QVMS - Federal Reserve Watch: Getting More Serious

Summary

• Jerome Powell attempted to set the tone in his Jackson Hole speech, the Fed was serious about fighting inflation and they would persistently work toward a 2.00 percent inflation rate.
• There will be more increases in interest rates and the Fed will step up its efforts to reduce the size of the Fed's securities portfolio.
• Concerns still exist about the credibility of Mr. Powell and the Federal Reserve, concerns that they will continue to keep to the plan.
• Takeaway: the battle is not over and may last a relatively longer period of time so that investors continue to watch and evaluate what is going on in the policy world.

The speech by Federal Chairman Jerome Powell at Jackson Hole last week set the tone.

We are serious.

We are tightening up on monetary policy.

Just watch us.

The Fed's policy rate of interest had been raised in a regular fashion this year, so this policy variable was not in question.

Since July 28, the effective Federal Funds rate has been at 2.33 percent.

The next meeting of the Federal Open Market Committee will be on September 20 and 21. Right now the expectation is that the FOMC will raise the range of the policy rate of interest by at least 50 basis points, perhaps it may even go as high as 75 basis points to match the last two moves made by the Fed.

So, the Fed is seriously moving up interest rates.

Securities Portfolio

The Federal Reserve has also been reducing the size of its securities portfolio.

The Fed has not reduced the portfolio by much, up to this date.

First of all, the Fed is not selling securities outright but is allowing securities to mature from its balance sheet and then replacing only an amount that will allow it to see the whole portfolio reduced in size by the amount it desires at this particular time.

Secondly, the Fed seems to have been waiting for the Jackson Hole event to increase the amount of securities in its portfolio each month.

The Fed even seemed to hold off doing anything with the securities portfolio the week before Chairman Powell's speech at Jackson Hole in order to be sure nothing happened in the markets before the speech .

But, now the Powell speech has been given, the tone has been set, and it is now time for more work to be done to reduce the size of the securities portfolio.

According to the Fed's statistical release H.4.1, "Factors Affecting Reserve Balances Of Depository Institutions And Condition Statement of Federal Reserve Banks," the Fed's securities portfolio declined by $22.3 billion in the banking week ending August 31, 2022.

This was the largest one-week drop in the portfolio since the Fed began to tighten up monetary policy in the middle of March.

This decline brings the total reduction in the portfolio to $87.9 billion since the banking week ending June 22, 2022.

Here is a chart reflecting the size of the Fed's securities portfolio.

Note that the peak amount held in the securities portfolio was $8,504.6 and this came on April 13, 2022, at $98.0 billion more than the current level held on August 31, 2022.

So, the Fed's holdings of securities have dropped by almost $100.0 billion since the "tightening" program began in March of this year.

Moving Forward

Mr. Powell attempted to use the Jackson Hole speech to amend some of the concerns that have been expressed about his credibility as the leader of the Federal Reserve.

Some analysts are still now sure that the Jackson Hole speech fully achieved what Mr. Powell wanted .

Concerns still seem to persist.

However, many investors seemed to get the message as the stock market began to decline soon after his speech was done and followed through until, at least, Thursday, September 1, 2022.

Right now, things seem to be moving the way Mr. Powell and the Federal Reserve would like them to move.

And, Mr. Powell and other Federal Reserve officials continue to assert their commitment to seeing this policy stance through until the back of inflation has been broken and the inflation rate drops back to the Fed's target goal of 2.00 percent.

Still, some investors have doubts that Mr. Powell and the Fed will carry through.

There is still the reality of the Fed's actions from the appearance of the Covid-19 pandemic, where Mr. Powell and the Fed moved to make sure that the disruptions taking place did not deteriorate into an even worse, financial collapse.

What is this reality?

Well, when Mr. Powell and the Fed began to protect the banking system, the Fed's portfolio of securities amounted to $4,009.8 billion. This was in the middle of March 2020.

Today the portfolio amounts to double this amount, $8,406.6 billion.

Commercial banks held reserve balances of $1,945.4 billion, a proxy for excess reserves in the banking system.

Currently, these reserve balances amount to $3,115.8 billion.

In essence, the commercial banking system has $3.1 trillion in excess reserves.

The point of this is that the banking system, the financial system is flush with cash. These "excess" funds are the foundation for inflation.

The current talk coming out of the Federal Reserve is that Fed is only going to take back just a part of these funds. The Fed does not recognize that never has so much cash been pumped into the U.S. banking system in such a short time.

The Fed's plans, the ones that they have shared with the public get us nowhere close to when the banking system needs to be in order to return to some kind of normality.

The financial system is set up to generate inflation over a long period of time.

What a central bank does in order to be overly protective in times of a downturn must be accounted for in the future.

In essence, we are not getting a picture from the Fed about how they are going to deal with the whole situation they created beginning in 2020 and 2021.

The economic period we are entering is of a longer-term nature than people are talking about at this point. The return of financial stability is not for the short-run.

Investors need to be prepared for this.

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