave the stock market. Fewer investors lead to lower prices.

Paul Hoffman

Managing Editor, Channelchek

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How the Bureau of Labor Statistics Confirms Your Sticker Shock by Measuring CPI

As purchases of pretty much everything cost more than they did a year ago, a correct accounting of average cost per household has recently taken the spotlight. The methods the federal government uses to track changes in prices each month on a hundred thousand goods and services were given little thought during non-inflationary periods. But now, as more consumers are asking whether the 8.3% inflation rate corresponds with their anecdotal 23% increase in groceries or the change in prices they’re experiencing with cars, understanding where the government gets the statistics from is useful information.

Bureau of Labor Statistics

Quantifying the magnitude and pace of inflation is among the Bureau of Labor Statistics (BLS) official jobs.

There are 477 workers that work for the BLS that track price changes. Many of these are “on-the-ground” economists whose job it is to confirm that you just paid $1.37 for a can of tuna and that it isn’t a fluke. Their work literally moves markets, including all those tied to interest rates, the stock market, COLA raises for Social Security recipients, and other prices tied to one of the CPI indices.

After a two-year pandemic-related shift away from in-person confirmation, many price checkers have returned and are back out in stores and visiting service businesses in person to collect data. This could include visiting a reception hall, checking prices on a manicure, asking accountants what they charge for a basic tax return, oil change, etc.

Under the Spotlight

For decades there was little attention paid to inflation. For most of the years, the risk of deflation was the most spoken about concern. Retirees would complain that their COLA was more than eaten up by rising Medicaid deductions, and many of us were amazed each time we decided to buy electronics like a new TV. Not only did it cost less than the last one we purchased, but it had better features.

A recent story in the Wall Street Journal about one of these BLS price-checking economists explains she spends more time than ever at each location. Not because she has more business there, but because business owners want to complain to her about rising prices. The story in the Journal says this checker has six children and lately she’s been called upon by her husband and friends to suggest ways to avoid higher bills. This advice she can share. What she cannot help with is sharing any information she has that is confidential, as it could be market moving and considered insider information.

The job of a price-checker has been described as a treasure hunt. As you might imagine, they have very strict price collection rules. Shop owners are not at all counted on to know any of the rules because there is no financial incentive or accountability for them to care enough to treat the task with the importance required.

The job is exacting. To price an item, BLS workers go through up to an 11-page list of data points to make sure they are pricing the same item as they did the prior month. As an example of how exacting, a can of soup will have 12 different specifications, including flavor, size, brand, organic labeling, material of the packaging and dietary features, such as sodium content.

Challenge of Monthly Measurement

The BLS tracks prices on their list of goods and services, along with 8,000 housing units each month. The bureau determines which items to include using census-collected data on buying habits. This makes sure the measurements reflect the way Americans spend their money and captures new buying habits as they emerge using a four-year cycle.

Business participation in the monthly CPI price gathering is voluntary. Businesses can’t be required to participate.  

One challenge they have recently run into is supply-chain shortages. It has made it more difficult to check prices from month to month over the pandemic since goods are often out of stock.

And what about shrinkflation? The price checkers are challenged with watching for quantity changes. If a container of ice cream or can of Pringles has an unchanged price, but the package has shrunk, the price checker has to account for it as a price increase.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://newscorp.com/business/dow-jones/

https://www.dowjones.com/

https://www.marketwatch.com/

https://www.wsj.com/articles/inflation-bls-price-checkers-who-determine-cpi-11652132333?mod=hp_lead_pos8

https://bigcharts.marketwatch.com/

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Image Credit: Jaime Robles (Flickr)

Fed Hopes for ‘Soft Landing’ for the US Economy, but History Suggests it Won’t be Able to Prevent a Recession

The Federal Reserve will likely soon learn what gymnasts already know: sticking a landing is hard.

With inflation surging to a new 40-year high and continuing to accelerate, the Fed is expected to again lift interest rates by a half-percentage point at the end of its next meeting. It will be the third of seven planned rate hikes in 2022 – following increases in March and May – as the Fed tries to cool consumer demand and slow rising prices.

By raising interest rates, the central bank is hoping to achieve a proverbial “soft landing” for the U.S. economy, in which it’s able to tame rapid inflation without causing unemployment to rise or triggering a recession. The Fed and professional forecasters project that inflation will recede to below 3% and unemployment will remain under 4% in 2023.

Our recent research, however, suggests that engineering a soft landing is highly improbable and that there is a significant likelihood of a recession in the not too distant future.

That’s because high inflation and low unemployment are both strong predictors of future recessions. In fact, since the 1950s, every time inflation has exceeded 4% and unemployment has been below 5%, the U.S. economy has gone into a recession within two years.

Today, inflation is at 8.5% and unemployment is at 3.6% – suggesting a recession will be very hard to avert.

Behind the Curve

Inflation is fundamentally caused by too much money chasing too few goods.

In the short run, the supply of goods in the economy is more or less fixed – there is nothing that fiscal or monetary policy can do to change it – so the job of the Fed is to manage total demand in the economy so that it balances with the available supply.

When demand runs too far ahead of supply, the economy begins to overheat, and prices rise sharply. In our assessment, measures of overheating – such as strong demand growth, diminishing inventories and rising wages – began to show in the economy throughout 2021. But a new operating framework that the Fed adopted in August 2020 prevented the Fed from taking action until sustained inflation was already apparent.

As a result, the Fed is way behind the curve today in responding to an overheating economy.

Sticking a Soft Landing
is Hard

To bring down surging inflation, the Fed will now try to raise interest rates to curb consumer demand.

The resulting increase in borrowing costs can help slow economic activity by discouraging consumers and businesses from making new investments. But it would come at the risk of causing major economic disruptions and pushing the economy into a recession. This is the soft landing: Interest rates rise and demand falls enough to lower inflation, but the economy keeps growing.

The history of engineering soft landings is not encouraging, however. We found that every time the Fed has hit the brakes hard enough to bring down inflation in a meaningful way, the economy has gone into recession.

While some have argued that there have been several examples of soft landings over the last 60 years, including in 1965, 1984 and 1994, we show in our analysis that these periods had little resemblance to the current moment.

In all three episodes, the Fed was operating in an economy with significantly higher unemployment, lower inflation and lower wage growth. In these historical examples, the Fed also raised interest rates well above the inflation rate – unlike today, where inflation is at 8.5% and interest rates are projected to remain below 3% through 2023 – and explicitly acted early to preempt inflation from spiraling, rather than waiting for inflation to already be excessive.

Why is the Labor Market
Relevant for Inflation?

One reason the Fed’s challenge is particularly difficult today is that the labor market is unprecedentedly tight, meaning the demand for workers is far outpacing the available supply of them. A tight labor market implies that companies need to raise wages to attract new workers.

Usually, the unemployment rate is used as an indicator for labor market tightness. Unemployment is very low today, and the Fed expects it to go even lower. But our research shows that the pressure to raise wages is even higher than indicated by the unemployment rate. The number of job openings are at all an all-time high, and workers are quitting at record rates – both of which are significant for driving up wages.

In a sense, wages are the ultimate measure of core inflation – more than two-thirds of business costs go back to labor – so rising wages put significant upward pressure on inflation. Wage growth today is running at a historic rate of 6.6% and accelerating.

With wages rising so fast, there is little basis for optimism that inflation can slow to the 2% range targeted by the Fed. Our analysis shows that current wage growth implies sustained inflation above 5%, and that historically wage growth does not slow without significant increases in unemployment and a recession.

The U.S. economy today is facing additional inflationary pressures from higher grain and energy prices due to the Ukraine war and more supply-chain disruptions as COVID-19 forces new lockdowns in China. These factors threaten to exacerbate inflation even more over the coming year.

In our assessment, the inflation problem facing the Fed today is substantial and unlikely to be resolved without a significant economic slowdown. Overall, the combination of an overheating economy, surging wages, policy delay by the Fed and recent supply shocks means that a recession in the next couple of years is certainly more likely than not.

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Image Credit: Federal Reserve (Flickr)

The FOMC Decision on Rates

The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from a target of 0.25%-0.50% to the new level of 0.75%-1.00%.  The monetary policy shift in bank lending rates was exactly as expected as Fed Chair Jerome Powell and other Committee members had been telegraphic the policy shift in advance of the two-day meeting. The early reaction from the bond market was almost lifeless as the UST 2-year and UST 10-year barely moved after the statement was released.

The statement accompanying the policy shift also included plans to shrink the Fed’s balance sheet. Once again, there was no surprise at the size of the reduction in bonds owned by the Fed. It will follow the exact schedule as outlined earlier. For Treasury securities, the cap of securities allowed to roll off the balance sheet will be set at $30 billion per month and, after three months, will increase to $60 billion per month. The decline in holdings of Treasury securities under this monthly cap will include Treasury coupon securities and, to the extent that coupon maturities are less than the monthly cap, Treasury bills.

For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month beginning June 1, and after three months will increase to $35 billion per month.

Over time, the Committee intends to maintain securities holdings in amounts needed to implement monetary policy efficiently and effectively in its ample reserves regime.

The Committee also stated it is prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments.

Take-Away

Higher interest rates can weigh on stocks as companies that rely on borrowing may find their cost of capital has increased. Additionally, investors that would prefer the “known” result of investing in the bond market or other interest rate products may pull assets out of stocks if they are attracted by the fixed income alternative. Investor money leaving the stock market reduces demand.

The next FOMC meeting is also a two-day meeting that takes place June14-15. If the pace of employment and overall economic activity is little changed, the Federal Reserve is expected to again raise interest rates.

Paul Hoffman

Managing Editor, Channelchek

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Source

https://www.federalreserve.gov/newsevents/pressreleases.htm

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