A Depressing Situation

A year and a half before the election, and a little less than a year before the first primary, the Wall Street Journal is already proclaiming that “Another Biden-Trump Presidential Race in 2024 Looks More Likely.”

Doesn’t that get you excited?

It’s pretty sad that out of more than 260 million adults the best the two parties could come up with is the current president, octogenarian Joe Biden, and his predecessor, Donald Trump, who is 76.

And advanced age isn’t their only drawback: both are, shall we say, not very popular.

Yet only a few people, so far, seem to have the guts to stand up and challenge them—no serious Democrats so far and only a handful of Republicans. But it’s early yet, so let’s not lose hope that others will step into the ring.

As Winston Churchill is credited with saying, “Democracy is the worst form of government, except for all the others.”

There are good reasons why the best and brightest people shun politics and have no desire to be president. Politics played at that level is an ugly sport. Few smart and ambitious people want to put themselves or their families through that. It’s a lot more lucrative and less painful to be CEO of a large corporation than to sully your name in politics. It’s also a lot easier to look yourself in the mirror every morning.

If you are willing to mix it up and eventually succeed into the Oval Office, you often have to do things you may not be proud of. In the spirit of “compromise,” you often have to lie and make empty promises—or worse—in order to get a fraction of what you really wanted. So it’s understandable why the government often botches things—we never get the best people or the best policies, so problems just seem to fester and get worse.

Which brings me to my point and how it applies to the Federal Reserve. Continue reading "A Depressing Situation"

What Happened To Reducing The Fed’s Balance Sheet?

Over the past year the Federal Reserve has driven up interest rates by nearly 500 basis points in its quest to try to tamp down inflation.

From a range of 0.25%-0.50% back on March 17, 2022, the Fed since then has steadily raised its target for its benchmark federal funds rate to 4.75%-5.00%, with the possibility of more to come. Over that time the Fed has raised rates nine times—four times by 75 basis points, twice by 50 bps, and three times by 25 bps.

At its two most recent meetings, in February and March, the Fed raised rates by only 25 bps each, possibly because it saw fit to take a slight pause and measure the effect of all these rate increases to see if they are having the desired effect of slowing the economy in order to bring down inflation.

Of course, as we know, the rate hikes haven’t done a whole lot in reining in inflation.

Rather, they created a panic among some fairly large regional banks that has unsettled the entire banking industry, the effect of which has done more to slow the economy than raising rates has done.

Should the Fed then say that the ends justify the means, even if the means—creating the panic—were totally accidental? Should the Fed now brand its “policy normalization” program a success even if a couple of banks failed in the process? Let’s hope not.

This fiasco does call attention to the other prong of that normalization process, namely a reduction in the Fed’s massive balance sheet, which was supposed to help raise long-term interest rates gradually and lessen the Fed’s presence in the U.S. economy.

On that score, there has been negligible progress.

Back in the good old days, before the 2008 financial crisis, the Fed’s balance sheet never totaled more than $1 trillion, a figure that now looks fairly quaint, yet it was a mere 15 years ago. Continue reading "What Happened To Reducing The Fed’s Balance Sheet?"

What to Do When Interest Rates Rise

Last year, when the Federal Reserve realized that the inflation, which was earlier thought to be “transitory,” might be feeding on itself and soon spiral out of control, it acted swiftly to respond with an aggressive interest rate hike cycle, one of the quickest on record.

As a result, we have gone from living in a world of virtually free money, marked by a target federal funds rate of 0% to 0.25%, for more than 12 years since the global financial crisis to a world of constricted credit, with a target rate at 4.50% to 4.75%, the highest since 2007.

Right on cue, the market and economy responded to the end of the era of easy money with withdrawal tantrums. Although the Fed has been able to bring down CPI inflation from a 40-year high of 9.1% in June 2022 to 6.4% in January 2023, it has come at the cost of increased market volatility, stressed margins due to increased borrowing costs, and bank runs due to bond price devaluations.

Given that the federal funds rate appears to be nothing short of a force of nature for the capital markets and the economy at large, its deeper understanding would serve market participants well.

What is the Federal Funds Rate?

The federal funds rate is the interest rate that banks charge other institutions for lending excess cash to them from their reserve balances on an overnight basis.

Legally, all banks are required to maintain a percentage of their deposits as a reserve in an account at a Federal Reserve bank. This mandated amount is known as the reserve requirement, and compliance of a bank is determined by averaging its end-of-the-day balances over two-week reserve maintenance periods.

Banks, which expect to have end-of-the-day balances greater than the reserve requirement, can lend the surplus to institutions that expect to have a shortfall.

The Federal Open Market Committee (FOMC) guides this overnight lending of excess cash among U.S. banks by setting the target interest rate as a range between an upper and lower limit. This target interest rate is called the federal funds rate. Continue reading "What to Do When Interest Rates Rise"

Higher Rates Are Here To Stay

If you believe what the inverted Treasury yield curve is saying, you must believe that, eventually — but probably sooner rather than later — the Federal Reserve will start lowering interest rates in response to the economic recession it will have caused by raising rates by more than 400 basis points in the past year.

But based on the strength of the economy despite those higher rates, it’s looking more like rates well above 4% - and possibly 5% — are going to be around for a long time to come.

But that’s not necessarily such a bad thing. For all those younger than 40, 4-5% long-term interest rates had been the norm for decades.

It’s only in this century that we’ve become accustomed to super-low interest rates, engineered by an activist Fed to insulate consumers and the financial markets from seemingly one financial crisis after another.

But that era looks to be over. And it looks like we’re managing.

Even though inflation appears to have peaked and is moving steadily downward, the Fed is likely to keep rates fairly high for quite a while, certainly the rest of this year and probably 2024 and beyond, absent yet another global financial crisis, to make sure the inflationary beast is truly slayed.

Even on the unlikely chance that the federal government defaults on its debt later this year if Congress can’t agree to raise the debt ceiling, the Fed isn’t likely to start lowering rates for a long time, despite what many investors hope and the inverted yield curve would indicate.

As we know, an inverted yield curve is when short-term rates are higher than long-term rates, which is the exact opposite of the natural order of things.

Long-term debt usually carries higher rates because a lot more can go wrong over, say, 10 or 20 years, than it can over just a couple of years or less. But that’s not what we have now. Continue reading "Higher Rates Are Here To Stay"

Jerome Powell's Declaration of Independence

Remember back about four or five years ago (was it really that long ago?) we heard a lot about how the Federal Reserve’s sacrosanct independence was being threatened because the incumbent in the White House at that time was trying to influence the Fed’s monetary policy?

We don’t hear that much about it anymore since the Oval Office and Congress switched sides, although the threats against that independence have grown even louder, largely because they don’t get reported on to nearly the same degree.

For example, last fall the chairman of the Senate Banking Committee, Sherrod Brown, and the then chairman of the House Financial Services Committee, Maxine Waters, both sent letters to Fed Chair Jerome Powell decrying his recent policy of raising interest rates by more than 400 basis points since March to combat inflation. “You must not lose sight of your responsibility to ensure that we have full employment,” Brown wrote.

Around the same time Sen. Elizabeth Warren, another Democrat, said Powell “risks pushing our economy off a cliff.” Warren, who loudly voted against Powell’s reappointment as Fed chair, added, “There is a big difference between landing a plane and crashing it.”

I suppose they have a right to criticize Fed policy as much as anyone else, although that right should extend to members of both parties. To his credit, Powell has largely kept silent or muted his comments on these attacks.

But now it appears that Powell believes he is being pushed too far. Criticizing the Fed for the way it conducts monetary policy to maintain stable prices and full employment—its legal mandate from Congress, after all—is one thing.

But to force the Fed to go way beyond its mandate and do something that is the rightful purview of Congress is an entirely different matter. And Powell said he won’t stand for it.

I’m talking about the desire of many progressives and environmentalists to have the Fed impose their views on climate change on the banks the Fed regulates and the customers those banks serve. Continue reading "Jerome Powell's Declaration of Independence"