Handicapping the FOMC

There’s a lot of analysis, speculation, and pontification going on about what the Federal Reserve’s Open Market Committee will decide tomorrow. The smart money (and by that I mean the prediction markets) seem to believe that the FOMC will decide to raise interest rates by half to three quarters of a basis point although some believe that interest rates will be raised by as much as a full point. At the Wall Street Journal Judy Shelton remarks:

The public may not be aware that when the Fed raises rates, it does so primarily by raising what it pays to commercial banks and other depository institutions on the reserves they hold at the Fed—which are interchangeable with cash and effectively serve as checking accounts. These funds currently total $3.3 trillion. Since December 2008, they reflect accumulated purchases by the Fed of Treasury debt obligations and mortgage-backed securities. The Fed paid for its purchases by crediting the reserve accounts of the sellers.

Another $2.5 trillion in cash is held at the Fed through reverse repurchase agreements that the Fed conducts with a broad set of eligible counterparties, including money market-mutual funds and government-sponsored enterprises as well as commercial banks.

When the Fed announces a higher target range for the federal-funds rate (currently 1.5% to 1.75%), it implements its decision by raising what it pays both on reserve balances (currently 1.65%) and on reverse repurchase agreements (currently 1.55%). Money to pay for these interest expenses comes out of the Fed’s interest earnings on its own portfolio.

and trouble for the Fed may be right on the horizon:

The tricky situation the Fed now faces is that its own net interest income—$116.8 billion in 2021, of which 93% was remitted to the Treasury—will soon be exhausted by the higher interest rates it intends to pay on those combined cash funds. A target federal-funds range of 3.25% to 3.5% by year-end would have the Fed shelling out more than $195 billion annually to maintain both reserves and reverse repurchase agreements at current levels. The Treasury will have to advance funds to cover the gap.

which might well prove counter-productive.

Meanwhile, also at the Wall Street Journal Donald Luskin notes rather tartly that Milton Friedman is actually still “running the game”:

Yet the relationship between money-supply growth, as measured by M2 (currency in circulation plus liquid bank and money-market fund balances) and subsequent inflation has been statistically near-perfect in the pandemic era, with a 13-month lag. Year-over-year M2 growth began to accelerate during the pandemic recession in April 2020, and core inflation started to accelerate 13 months later, in May 2021. M2 growth peaked at a history-making, off-the-charts 27% in February 2021, and core CPI peaked 13 months later, in March 2022. Both M2 growth and core CPI have been falling every month since their respective peaks.

Experience is proving, 40 years after Friedman taught Volcker, that inflation is still a monetary phenomenon. But that tells us only what caused the present inflation, not what caused the money supply to grow so rapidly.

Also, Dr. Doom himself, Nouriel Roubini weighs in at Bloomberg via Yahoo! Finance in an interview by Isabelle Lee:

(Bloomberg) — Economist Nouriel Roubini said the US is facing a deep recession as interest rates rise and the economy is burdened by high debt loads, calling those expecting a shallow downturn “delusional.”

“There are many reasons why we are going to have a severe recession and a severe debt and financial crisis,” the chairman and chief executive officer of Roubini Macro Associates said on Bloomberg TV Monday. “The idea that this is going to be short and shallow is totally delusional.”

Among the reasons he cites are historically high debt ratios in major economies.

I would hope that the lesson learned would that quantitative easing was a bad idea to start with and continuing to run as bad a balance sheet as it has for as long as it has was a mistake by the Federal Reserve. I don’t believe that will be the lesson but one can always hope, can’t one?