Author Topic: The Fed is not doing what I expected - why?  (Read 840 times)

ChpBstrd

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The Fed is not doing what I expected - why?
« on: January 13, 2022, 04:38:06 PM »
In recent months, I've written that quantitative easing / quantitative tightening are far more powerful and precise tools than interest rates. Interest rate hikes hurt the profitability of businesses and reduce their propensity to expand and add employees. I.e. a business is less likely to expand operations when they have to borrow at 10% than if they could borrow at 5%. So if your goal is to maximize employment, you want to keep interest rates as low as possible. The risk of low rates is rising inflation - too many dollars chasing after too few goods, also known as a high velocity of money. This occurs when lots of people are making lots of purchases, causing each other to make lots of money, leading to more and faster purchases, etc.

For a long time, I've been saying that if the Feds wanted to tamp down inflation, the logical thing to do would be to first stop buying $80B in treasuries and $40B in mortgage backed securities per month. These purchases are intended to add new dollars to the economy, in order to encourage faster growth and faster velocity of money. Stopping these purchases would remove one of the factors driving up inflation - a $120B monthly injection of cash into the economy. This is metaphorically equivalent to taking one's foot off the gas pedal (stopping QE) before hitting the brakes (interest rate hikes). Additionally, doing this would not hurt the aforementioned businesses, because their interest rates would not change.

If inflation still persisted, the Fed could perform quantitative tightening, selling some of the assets off their massive balance sheet. In theory - my theory at least - the Fed could manage inflation and employment through QE/QT alone, and we'd live through an era of low unemployment and low interest rates. The power of QE/QT has been demonstrated since 2008 - it is sufficient to get us out of just about anything. Furthermore, the Fed's balance sheet is so large, they could plausibly sell enough assets to take a large percentage of the existing currency out of circulation. The federal reserve currently holds over $8.7 trillion in assets on its balance sheet (e.g. treasuries, mortgages...) as shown below.

So if I was Jerome Powell, I'd be managing the current bout of unexpected inflation numbers by:
(1) Immediately stop buying treasuries and MBS.
(2) Give it a quarter or two to see the effect on inflation.
(3) Consider selling a couple hundred billion in treasuries/MBS per month if inflation persists.
(4) Raise interest rates as a last resort, maybe in late 2023 or 2024.

Instead, the Fed seems to be doing the following:
(1) Taper down their asset purchases at a very slow rate. As recently as November they were buying $80B in treasuries and $40B in MBS per month. The latest word is that they will keep the foot on the gas pedal until after the March meeting - so not hitting zero QE until April!
(2) According to reports, most Fed officials plan three interest rate hikes this year.

So basically we'll keep giving the car gas until April, and then we'll slam on the brakes in April at the same time we have one foot on the gas pedal. IDK... does that make sense? Why is the Federal Reserve even contemplating interest rate hikes when they have so many assets on their balance sheet and while they plan to continue QE for a few more months? Why not sell some assets and pull hundreds of billions of dollars in currency out of the world economy?

Possible explanations:

1) Political: The majority of Federal Reserve Board members were nominated by President Trump. Perhaps they'd rather engineer an economy-wide slowdown than sell assets off the balance sheet?
2) Mandate Creep: Perhaps the FRB are more concerned about asset bubbles being inflated by low interest rates, and raising rates is a way to address both inflation and asset bubbles at the same time. The Fed is not supposed to worry about the housing, stock, or bond markets, but perhaps they do.
3) Roll-Off Theory: Every time one of the Fed's bonds matures, cash is paid from the broader economy into the Fed's balance sheet, where it essentially disappears from economic reality. I.e. the mere existence of a $8.7T fed balance sheet is disinflationary, because lenders are steadily paying off those loans and those payments and payoffs go into oblivion. So perhaps the Board is looking at the amount of money being sucked out of the economy by routine payoffs in the current block of assets and thinking when they stop buying more assets to replace the old ones, that will be as much disinflation from QT as they're willing to do?

Does anyone have any better theories? Like maybe the Fed is trying not to flatten the yield curve? I cannot explain this behavior, so I'm thinking about getting out of the way rather than accidentally fighting the fed.

djadziadax

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Re: The Fed is not doing what I expected - why?
« Reply #1 on: January 14, 2022, 07:11:01 AM »
I think #1 is very possible but it is most likely combination of all three theories - recently (under Obama and Trump) political pressure on the FED has been enormous to ease rates. Current high inflation is very bad politically for the current admin, and am sure there are also pressures to "do something visible". Raising rates is a very obvious way to ease inflation that even the general population would understand - the "politicians" are doing something!!!! (even though the FED is supposedly apolitical). Stopping QE does not have the same bang for the buck politically and does not ease general negative sentiment as most people do not understand it.

How fast would FED raise rates? I cannot imagine it being more than 25bp per raise, and that would equate to 1 percentage point for the year. Is this really enough to ease inflation which officially is at 7% (and probably up to 10% unofficially). But what if they go faster - is that good politically? Mid-terms are this year....is a seriously tanking market (-20%) for example good politically while at the same time inflation is still raging and supply chain issues are still visible?

I don't know, but to have an effect on inflation, the rates have to come up fast...is that possible at this moment?

Just my random thoughts...

tooqk4u22

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Re: The Fed is not doing what I expected - why?
« Reply #2 on: January 14, 2022, 08:07:10 AM »
First, QE does drive interest rates but mostly on the longer end (whereas Fed funds is shorter end) as the funds have gone into the bond market directly as you indicated and indirectly through banks excess reserves.   

Also, in addition to Fed monetary policy inflation has been caused by the many trillions of stimulus (fiscal policy) and the supply chain challenges.

But to your expectation/question, yes the Fed has not met expectations and has boxed itself in and screwed the pooch.   It hung its hat on inflation being transitory due to political pressures of managing a dual mandate of moderate inflation an full employment (with greater emphasis on full employment) and further augmented with political pressures of an unofficial mandate to social engineer the economy.   Good news is wages are way up especially on the lower end so minimum wage is now non existent and politicians can take victory laps raising minimum wage from $7-10/hr to $12-15/hr without consequence bc even the lowest of low jobs pays $15/hr now.

Bad news is everything else is higher and investment in technology will accelerate to eliminate said jobs.   

Fed absolutely should have stopped buying bonds a year ago and should be selling now and increasing rates this year.     But now being boxed in anything too sudden will hurt markets and housing, and if you think the Fed and politicians don't factor that in then your nuts. 

Longer term though we will still be fighting a deflationary environment due to population trends (low birth rate, aging boomers, low immigration) and tech/productivity improvements.   

vand

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Re: The Fed is not doing what I expected - why?
« Reply #3 on: January 14, 2022, 08:29:10 AM »
You can always trust the Fed to do the right thing. After they're tried everything else.

PDXTabs

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Re: The Fed is not doing what I expected - why?
« Reply #4 on: January 14, 2022, 09:55:37 AM »
I think that the Fed in conjunction with Congress overreacted because they thought that this was going to be another great recession only worse. This isn't a completely unreasonable fear if you look at 2020 Q1 and Q2 GDP numbers. I don't think that they saw the uptick in goods sales or the long term supply chain disruptions. Also, to the extent that inflation is better than deflation, it worked.

I completely agree with regard to QE and I would add that I think that the Fed bought us another real estate "bubble."* Running a massive QE program with 0% rates while inflation runs ~8% is unprecedented bordering on criminal negligence. If you want to read a book about some of these themes I enjoyed Engine of Inequality: The Fed and the Future of Wealth in America by Karen Petrou.

I would add that it is very hard to argue that we should have ~0% overnight rates with ~8% inflation. No one at the Fed thinks that 0% is a neutral rate.

* - not really a bubble if RE is priced correctly with current mortgage rates but then falls sharply as rates rise

tooqk4u22

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Re: The Fed is not doing what I expected - why?
« Reply #5 on: January 14, 2022, 10:42:00 AM »
I think that the Fed in conjunction with Congress overreacted because they thought that this was going to be another great recession only worse. This isn't a completely unreasonable fear if you look at 2020 Q1 and Q2 GDP numbers. I don't think that they saw the uptick in goods sales or the long term supply chain disruptions. Also, to the extent that inflation is better than deflation, it worked.

I completely agree with regard to QE and I would add that I think that the Fed bought us another real estate "bubble."* Running a massive QE program with 0% rates while inflation runs ~8% is unprecedented bordering on criminal negligence. If you want to read a book about some of these themes I enjoyed Engine of Inequality: The Fed and the Future of Wealth in America by Karen Petrou.

I would add that it is very hard to argue that we should have ~0% overnight rates with ~8% inflation. No one at the Fed thinks that 0% is a neutral rate.

* - not really a bubble if RE is priced correctly with current mortgage rates but then falls sharply as rates rise

I don't think the initial reaction by congress and the Fed in the months immediately after the pandemic was an over reaction but the bills passed late in 2020 and early 2021 (especially stimulus checks and high extended unemployment benefits) and the continuation by Fed of bond buying is downright negligent as you say.

Unfortunately if there is a real estate bubble there is also a market bubble for both bonds and equities. 

Real estate lending standards (housing and commercial) weren't terribly loose so while there may be some lost equity the inflated rents and incomes that will service debt (much of it fixed rate)  should weather it well.

Equities will likely just have a modest correction at some point and then earn their way into more appropriate multiples which to some extent is already happening.

Bonds .....ouch.   

PDXTabs

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Re: The Fed is not doing what I expected - why?
« Reply #6 on: January 14, 2022, 11:41:32 AM »
I think that the Fed in conjunction with Congress overreacted because they thought that this was going to be another great recession only worse. This isn't a completely unreasonable fear if you look at 2020 Q1 and Q2 GDP numbers. I don't think that they saw the uptick in goods sales or the long term supply chain disruptions. Also, to the extent that inflation is better than deflation, it worked.

I completely agree with regard to QE and I would add that I think that the Fed bought us another real estate "bubble."* Running a massive QE program with 0% rates while inflation runs ~8% is unprecedented bordering on criminal negligence. If you want to read a book about some of these themes I enjoyed Engine of Inequality: The Fed and the Future of Wealth in America by Karen Petrou.

I would add that it is very hard to argue that we should have ~0% overnight rates with ~8% inflation. No one at the Fed thinks that 0% is a neutral rate.

* - not really a bubble if RE is priced correctly with current mortgage rates but then falls sharply as rates rise

I don't think the initial reaction by congress and the Fed in the months immediately after the pandemic was an over reaction but the bills passed late in 2020 and early 2021 (especially stimulus checks and high extended unemployment benefits) and the continuation by Fed of bond buying is downright negligent as you say.

Sending stimulus checks to single folks with no kids with AGIs below $100k ($75k for full check, and double for married) who didn't lose a single dollar to the pandemic was too much in my book. Meanwhile the executive had eviction moratoriums and mortgage forbearance for anyone who did lose money while the Fed was buying up mortgage backed securities. Mailing everyone a check who didn't lose a dime was further than Europe was willing to go. To put it another way my wife and I maxed out 2+ retirement accounts and bought a house and didn't lose a dime (actually, our commute costs went down) and the govmnt was nice enough to mail us a check. Thanks future generations!

I, personally, think that it is disgusting. If you are a conservative you should hate it because its handing out money for no good reason and if you are a progressive you should hate it because every dollar that you sent to me was a dollar that you didn't spend on an actual poor person. Did I mention that my neighbor lives in a tent? There are actual poor people in this country and you're mailing it to a couple with a combined income north of $200k and ~$0 in student loan debt and six figure retirement accounts. But perhaps mailing me the check was less stimulative because we just put it in the bank. Everyone else I know in my situation spent it on consumer goods that they didn't need.

waltworks

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Re: The Fed is not doing what I expected - why?
« Reply #7 on: January 14, 2022, 12:14:33 PM »
The inflation in consumer goods will ease up on it's own, there's not really much excess demand for cars and TVs vs, say 2019. Once factories and ports are working right, that stuff is a non-issue.

Housing and big purchases that require financing for most 'muricans will be affected immediately by interest rate moves by the Fed, which is presumably why they are telegraphing that move now. It's an aspect of inflation that they can actually affect.

No amount of QE reversal or interest rate increases will help with, say, beef prices if the meatpacking plant keeps shutting down from covid (or cars/computer chips/mountain bikes/whatever). On the other hand housing prices can be brought into line, maybe.

So I don't know that it's all that illogical, or that unlikely to succeed. If you'd told me 2 years ago that we'd have low unemployment, all time highs in stock/housing markets, etc now while covid was STILL raging - I'd say the Fed did a pretty good job, given the limited ability of the legislative/executive branches to take actual action most of the time.

-W

PDXTabs

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Re: The Fed is not doing what I expected - why?
« Reply #8 on: January 14, 2022, 12:27:41 PM »
No amount of QE reversal or interest rate increases will help with, say, beef prices if the meatpacking plant keeps shutting down from covid (or cars/computer chips/mountain bikes/whatever). On the other hand housing prices can be brought into line, maybe.

I disagree with this. If the meat packing plant is the fire, then low rates and QE is pouring gasoline on the fire. Goosing the stock market and home prices with low rates and QE literally gives me more money to spend on the beef as well as the "wealth effect" to keep buying. Seriously, the SP-500 is up 26.9% for 2021, you think I cut back on meat, really? Because I didn't. I just paid whatever the super market wanted to keep eating exactly like I always do.

djadziadax

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Re: The Fed is not doing what I expected - why?
« Reply #9 on: January 14, 2022, 01:39:38 PM »
Again, who much can they raise rates to tame the housing market or affect inflation? Is 25pb every 3 months enough at this point to achieve what they need? Can they go higher?

Personally what should one's moves be in this environment? I have been accumulating cash...

ChpBstrd

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Re: The Fed is not doing what I expected - why?
« Reply #10 on: January 14, 2022, 04:35:57 PM »
I've also heard the theory that higher interest rates will increase the spreads between good/less-good credit, which creates an incentive for banks to lend more. Thus, higher rates incentivize more bank lending, which might lead to more inflation. IDK if I buy this theory though.

Mrs. Burning Bush

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Re: The Fed is not doing what I expected - why?
« Reply #11 on: January 14, 2022, 06:14:36 PM »
"For a long time, I've been saying that if the Feds wanted to tamp down inflation, the logical thing to do would be to first stop buying $80B in treasuries and $40B in mortgage backed securities per month. These purchases are intended to add new dollars to the economy, in order to encourage faster growth and faster velocity of money. Stopping these purchases would remove one of the factors driving up inflation - a $120B monthly injection of cash into the economy. This is metaphorically equivalent to taking one's foot off the gas pedal (stopping QE) before hitting the brakes (interest rate hikes). Additionally, doing this would not hurt the aforementioned businesses, because their interest rates would not change."

ChpBstrd - I generally agree with you that it seems logical to quit QE before raising rates.  However I am not sure I agree with your last sentence above.  If the Fed quits buying treasuries and MBS, is it not possible or even probable that those rates will float up?   And if those rates go up, will other rates not follow suit? I don't know what percent of the bond market $120B/month represents, but I would argue it has been enough to distort interest rates downward on all debt instruments.  Appreciate everyones thoughts on this topic.


waltworks

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Re: The Fed is not doing what I expected - why?
« Reply #12 on: January 14, 2022, 09:27:11 PM »
Again, who much can they raise rates to tame the housing market or affect inflation? Is 25pb every 3 months enough at this point to achieve what they need? Can they go higher?

Personally what should one's moves be in this environment? I have been accumulating cash...

On a median $450k or so house, a .25% increase in interest rates means something like an extra $700 a year/$60 a month for a typical 20% down borrower. Not enough to move the needle, but if you do it 4 times in a row, that's real money to a typical household.

So yes, I think they can prevent further housing price increases, or at least slow them down.

LOL to accumulating cash... I guess you're not worried about inflation!

-W

ChpBstrd

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Re: The Fed is not doing what I expected - why?
« Reply #13 on: January 14, 2022, 10:39:25 PM »
"For a long time, I've been saying that if the Feds wanted to tamp down inflation, the logical thing to do would be to first stop buying $80B in treasuries and $40B in mortgage backed securities per month. These purchases are intended to add new dollars to the economy, in order to encourage faster growth and faster velocity of money. Stopping these purchases would remove one of the factors driving up inflation - a $120B monthly injection of cash into the economy. This is metaphorically equivalent to taking one's foot off the gas pedal (stopping QE) before hitting the brakes (interest rate hikes). Additionally, doing this would not hurt the aforementioned businesses, because their interest rates would not change."

ChpBstrd - I generally agree with you that it seems logical to quit QE before raising rates.  However I am not sure I agree with your last sentence above.  If the Fed quits buying treasuries and MBS, is it not possible or even probable that those rates will float up?   And if those rates go up, will other rates not follow suit? I don't know what percent of the bond market $120B/month represents, but I would argue it has been enough to distort interest rates downward on all debt instruments.  Appreciate everyones thoughts on this topic.

As big as the Fed's treasury purchases are, they are a drop in the bucket of the monthly trading volume in US treasuries. As recently as 2018, average DAILY trading volume of US Treasuries was almost $550 billion. Not sure why this source doesn't list 2019-21, but I cannot imagine volume has declined. If the Fed is buying a few billion a day to hit $60-80B a month, they are less than 1% of the trades each day.

https://www.statista.com/statistics/189302/trading-volume-of-us-treasury-securities-since-1990/

To me, this suggests the Fed can add and remove enormous sums of cash from the economy through open market activities alone and it wouldn't affect supply and demand for interest-paying securities in a particularly big way.

PDXTabs

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Re: The Fed is not doing what I expected - why?
« Reply #14 on: January 14, 2022, 11:25:35 PM »
I've also heard the theory that higher interest rates will increase the spreads between good/less-good credit, which creates an incentive for banks to lend more. Thus, higher rates incentivize more bank lending, which might lead to more inflation. IDK if I buy this theory though.

I've seen this written about before. But in practice large corporations still have access to capital through other means (bond sales, stock issuance). Raising interest rates would increase capital availability for small businesses while raising borrowing costs for large ones.

alm0stk00l

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Re: The Fed is not doing what I expected - why?
« Reply #15 on: January 14, 2022, 11:49:57 PM »
I think that the Fed in conjunction with Congress overreacted because they thought that this was going to be another great recession only worse. This isn't a completely unreasonable fear if you look at 2020 Q1 and Q2 GDP numbers. I don't think that they saw the uptick in goods sales or the long term supply chain disruptions. Also, to the extent that inflation is better than deflation, it worked.

I completely agree with regard to QE and I would add that I think that the Fed bought us another real estate "bubble."* Running a massive QE program with 0% rates while inflation runs ~8% is unprecedented bordering on criminal negligence. If you want to read a book about some of these themes I enjoyed Engine of Inequality: The Fed and the Future of Wealth in America by Karen Petrou.

I would add that it is very hard to argue that we should have ~0% overnight rates with ~8% inflation. No one at the Fed thinks that 0% is a neutral rate.

* - not really a bubble if RE is priced correctly with current mortgage rates but then falls sharply as rates rise

I don't think the initial reaction by congress and the Fed in the months immediately after the pandemic was an over reaction but the bills passed late in 2020 and early 2021 (especially stimulus checks and high extended unemployment benefits) and the continuation by Fed of bond buying is downright negligent as you say.

Sending stimulus checks to single folks with no kids with AGIs below $100k ($75k for full check, and double for married) who didn't lose a single dollar to the pandemic was too much in my book. Meanwhile the executive had eviction moratoriums and mortgage forbearance for anyone who did lose money while the Fed was buying up mortgage backed securities. Mailing everyone a check who didn't lose a dime was further than Europe was willing to go. To put it another way my wife and I maxed out 2+ retirement accounts and bought a house and didn't lose a dime (actually, our commute costs went down) and the govmnt was nice enough to mail us a check. Thanks future generations!

I, personally, think that it is disgusting. If you are a conservative you should hate it because its handing out money for no good reason and if you are a progressive you should hate it because every dollar that you sent to me was a dollar that you didn't spend on an actual poor person. Did I mention that my neighbor lives in a tent? There are actual poor people in this country and you're mailing it to a couple with a combined income north of $200k and ~$0 in student loan debt and six figure retirement accounts. But perhaps mailing me the check was less stimulative because we just put it in the bank. Everyone else I know in my situation spent it on consumer goods that they didn't need.

It is apparent that you understand microeconomics and how money exists in your bank account; however, the bolded part shows that you cannot seem to understand the economics of changing financial systems for the overall good. If you would like some recommendations for books on macroeconomics let me know.

PDXTabs

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Re: The Fed is not doing what I expected - why?
« Reply #16 on: January 15, 2022, 12:13:52 AM »
It is apparent that you understand microeconomics and how money exists in your bank account; however, the bolded part shows that you cannot seem to understand the economics of changing financial systems for the overall good. If you would like some recommendations for books on macroeconomics let me know.

If you happen to have any suggestions for a book that includes multiple economic schools in one digestible book I would be interested. Bonus points if they are laid out in chronological order of development. Also, I am particularly interested in monetary velocity as it relates to either monetarism in specific or inflation in general, classical political economy, and Georgism. Given the time period between 2007 and today I think that we are going to get some good books pretty soon. Also, I'm pretty sure that the macroeconomics of getting people housed would be net positive.

EDITed to add that we basically helicopter dropped money to 85% of households and were then surprised that it worked.
« Last Edit: January 15, 2022, 01:01:18 PM by PDXTabs »

Wintergreen78

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Re: The Fed is not doing what I expected - why?
« Reply #17 on: January 15, 2022, 09:56:31 AM »
Iím going to recommend one of my favorite books from college. It is about how decisions are made and different frameworks you can use for understanding why a group makes one decision and not another. If you are on the outside looking in and you think a groupís decisions donít make sense, then you might want to re-evaluate your understanding of their decision-making process and their priorities.

https://www.amazon.com/Essence-Decision-Explaining-Missile-Crisis/dp/0321013492