The Fed has backed itself into a corner. Whether it be the Greenspan put or the taper tantrum, all eyes are on the fed and it has its hands full. You see, over the years, trust in the fed has reached near mythical status. Singlehandedly able to cause rallies or bear markets, investors analyze every word put out by the fed for signs of what to expect next.
Last week, the fed clarified what its intentions are. It raised rates by 50 basis points for the first time in decades, and promised to do the same at the next two meetings. The fed then plans to skip a meeting and monitor the economy before deciding how to follow up in the fall.
Although the fed’s influence on the economy is powerful, it is not omnipotent. The fed might WANT to engineer a soft landing, but will it be able to? That is what we are about to find out. Before we get to what the fed will likely do, let’s take a quick look at what it has done to get us to where we are today.
A year before Covid hit, the fed was feeling pressure from President Trump to lower rates and increase the money supply. Normally, the president doesn’t publicly attempt to influence fed policy, but Trump looked around the world and saw a sea of easy money, and couldn’t understand why a nation with a credit rating as good as ours wasn’t joining in the party.
Although the market might view Jerome Powell as something more than human, I assure you, he is skin and bones like everyone else. That means he is just as vulnerable to presidential pressure as any other person would be, and THAT means, rates came down and the printing press went into overdrive.
When covid hit, the fed pressed on the gas even more, lowering rates to zero and printing money to buy US treasuries, corporate debt, and mortgage backed securities to the tune of $95billion….per MONTH.
The fed’s actions had the desired affect of goosing the economy. Business activity flourished, but not without a cost of its own. Printing money to stimulate the economy tends to work for a while, but it leads to malinvestment because it distorts price signals that entrepreneurs depend on to properly operate their businesses.
Printing money also tends to be inflationary. As the supply of money increases, the quality of each unit of money is diluted slightly so that it purchases less than it used to. We see this as rising prices. Today, we have official inflation hovering around 8%, thanks to the dovish central banks around the world.
But now? Now the stimulus has been slammed into reverse. Instead of increasing the supply of dollars, the fed is actively withdrawing $95billion per month by allowing its portfolio of bonds and mortgage backed securities to expire and be redeemed.
This has the net effect of pulling money OUT of the economy, just as the economy is already beginning to slow from the sugar high it experienced when the Fed went into stimulus overdrive. Since stimulus has a shelf life of its own, the economy was already slowing prior to the current rate hiking campaign.
Even though the economy is already contracting without any action from the fed, the fed’s actions will make it look like they are the reason the economy is slowing. That’s where things can get tricky. If Powell is able to engineer a soft landing, he will be assured a legendary status amongst the investment community. But if he oversteps and the economy contracts too much, well, he just might become a convenient villain to blame for the economy’s troubles. One thing I know for sure, is I wouldn’t want his job right now.
Living and traveling on a boat means for a few months each year we have to wait out hurricane season. This year we did that in Guatemala, and have had a great time. But it still feels great to untie the docklines. We were due to set off a couple of days ago, but in typical fashion, after months without any boat problems, our water lines began to burst the morning of departure. Turned out to be a problem with the accumulator tank—not a huge issue—that took two days to work out. Finally, Saturday afternoon we were on our way. We said our goodbyes and pulled out of the marina with an exciting season of cruising ahead of us. This year will take us—assuming our plans actually work out—from Guatemala to Honduras, the Grand Caymans, Jamaica, the Dominican Republic, and finally Puerto Rico. As I write this I'm anchored in front of a 1600s Spanish colonial fort built to defend against pirates. It's still astounding to me that I can sit on my boat at anchor in foreign lands, trading the stocks of companies located around the world, and communicate with all of you at the same time. The uniqueness of this life is not lost on me.
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