Take Notice Of The Fed’s Big Red Flag

Every six weeks the Federal Open Market Committee (FOMC) meets to decide whether a change in policy is needed to coax our economy in the right direction. They wrapped up their latest meeting on Wednesday. When Fed Chair Jerome Powell delivered his policy statement, stocks bounced and Treasury yields fell sharply.

(Keep in mind the Fed has a Congressional mandate to provide maximum employment and stable prices. It accomplishes this goal primarily by manipulating interest rates.)

According to Powell, interest rates aren’t helping or hindering economic growth. The jobs market is strong, and inflation is near the Fed’s 2% target. Everything seems just about right. So, the Fed is now looking for signs of a slowdown, even though they aren’t expecting one.

What caught investors’ attention was the Fed’s change in projections. Back in December, the Fed expected to hike twice: one in 2019 and another in 2020. But now the Fed isn’t projecting any rate hikes in 2019.

Why the Change of Heart?

Worry over the prospects of our economy.

All evidence indicates that a slowdown is indeed ahead. Housing is worrisome, consumer spending is falling, and inflation isn’t rising as planned. The Fed may have gone too far already in hiking rates and reducing the balance sheet, even if Powell seems reassured.

The Fed decided to leave the federal funds rate (the overnight interest rate it charges borrowing member banks) unchanged at the 2.25%-2.50% range for now. An increase to the rate means that the economy is growing too quickly, or inflation is moving too high. A cut to the rate suggests a sluggish economy or falling prices.

“Normalize” the Balance Sheet

The balance sheet before October 2017 stood just above $4.5 trillion and held a mix of mortgage-backed and Treasury securities. Since then, the Fed has been shedding $30 billion per month of maturing bonds by not reinvesting. When May comes around, the Fed will reduce that $30 billion to $15 billion per month, leading to the end of “normalization” in September with a little over $3.5 trillion in Treasury securities.

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