How much is too much?
That’s the question everyone wants answered vis-à-vis Fed tightening at the onset of a hiking cycle the Committee imagines will eventually see rates turn moderately restrictive, somehow without triggering a recession.
Traders are dubious. As noted here on countless occasions over the past several days, market pricing now indicates a pivot to easing sometime between mid-2023 and end-2024, not exactly a vote of confidence in Jerome Powell’s “soft-ish” landing objective.
Simply put: The market is unconvinced the Fed will manage to take rates beyond neutral and keep them there for any appreciable length of time, or at least not without risking a downturn and an overshoot in financial conditions (e.g., from a rolling bear market in equities and/or wider credit spreads).
Last week, I reiterated that it’s important to measure from the low in the shadow rate, which incorporates the impact of QE. The nominal shadow rate didn’t quite hit a new record low this cycle, but an inflation-adjusted version did (figure below).
Note that the nominal rate (light blue line in the figure) has already risen quite a bit off the lows.
It’s with all of that in mind that I wanted to highlight the latest from SocGen’s Solomon Tadesse who, some readers may recall, correctly identified peak tightening during the last cycle months ahead of time.
“We define the degree of monetary easing as the cumulative fall in the effective fed funds rate including the fall in the shadow rates during periods of unconventional policies since the last rate peak [and] the degree of monetary tightening [as] the cumulative rise in the effective fed funds rate, including rises in shadow rates, during periods of unconventional policy since the last rate trough,” he wrote, recapping. The figures (below) are instructive.
What sticks out immediately is that policy has already tightened quite a bit. “The current tightening cycle began in earnest in June 2021 after the trough in shadow rates in May,” Tadesse said, noting that the shadow rate has already climbed some 250bps “as a reflection of the recent QE tapering, the expiration of temporary credit and liquidity facilities introduced during the pandemic as well as markets’ anticipation of the impending policy rate hike.”
Next, Tadesse addressed the big question: How much tightening will the Fed actually manage to deliver? Using the post-inflation era (i.e., taking the mid-80s as the starting point for comparison given the onset of structural macro changes that impacted monetary policy), Tadesse calculated a ratio of tightening to easing and used the average to determine “how far the current level of tightening is from what it should be at a tightening peak.” That figure, conveniently for the Fed, is about 300bps, close to what officials and some analysts are now penciling in.
However, as Tadesse was quick to point out, “the extent and duration of tightening would be significantly curtailed if the overall tightening is implemented via a combination” of rate hikes and balance sheet runoff which, of course, is precisely what’s set to transpire. An official QT announcement is likely at the May meeting when an unveil could be paired with a 50bps hike.
If Tadesse is correct to assume the overall amount of tightening this cycle will be 5.5% (figure below), the Fed has 300bps to work with. As noted above, the shadow rate is already 250bps off the lows. But, as Tadesse emphasized, that 300bps “reflects the required change in the overall monetary policy stance.” The implication: Assuming QT runs alongside rate rise, a Committee that attempts to implement a dozen hikes will be a Committee that overshoots materially.
Put differently: QT will constrain the Fed in its capacity to execute the number of rate hikes some Committee members are currently calling for in public.
“The pace of policy rate hikes critically depends on how much of the tightening is implemented through QT, with more use of QT significantly shortening the amount of policy rate increases and the duration of the cycle phase,” Tadesse went on to say, before noting that,
Normalizing the Fed’s oversized balance sheet through QT would curtail the space for rate increases significantly. Based on a preliminary assessment of QT’s impact on the sharp tightening witnessed in late 2018, a QT program at the scale of at least the 2018 level, a highly likely move, would allow only about half or less of the projected tightening from explicit policy rate hikes, with higher QT generally limiting the extent and number of rate hikes before reaching the tipping point at the cycle top.
Clearly, there are a number of confounding factors and caveats, not least of which is that awestruck policymakers, reeling from a series of unabated inflation overshoots, may fully intend to overdo things in an effort to reclaim some semblance of credibility on the inflation-fighting front.
But the important point is that although SocGen’s estimate of the total degree of tightening is (basically) in line with the Fed’s, the bank’s projection reflects a mix of QT and rate hikes, with the latter’s scope constrained by the scale of the former.
Needless to say, a deep selloff in equities (or a material tightening in credit spreads) could also constrain the Fed in its capacity to deliver the number of hikes the Committee currently expects. One way or another, it seems unlikely Powell will be able to follow through on all the promises implicit and explicit in what he somewhat euphemistically called “a plan” during last week’s press conference.
9 thoughts on “Why The Fed May Only Deliver Half Its Planned Rate Hikes”
Re: “unlikely Powell will be able to follow through on all the promises”
It’s likely that the election in the Fall will play a role in this Kabuki, primarily because if the Fed is too aggressive in it’s policy mistake, we’ll see an accelerated amount of demand destruction in the economy.
The Fed’s attack strategy is almost like class warfare, which tosses jet fuel on inflationary bottleneck problems, needlessly compounding an already complex puzzle. The vast amount of lower income people will be the ones to feel the greatest impacts from the Fed, which serves absolutely no purpose. Instead of helping stabilize the most needy, the plan is to bulldoze them off a cliff and pretend this attack is about fighting inflation. Pushing people to extremes helps pave the way towards trumps coronation, a perfect storm where poor people will unite behind a monster who will destroy them, it’s pure genius, making America Great Again.
I don’t buy the conspiracy aspect – whether meant literally or figuratively. Powell and the few remaining standard Republicans (rather than Trumpers) are very invested in maintaining the status quo and I suspect they’d prefer Biden over Trump in 2024.
That said, you are correct that the Fed (and Biden) are being crushed between a rock and a hard place : inflation pisses people off (and they vote Trump). Recession pisses people off too (and they vote Trump).
There doesn’t seem to be much of a way out for Biden in 2024… except that it’s still 2 years away so maybe some random event(s) will save him?
There is no conspiracy. Plainly stated, Republican governors are refusing to use already allocated Fed funds to help their poor populations simply because a D is in the White House. They do this because it helps them hold onto power, it gives them an easy scapegoat to mirror the right wing media perpetual scapegoat that Democrats are your enemy.
The simple solution to all of this is using Fed funds to support poor people during inflationary periods while the Fed uses its tools to squeeze the rich. That way inflation abates and poor folks don’t feel the pain of it happening. Unfortunately, that will never happen because politics are always in play.
I’ve been watching the sun come and go down for 71 years, scratching my head trying to figure it out. Meh. ‘Shit happens’ and people blame whoever in charge at the time.
Here’s an oldie but a goodie from this site. For some reason the ‘.png’ files are missing, but the text gives you the idea.
Dear America: Here’s What Egregious Wealth And Income Inequality Looks Like
It won’t be Trump, but somebody just as bad or worse.
Part of the Fed’s goal should be to keep government interest expense from increasing to a “too significant” percentage of the Federal budget.
The 2022 Federal budget is about $6T, which is $1.9T more than the revenues. The interest is about $300B.
It is a very complicated puzzle with intended and unintended consequences occurring from the Federal Reserve’s (among others) actions. Hopefully, Powell is a genius and can see into the future.
Luckily, in an “emergency situation”, he also controls the printing press.
H-Man, nice post. Food for thought.
If this supposition is right, that the Fed will flip back to easing within this year, then that means sustained inflation. Sustained inflation will then be built upon again with more transitory -> sustained inflation and I guess we speed up the USD demise to somewhere within my lifetime.
If all of this is try to save the Dem majority later this year, it’s a fools errand. The R’s will attack their D opponents on inflation and the economy which is continually being reported as bad under Biden (from all media outlets) despite meaningful gains. The majority of voters who don’t know how to do their own research will implicitly trust their favorite propagandists and vote against their conditioned literal enemy (the some vitriol Dems). When R’s take back over it’s more tax breaks for the rich and more cuts to social spending programs. Inflation will grow again within a year.
And why are we here? Because the Fed was late to recognize inflation and late to respond to it. Because Republicans, by and large don’t care about their voters, they care about power and campaign donations from dark money institutions. Because Democrats can’t get on the same page like Republicans do and actually agree to pass meaningful change in their legislative actions. Because we are watching the fall of Rome in real time.
Patrick Howley writes for the National File
During last Sunday’s episode of his “The Campaign Show,” Patrick Howley had a screaming meltdown over the fact that he has not achieved the comfortable life to which he believes he is “entitled” as a white man in America and that he is instead being “screwed” by a system that is actively trying to replace him with non-white citizens and committing genocide against white people.
‘I Want to See the Manager!’
White Nationalist Patrick Howley Has a Meltdown
As cdameworth says, things are bad, but what can you do?
You can analyze things all you like but, in the end, it all VERY UNFORTUNATELY comes down to people like Patrick Howley.
H-man — I’m flaunting my ignorance here, but can you explain why a TIGHTENING in credit spreads is constraining for the Fed? My lizard brain would have expected the opposite. And my ignorant two cents is that I don’t think the Fed is as lost as they look and they realize their predicament — hence I think we continue to see a lot of strong talk and jawboning (the appearance of tightening) to help bridge the gap between how much they’d like to tighten and how much they will reasonably be able to. Would be ironic if FedSpeak is what upends the market, rather than actual tightening.