The Federal Reserve is expected to set a new monetary policy stance.
“This should be done via an immediate end to QE, forward guidance on three interest rate hikes and signaling that the balance of risk has tipped towards tighter policies.”
“The Fed should schedule the announcement of its ”quantitative reassurance” plan in March.”
The quantitative tightening plan means that the Fed should “advance the announcement of plans to reduce its balance sheet to March”.
The Federal Reserve reduces the amount of securities it buys each month.
But, the Fed “is still ultra-stimulative, and on track to stay that way for a while.”
“Rather than stepping on the brakes, the Fed always has its foot on the accelerator…”
That of Mohamed El-Erian, bond specialist, at the Financial Times.
“Having grossly mischaracterized inflation for most of 2021 and missing one policy window after another, the Fed’s persistent and late policy response risks what (Fed Chairman Jerome) Powell himself has warned it was a ‘serious threat’ to livelihoods.”
“As a result, at its meeting this week, (the Fed) should send a clear message that it is serious about tackling inflationary pressures.”
I have quoted Mr. El-Erian extensively because his words sum up exactly what I have been writing for several months.
Although the Federal Reserve is reducing its securities purchases these days, the Fed remains extremely expansive.
Even though the Fed is reducing the amount of its securities purchases each month, in the past six weeks the Fed has purchased more than $140 billion worth of securities outright.
This amount of purchases cannot be called a crunch.
Moreover, the financial markets are “overflowing with liquidity”.
That’s Mr. El-Erian’s wording.
But it is true that over the last couple of years or so the Fed has pumped an incredible amount of reserves into the banking system resulting in an incredible wave of financial largesse that is filling the pockets of investors who are able to play the game. In progress. play.
In fact, the Fed’s stance can be defined as extremely accommodative.
What brought us here
Again, as I tried to point out, Mr. El-Erian reviews the recent past and concludes that the Fed may not be living up to his suggestion.
“Marked by the experience of three years ago when market volatility forced it to turn around (i.e. return to more accommodative monetary policy even if the economy does not justified), the Fed may well favor a more gradual approach.”
Simply put, the Federal Reserve overreacted to the market at the onset of the Covid-19 pandemic and accompanying recession, and is likely to underreact now in terms of the inflationary threat.
Mr. El-Elian seems to share the same concerns as me about the ability of the Fed to respond to the current situation.
Mr. Powell and the Federal Reserve overreacted to the financial distress resulting from the spreading pandemic and recession, as the central bank was quite content to err on the side of monetary stimulus and not risk leaving a further disruption send the banking system and the economy into even more dire straits.
Mr. Powell and the Fed seem very comfortable with erring on the side of monetary easing and that is, I believe, what Mr. El-Erian is pointing to.
Mr. El-Erian and I believe that “the Fed may well favor a more gradual approach.”
In other words, although the Fed really wants to fight inflation, Mr. Powell and his team still believe that it is better to err on the side of monetary easing.
But, as Mr. El-Erian suggests,
“Judged in terms of risk scenarios, the threat to society is that of a still-sluggish Fed that will be forced later this year into an even bigger set of monetary restraints.”
This is what happens when policy makers try to avoid mistakes by overreacting to market situations. These can be termed as strategy errors.
But that is how Mr. Powell and the Federal Reserve have positioned themselves during the events of the past three years.
We can equate their behavior to that of being afraid of making any type of error. I mean that while the Fed’s reaction in 2020 to the pandemic and subsequent recession may have been in the right direction, and even the desire to err on the side of monetary easing may have been Appropriate at the time, the Fed’s response was, excessive.
Buying $120 billion worth of stocks every month for a long time is huge. At this rate, 8.3 months will increase the Fed’s balance sheet by $1 trillion. At 16.5 months, the Fed’s balance sheet has grown by $2 trillion
A trillion dollars is larger than the entire Fed balance sheet just before the start of the Great Recession in December 2007.
The commercial banking system received about $4 trillion in “excess reserves”,
Debt markets have gone wild with the explosion of opportunities such as blank check companies, special purpose acquisition companies (SPACs), many of which are experiencing financial problems.
What if the Federal Reserve started to reduce the size of its balance sheet?
Well, there is still, I believe, one problem that the Fed has yet to address.
The Federal Reserve still has about $1.9 trillion in reverse repurchase agreements on its balance sheet. This represents securities that the Fed has sold, under an agreement to buy them back in a few days.
How will the Fed manage these “repos” as it tries to reduce the size of its securities portfolio?
The answer is not entirely clear?
In fact, this is another area where the Fed has not been fully forthcoming with the financial market.
So, entering this period, the Fed failed in a few areas.
Mr. El-Erian argues that the Fed needs to “be clear about why it has misread inflation so badly for so long…”.
This error, for Mr. El-Erian, “will go down in history as one of the worst calls for inflation by the central bank…”.
The Fed also needs to shed light on why the projections for the future will be better.
And the Fed needs to provide clarity on how it will manage its balance sheet in the near future.
And, Mr. El-Erian concludes that it is time for the Federal Reserve to be bold, and I agree with him.
“Continuing on its current path risks another much more disruptive policy error later this year.”