The Fed Won’t Have A Free Lunch

The Fed Won’t Have A Free Lunch

The Fed raised its Fed Funds rate by 50 basis points today as we and many others expected. The problem is that it is too little too late.

It will be impossible for the Federal Reserve and its perma-dove Chairman Jerome Powell to take CPI back down to 2% in relatively short order without causing a recession. The Fed Funds rate now stands at a 0.75-1.00% range which is enormously accommodative. Further, the Fed announced today that it will begin to trim its balance sheet next month. From our perspective the Fed’s paring of balance sheet assets will have a greater impact on bond yields than arbitrary moves in the Fed Funds rate. However, why wait to trim the balance sheet? The Fed is late to the inflation party and given the $30.4 Trillion in public debt outstanding the Fed can’t allow rates to float too high as Treasury won’t be able to service its debt (unless the Fed plans to subsidize that effort as well).

We expect the Fed to tighten by another 50 basis points in its June 14-15th meeting. We expect the Fed to observe where treasury yields sit before deciding what action to take on the Fed Funds rate during its July 26-27th FOMC meeting. In other words, the Fed will take a “stop and observe” approach to tightening rather than focus on its supposed mission of controlling inflation. At the end of the day the Fed serves too many political masters – the Fed itself is highly political – and this muted mission will cause the Fed to fail in its effort to curb inflation (those other masters of course are the equity market and subsidizing the U.S. Treasury so that Congress and the Executive Branch may have funding for entitlements and other fiscal spending programs including wars). The Fed will be forced to elevate its target CPI rate as a result of its feckless monetary policy.