Fed policy in a nutshell

Posted By Darren Winters on Oct 29, 2019

Fed policy in a nutshell

Fed policy, in a nutshell, might be a too ambitious title for a piece, after all, what if the Fed is merely improvising monetary policy as it goes along.

Some Fed watchers would argue that Fed policy in a nutshell, can be summed up in a few words; that the Fed is clueless, monetary policymakers are making it up off the cuff

Fed policy in a nutshell

So a growing number of Fed watchers are questioning the Fed’s foresight.

Cast your mind back to this time last year when the Fed was making it clear that it was ending monetary accommodation. Many believed that the Fed would raise the Fed fund rates to 3.5%. Moreover, we were all led along the train of thought that the Fed would start unwinding its balance sheet of trillions of US dollars of assets, which was known as quantitative tightening QT.

Remember the former Fed chair Janet Yellen famous words that QT “would be like watching paint dry”, a non-event as the Fed starts to implementing its normalization policy on autopilot.

Fast forward a year later, and the Fed fund rates are at1.75% and likely to head lower, which is nowhere near the 3.5% Fed fund rate that so many forecast. Furthermore, the Fed’s QT program crashed the junk bond market and sent stocks tumbling in December, which was the worst single month fall for stocks since the Great Depression.

In a few words, the Fed’s attempted transition to monetary normalization almost triggered a market meltdown, it was certainly not like “watching paint dry,” as described by former Fed chair Yellen

Fed policy in a nutshell, could be that they don’t have one, that they are flying blind

Recent events expose the obliviousness of the Fed, that they are no better at forecasting the economy’s trajectory as you or me. But that does seem rather strange, bearing in mind that the Fed has at its disposal unlimited resources to higher the brightest Ph.D. economist from Ivy league colleges and run the most complex forecasting algorithms on supercomputers.

The Fed’s great pivot has meant not only the end of QT but the beginning of another round of quantitative easing QE, although the Fed refuses to refer to it as QE.

Fed policy in a nutshell, is QE to infinity, the continuation of monetizing debt

The Fed once again, through its open market operations, is buying 60 billion dollars a month of assets. This entails creating money by electronic credit, fiat credit, and then pumping it into the financial system.

So an obvious question comes to mind…

Why is the Fed easing again with stocks near a record high in the “greatest economy ever,” according to US President Trump?

Stocks are sky-high by several matrices. For example, the total market capitalization of stocks as a percentage of the underlying GDP is 1.5 the size of the underlying economy.

This has never happened before. It was almost this high when the total market capitalization of stocks, as a percentage of underlying GDP, was 1% of the economy in 2007. The average of that ratio is 0.8%. So the market value of stocks should be about 0.8 the size of the economy and not 1.5 times the size of the economy. This matrix indicates that stocks are overpriced.

Surely, the Fed is not embarking on more QE to push stocks into an even greater bubble. There has got to be another reason for it? Perhaps they are “fixing” the inverted yield curve.

Fed policy in a nutshell, could be about buying short term treasuries and thereby steepening the yield curve

In other words, the Fed is financially engineering out of existence the great recession indicator, the inverted yield curve. 

This new round of QE is intended to keep the stock market high and push down short term interest rates. In a few words, the Fed is using newly created funds and with it buying short term treasuries. Some commentators refer to it as baby QE

But they are still monetizing debt and they may have a different reason for doing it this time, which is to permanently push down the short term yield curve by monetizing debt.

Perhaps to best understand Fed policy in a nutshell, we need to know why the Fed exists

The Fed is similar to a private corporation with shareholders and its main purpose for existence is to protect the interests of its shareholders, the banks. So the Fed is protecting a powerful banking cartel’s monopoly profits. Don’t be fooled into thinking that the Fed is there to protect us, the little people. We are seeing the return of monetary easing to protect banking profits. 

The global economy is fragile and Fed Chair Powell knows it. The banks need to keep lending money from savers at near-zero interest rates and then lend it out to deposits at a much higher rate so that they can keep extracting profits.

The Fed shareholders, the banks don’t want to be paying out the same that they are getting on their loans, so they are trying to engineer by design a fantasy world, a bankers’ wet dream.

In this fantasy world the yield curve never inverts, bear markets are ruled out and there is no recession.

Fed policy in a nutshell, is to keep building its balance sheet with fake money, even though it already has 3.7 trillion US dollars of assets

The Fed fund rates of 1.75% are now considered too high and are expected to fall.

The Fed mandate of stable prices, 2% inflation is now the floor and not the ceiling. Nevertheless, the Fed is trying to keep asset prices high, lower the US dollar and the best way to do that could be to get rid of interest rate differentials. BoJ has a negative deposit rate, ECB has a negative deposit rate and the Fed could be following the other central banks to a zero interest rate policy.

Perhaps this is the beginning of global monetary policy with zero interest rates and QE to infinity. 

But what happens when the world interest rates fall to zero or below?

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