Surprises in the Federal Reserve’s decision

Surprises in the Federal Reserves decision

The FED statement has several very striking points that could not be anticipated and that – together with Powell’s recent statements – give the clue of what is in the making about monetary policy for the future. 

As we argued would happen, in his recent decision last Wednesday, contrary to an important sector of Wall Street headed by the powerful chairman of Black Rock, Larry Fink, and by the well-known analyst Mohamed El Erian, neither Jerome Powell nor the statement of the Federal Reserve said even a single word that would hint at the slightest change in US monetary policy. The Monetary Policy Committee of the Federal Reserve took good care of itself, in its long and elaborate statement leaving the slightest suspicion open that there is now under study any idea of ​​altering interest rates of 0.25% per year by 2023, or the disputed buyback of Treasury bonds for $80,000 million and MBS (private mortgage bonds) for another $40,000 million, which together imply a moderate issuance of the order of 2% per month as we saw last Friday.

It is no surprise to us that the Fed ignored even Black Rock: we already anticipated it. However, the Federal Reserve statement has several very striking points that could not be anticipated and that – along with recent statements by Powell – give the clue of what is in the making about monetary policy for the future.

The truth is that far from cutting monetary aid to the financial system through the purchase of bonds with the monetary issue, the Federal Reserve has just created two additional lines of credit to grant new funds to the market. Both are through the Repo mechanism, that is, they materialize as short-term loans with a commitment to repay, in contrast to bond purchases that do not have future reversion clauses. It is worth saying then that just at the moment when many heavyweights on Wall Street are demanding a practically immediate monetary contraction, the Federal Reserve has just decided to issue more currency in the immediate future. And when you say more currency you have to understand what magnitudes we are talking about.

One of the new Repo lines is worth nothing more and nothing less than $500,000 million. And the other for $60,000 million. That is more than half a trillion dollars altogether. But things don’t stop there. On the contrary, the Monetary Policy Committee authorizes the New York branch of that body to increase these amounts at its discretion, that is, without a maximum ceiling.

Let’s do the math then: the Federal Reserve had been expanding the monetary base by $120,000 million a month. And here an authorization is given to expanding it by almost five times that magnitude, which in turn is expandable. Of course, that is in addition to the $120,000 million it places this month for bond purchases. Far from decreasing, the rate of monetary issuance then increases. And it can do it in a big way.

Why is the Federal Reserve doing this? Because there are vast sectors of the North American economy that do not have Treasury bonds or MBS – mortgage bonds – to sell to the Federal Reserve and that are trapped in a severe situation of illiquidity. On the other hand, these companies do have other less secure assets that the Federal Reserve does not wish to acquire but which it is willing to take as collateral in exchange for liquidity. Therefore he now lends against them as collateral. The big question is why then the Federal Reserve did not cut bond purchases in order not to increase the issuance of the monetary base. The answer obviously must be sought from the side that it is judged that liquidity is not yet sufficient either in the “First A” segment of the North American market, which does have Treasury bonds and MBS to sell to the Federal Reserve. Some of this complicated issue began to be seen last April when the current Repo lines – which had almost no use previously – began to fill their limits.

If the generation of two new lines of credit and the greater – instead of less – increase in liquidity attract attention although very little is known about them, to this is added that the Federal Reserve has issued its unanimous statement yesterday. Why is it striking? Because in the Monetary Committee of the Federal Reserve hawks and doves coexist. Some of the FED members who come from less populated areas tend to be – paradoxically – much more restrictive in terms of monetary policy than the directors elected by New York, Massachusetts and California.

Those “tough” members tend to vote in dissent when they believe that the Committee is turning to policies that are too soft and expansive. Their pulse does not tremble to vote against. And although it is paradoxical, this also occurs with the great approval of the majority, because dissent gives the vision of a tough and attentive Federal Reserve where there are always guardians of the “healthy currency.” This means that dissenting votes are often consensual. Above all this happens when the financial market – as now – is divided and – also as now – the FOMC decides to take sides with “soft” policy. However, this time it does not happen. A clear signal that the Federal Reserve does not want to leave the slightest doubt that at the moment there is no chance of restrictive monetary policy changes, although there are chances, as can be seen,

In addition to all this, Powell stated that the Federal Reserve is prepared and also anticipates high rates of inflation for “a while” Note that it does not even put a time limit on the Fed’s patience with inflation and goes even deeper by stating that “for a time the Federal Reserve will seek an inflation rate higher than 2%” as a method of counteracting long periods. in which in the United States inflation, measured by the Personal Consumption Expenditure Index, was less than 2%. How much time are we talking about? To give the reader an idea: from 1992 until now the “core” version of the PCE only once reached 2.5%. All other years he was younger. And generally quite minor. By this, we do not mean that the Federal Reserve is going to seek inflation above 2% for 30 years, but we do mean that the Federal Reserve has sufficient pretext to tolerate inflation above 2% as long as it wants. If you wish, you could say that you are going to look for that inflationary figure for years, that you would not be missing your Organic Charter which, recently was changed and now forces the FOMC to look for average inflation of 2% and no longer inflation with a maximum of 2% as before.

In short, when the middle market expected contractionary news in the Federal Reserve’s decision, Powell surprises with new expansionary measures. Very expansive, if one takes into account that the mandate that the FOMC gives to the New York subsidiary to implement the two new Repo lines gives the New York bank the possibility of increasing their maximums “a piacere”. What does this mean? That in reality, the newly created Repo lines have no limit in their amount. That’s the reality. Let’s add, as the icing on the cake, that Powell has just brought a new rabbit out of the box by stating that new variants of the coronavirus, and new ones that emerge, can have a strong effect on the economy because they would be increasingly dangerous strains. How do you know? If we take into account that the chairman of the Federal Reserve has just immersed himself in immunological technicalities to justify more issuance… is that all said.