“Many” Fed officials believed “one or more” 50bps rate hikes may be warranted at future meetings. Especially if US inflation doesn’t abate or accelerates.
That was one, among many, takeaways from the March FOMC minutes. Notably, “many” officials also favored a 50bps move last month. So, it wasn’t just Jim Bullard. “Participants indicated, however, that, in light of greater near-term uncertainty associated with Russia’s invasion of Ukraine, they judged that a 25 basis point increase would be appropriate,” the minutes said. Saved by the war, I suppose.
In the lead up to the release, Fed speakers did an admirable job of preparing markets for what was guaranteed to be hawkish reading material. Lael Brainard did most of the heavy lifting on Tuesday. Brainard’s preparatory remarks set a high bar for a hawkish surprise. Initially, the market took the minutes in stride. Barring some truly extraordinary nod to what many already view as panic, the door was open to an “as-expected” interpretation of the March meeting account.
The onset of QT is imminent, and “several” officials were comfortable with “relatively high” monthly caps or no caps at all. That said, some participants were cognizant of the recent deterioration in Treasury market depth and noted that liquidity should be taken into account when deciding on caps for UST rolloff. In all likelihood, monthly caps will be $60 billion for Treasurys and $35 billion for MBS with a three-month phase-in. Bills will roll off when coupon maturities aren’t large enough to hit the caps.
“From a fundamental perspective, if the Fed is going to bring rates swiftly to (and through) neutral, we’re apprehensive that this cycle’s terminal will persist for a truly extended period before the realities of the recovery will require lower policy rates; fine tuning or otherwise,” BMO’s Ian Lyngen remarked.
Markets are pricing in the most aggressive one-year tightening effort in decades (figure below). It now appears all but certain that at least two meetings will feature 50bps hikes. In order to match the total 250bps of hikes priced by markets for 2022, the Fed would need to resort to “jumbo” hikes at a trio of this year’s remaining meetings.
When taken in conjunction with the tightening impulse from balance sheet runoff, this cycle will likely find the Fed materially overshooting, with potentially serious ramifications for risk assets. Or at least that’s my contention.
Not surprisingly, there was discussion at last month’s meeting of outright MBS sales once runoff is “well underway.” Specifically, some officials observed that passive runoff would leave the Fed with a sizable MBS portfolio “for many years.” That isn’t desirable. So, participants “generally agreed” that once QT is up and running, it’d “be appropriate to consider sales of agency MBS to enable suitable progress toward a longer-run SOMA portfolio composed primarily of Treasury securities.”
That isn’t imminent. “Well underway” likely means at least a handful of meetings, and in any case, the Fed promised to announce any intention to actively sell MBS “well in advance.” Remember: It’s MBS rundown that matters more for risk assets. “[Our] prior work on the 2017 / 2018 Fed balance sheet runoff shows heightened risk asset sensitivity particularly around large MBS week-over-week declines,” Nomura’s Charlie McElligott wrote Wednesday.
The figure (above) suggests big MBS runoff weeks can be associated with lower equities and higher volatility.
The Committee is keen to avoid a repeat of September 2019’s funding squeeze. “Participants generally agreed that it would be appropriate to first slow and then stop the decline in the size of the balance sheet when reserve balances were above the level the Committee judged to be consistent with ample reserves,” the minutes said.
Of course, the Fed doesn’t have to worry so much about that particular aspect of runoff this time around thanks to the standing repo facility which, the minutes said, “could address unexpected money market pressures that might emerge if the Committee adopted an approach to balance sheet reduction in which reserves declined relatively rapidly.” That’s a euphemistic way of saying the SRF is a safety valve in case the Fed misjudges what actually counts as “ample” when it comes to reserves. Somewhat amusingly, “several” officials noted that the facility isn’t supposed to be a stand-in.
Next month is absolutely on the table for a QT unveil. “The Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May,” the minutes remarked.
Inflation came up 83 times, and there was some concern about long-run expectations becoming unmoored. Uncertainty around inflation is “elevated,” officials agreed, and all seemed to judge the risks as skewed to the upside. That’s insightful of them.
Inflation is now overshooting by 440bps on headline, and 340bps on core (figure above).
By and large, officials focused on factors not related to the fact that, as of last month, rates were still zero and the balance sheet still ~$9 trillion. Instead, participants cited “ongoing supply bottlenecks” and “rising energy and commodity prices,” both of which were “exacerbated” by Russian aggression and new COVID lockdowns in China.
“All participants” voiced what the minutes described as a “strong commitment and determination” to slay the inflation dragon by any means necessary. “A few” officials warned that “if the public began to question the Committee’s resolve,” there’s “a significant risk” that inflation and inflation expectations could become “entrenched.”
Meanwhile, I looked at Treasurydirect, which indicates there is about $6B of publicly held marketable debt maturing in the next 12 months.
The maturity schedule for the existing US government debt is kind of scary- ss of September 30, 2021, 60 % of the outstanding US government debt which is publicly held matures in the next 4 years.
This is in addition to what is held by the Fed that they want to get rid of via QT.
Common sense tells me to turn to cash, but I have been burned by applying common sense when all of the sudden, after I went to the USD sideline, the Fed/US government cries “uncle”!
Meanwhile, back in my time machine, we go back to the birth of Fed overreaching, that moment in time when Bernanke successfully takes the purse away from other government branches. That’s a subtopic, but the Fed is now able to use its balance sheet as a political tool. The beauty of QE is Fed power.
This Pandora’s box of QE does connect to the Budget and deficit and eventually will impact social programs. Recall trump not being able to build his wall. I’m also trying to recall if trump tried to gain access to the Fed’s reserves?
From the 2008 time machine:
“Also warning against Fed overreaching has been Paul A. Volcker, the former Fed chairman who battled inflation in the 1980s. In speeches and testimony, Mr. Volcker suggested that the central bank’s interventions, particularly its direct role in the fire sale of Bear Stearns to JPMorgan Chase in March, could compromise its independence.
Another friend of Mr. Bernanke, Kenneth S. Rogoff, a Harvard economist, said the Fed chairman was taking the central bank into a new era in which it could be difficult to ward off political pressures in the future.”
“back to the birth of Fed overreaching, that moment in time when Bernanke successfully takes the purse away from other government branches”, is a cogent observation. It speaks to a dynamic in the American political economy I’ve been reading about in fits and starts more and more lately. I would, if I may as a humble citizen, just run your quote through the following formula and see what changes:
“The nation’s peculiar institutional terrain advantages political actors with the capacity to work across multiple venues, over extended periods, and in a political environment where coordinated government action is difficult and strategies of evasion and exit from regulatory constraints are often successful. These capacities are characteristic of organized groups, not individual voters. Moreover, organized groups not only seek to influence governance directly. They also seek to shape how and whether political parties respond to voters, and they have vital resources that parties and politicians want. Accordingly, despite frequent elections and the valorization of representative government, voter influence in American politics is highly mediated and conditional. When voters matter, how they are mobilized, and what they are mobilized for – all are powerfully shaped by the long-term strategies of organized economic interests. Of particular importance, we argue, is the “ issue bundling” (Rodden 2018) that parties engage in within America’s two-party system – the appeals, policies, and identities they highlight and those they do not – as they try to balance their need to attract voters with their desire to maintain support among key organized interests.”
“This perspective also carries with it a central message about political and economic power: it may be most consequential where it is least visible. Resourceful and long-lasting political actors prefer not to have to fight constantly for their interests; far better to embed imbalances of power in durable arrangements within the political economy, whether those be private market institutions, rules of the political game, or entrenched public policies. Powerful actors and coalitions often seek to organize governance in ways that effectively remove important issues from direct political contestation, or ensure that any consideration occurs within arenas and under constraints that favor their interests. Indeed, this kind of agenda control may well be the most significant product of sustained, effective political pressure. As E. E. Schattschneider famously put it, “ Some issues are organized into politics while others are organized out” (Schattschneider i960: 71). The fact that some matters receive limited or highly constrained attention in national legislatures or in election contests, for example, should not be taken as a sign that the matter is of marginal importance or removed from politics. It may mean quite the opposite: that powerful interests have successfully insulated preferred practices from popular or legislative challenge”[1],
plus,
“The Federal Reserve is the critical institution sustaining [F]inancialization, without which it would implode. Yet, calling the Federal Reserve on its role is extraordinarily difficult. One reason is the … is lack of analytic understanding owing to an intellectual hegemony that blocks seeing and speaking of the Federal Reserve in terms of financialization and its role therein….
Under Chairman Greenspan (1987 – 2005), the Federal Reserve was a champion of financial deregulation, neoliberal globalization, the neoliberal labor market flexibility agenda aimed at undercutting worker bargaining power, and the shareholder value maximization paradigm of corporate governance. Though subsequent Federal Reserve Chairpersons (Bernanke, Yellen, and Powell) have backed away from Greenspan’s forthright [N]eoliberalism, the Federal Reserve remains committed to the overarching paradigm….
That commitment is evident in its persistent refusal to use policy instruments that can counter-cyclically target asset prices and credit excess. The Federal Reserve has rejected using margin requirements to limit debt-financed stock market speculation. It has also refused to adopt measures such as asset based reserve requirements (ABRR) which can selectively raise the cost of credit to sectors and activities deemed over-heated (Palley, 2003, 2004)….
Another clue regarding the Federal Reserve’s role concerns its “lender of last resort” activities. According to classic economic theory, which supposedly guides the Federal Reserve, a lender of last resort should require good collateral and charge a penalty interest rate. However, the Federal Reserve does neither. Instead, it has lent freely below market rates and accepted junk which is consistent with the [F]inancialization hypothesis….
The defense of the Federal Reserve’s supportive policies is that this is the right thing to do in a crisis [they fomented]. The argument is not doing so would result in the financial system [which they helped build] crashing and triggering a repeat of the 1929 Great Depression. Additionally, it is argued that the central bank is just engaging in counter-cyclical monetary policy. In the past, it would lower nominal interest rates. However, now that rates are at the zero lower bound, it is compelled to buy assets as the way to inject liquidity and create demand for risky assets.[2]”,
had the effect of changing just a single word for this powerless voter and hapless taxpayer for inevitable repeating bail outs, specifically, “overreaching” became ‘handsfree-reacharounds.’
Of course, it is equally possible in some part that the inability of Congress to act in moments of crisis without dredging up simplistic moral hazard arguments, it oddly never applies to it’s own budget-busting pork-barrel projects (unless it is the other party’s pork), meant the FED and the interests it represents had the elected representatives right where they maneuvered (some more willingly than others) them. Possible, at least, if you are feeling a tad cynical about the FED vibe we’re getting yet again in 2022. Are the old excuses going to work again when this new sand-pile of problems finally avalanches? We think we know which grain-event will trigger it, most will blame IRs now, but once it starts we never know what sub-avalanches within the sand-pile of problems will come to the fore rendering the trigger grain insignificant. I suppose, as is often prognosticated here and elsewhere, the pressure to suppress any sort of day-of-reckoning (the “1929” level event the system repeatedly risks triggering) will be intense by the Financialization powers Palley suspects are behind-the-curtains pulling the levers while being insulated from electorial accountability/processes. Didn’t even get the to role SCOTUS and the legal system had in creating these recurring troubles. Oh well.
[1]”The American Political Economy: Politics, Markets, and Power”, Jacob S. Hacker, Alexander Hertel-Fernandez, Paid Pierson, and Kathleen Thelen, “Introduction” (2022)
[2]”Financialization revisited: the economics and political economy of the vampire squid economy”, Thomas Palley, July 2021.
Let’s not do the book-length, verbatim quotes masquerading as comments. I’m going to start removing these. They’re spam. Thanks.
This credibility discussion needs to involve far more congressional input and reign in Fed power. Obviously, Congress is stuffed full of idiots and perhaps they’d make this generational mess into a greater disaster, but, since we are chatting about tax payer funds, doesn’t make sense to enlarge this discussion beyond the closed doors of a handful of people that are in effect wall streets engine?
It’s bad enough to contemplate the return of the Putin branch of the republican party next year, but I’m not sure America Can Be Great Again, without accountability. Credibility was lost a long time ago, but shouldn’t there be done forensic audit going on with this overwhelming financial disaster?
Moving on, here’s a snapshot from Fed minutes back in 2008 when Bernanke grabbed power away Congress:
CHAIRMAN BERNANKE. I agree with you that this has disadvantages and advantages
relative to a formal target. Absolutely. I wanted to thank everybody for the very useful
discussion that we had in the videoconference, and I promise not to have a full discussion of
inflation targets any time soon because I do think we do have a pretty good sense of people’s
views. What I took from the conference call, among other things, was that the Committee was
willing to grant me some discretion to try to discuss with the political bodies what their views
would be on going forward with an explicit objective.
As I mentioned to you even before the meeting, I had spoken to the Administration, and I
have had some follow-up discussions there. My sense is that there would not be any serious
opposition from that side, although I need to continue to talk with them. But the more difficult
question is on the congressional side, and I have a meeting with Barney Frank on Monday, in
which I will raise this issue among other issues. My sense of the meeting was that it was worth
doing some socializing and some exploring of these issues but that we wanted to be very careful
and very sensitive at this difficult juncture about not creating new political problems for
ourselves but only if we can persuade the leaders of the country that this is something
constructive. So I will continue to try to do that and continue to work on this. I do think,
frankly, that this continued expansion of our projections actually makes it much easier to sell
because it creates a context in which the Congress can see that this is only part of a program that
involves meeting both parts of our mandate.
H-Man, a leaky boat will float until it sinks.
The tightenings will continue until morale improves.
It’s easy to criticize the Fed for its 2008 actions but it’s not clear how letting a Depression arise and, in all probability, a Republican/fascistic autocracy install itself (at least it wouldn’t have been Trump?) would have been in the public interest?