Fed Would Like Animal Spirits Unleashed – Would Investors/Businesses Oblige?

The sharp decline in US stocks last October-December forced the Fed to do a 360 as relates to its campaign to tighten monetary policy. The dovish shift apparently wants to unleash animal spirits. Investors have obliged – thus far. Will it continue? Better yet, what if it is not long-lasting?

It did not take much for the Fed to bid adieu to its hawkish bias.

On October 3 last year, US stocks, in general, began what soon turned out to be a waterfall dive. On that same day, Jerome Powell, Fed chair, said interest rates were still “a long way” from neutral. Deeply overbought stocks were not in a mood to hear that. They tumbled, forcing the central bank to rethink its tightening bias. On November 28, Powell said interest rates were “just below” neutral.  In the dying weeks of 2018, his speeches had decidedly taken on a dovish turn.

In the December 18-19 meeting, the FOMC went on to raise the fed funds rate by 25 basis points, to a range of 225 to 250 basis points. This was the ninth hike since December 2015 when rates rose after remaining near zero for seven long years (Chart 1). There are seven more scheduled FOMC meetings this year. In the futures market, the Fed is expected to stay pat in all these meetings.

In the meantime, minutes from the January 29-30 meeting showed last Wednesday FOMC members plan to stop reducing the balance sheet later this year. In the wake of the financial crisis of a decade ago, the Fed’s SOMA (System Open Market Account) holdings went from under $500 billion in December 2008 to $4.24 trillion in April 2017. In October that year, it began to run down its bloated balance sheet. As of last Wednesday, it was down to $3.78 trillion, down $118 billion in the past three months. At this pace, it would have dropped to still-massive $3.4 trillion – give and take – by the end of the year.  Despite this, the Fed wants to stop the so-called quantitative tightening, and, if the need be, expand the balance sheet. The question is why?

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Disclaimer: This article is not intended to be, nor shall it be construed as, investment advice. Neither the information nor any opinion expressed here constitutes an offer to buy or sell any ...

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