VTI - Federal Reserve Watch: Higher Interest Rates

2023-07-07 10:50:16 ET

Summary

• New data on the economy indicate that the economy still is a lot stronger than expected and inflation is going to remain a problem.
• The Federal Reserve continues to pursue its quantitative tightening program into July and talks of the need to keep moving its policy rate of interest upwards.
• But, the Biden administration continues to pursue its policy of fiscal stimulus to get the economy moving faster.
• A definite conflict in policy goals exists within the federal government.
• Right now, expect two to three more increases in the Fed's policy rate of interest and expect a continued push by the fiscal authorities for more government debt - not good!

The Federal Reserve is getting no breaks these days.

On Thursday, new jobs data were released.

S&P 500 Stock Index (SP500) closed down over 35 points.

NASDAQ Index (COMP.IND) closed down by almost 113 points.

Dow Jones Industrial Average (DJI) closed down by 366 points.

Headlines: Federal Reserve is going to have to raise its policy rate of interest to higher levels than previously thought.

In other words, the fight against inflation is still on.

In fact, we seem to be in a " World of Inflation ."

Interest rates must go up.

Oh, and by-the-way, more and more analysts are contending that, maybe, the fiscal policymakers in the U.S. need to get in line with the monetary policymakers in the U.S. Maybe it's time for the Biden administration to quit trying to " stimulate the heck out of the economy, " and start to get "on board" with the monetary authorities.

The current fiscal policy being promoted in the United States is just not in sync with the monetary policy.

Something must be done here.

Federal Reserve Still In Quantitative Tightening

The Federal Reserve is still maintaining its program of quantitative tightening, begun in March 2022.

Reviewing the Fed's data on its weekly statistical release, we see that the Fed oversaw $38.7 billion leaving its securities portfolio in the banking week ending July 5, 2023.

This brings the total reduction, starting in the middle of March 2022, to $843.6 billion. Or, if one includes the portfolio adjustment that adjusts for premiums and discounts on the securities running off, the total reduction amounts to just over $900.0 billion.

In terms of how the Fed is managing the "excess reserves" of the commercial banking system, we see that in the banking week ending July 5, 2023, Reserve Balances with Federal Reserve Banks, a proxy for excess reserves, are now at $3,179.6 billion, or $3.2 trillion.

Note that Reserve Balances declined from March 16, 2022, until early March 2023, when the problems with Silicon Valley Bank and other banks became known.

Since then, reserve balances have increased some and remained at this higher level.

The Federal Reserve has continued to oversee the reduction in its portfolio of securities held outright but has had to "manage" the "excess reserves" in the banking system since then in order to maintain a "stable" banking system.

So far, it appears as if the Fed has done a good job, continuing to oversee the decline in its securities portfolio, while maintaining the stability of the commercial banking system and while continuing to raise the Fed's policy rate of interest.

Since March 16, 2023, the Fed has had to deal with the inflows and outflows of U.S. Treasury funds going into the Treasury's account at the Fed. It has been able to manage the Reserve Balances through the use of the Fed's own "Reverse Repurchase Agreement" account.

Notice how these "reverse repos" have dropped off in the last month or so as the banking system seemed to settle down from the turmoil arising from the bank problems arising in March.

The concern here is whether or not the Fed continues to oversee a continued decline in the use of the "reverse repos" combined with a continued decline in the Fed's portfolio of securities held outright.

And, this will apparently be taking place as the Fed gets back into raising its policy rate of interest.

Just How High?

The question then becomes, "How high will the Fed takes its policy rate of interest?"

The Federal Reserve began raising its policy rate by 50 basis points each increase.

Recently, however, the Fed has only been increasing its rate by 25 basis points.

And, the range of the policy rate is now 5.00 percent to 5.25 percent, with the effective Federal Funds rate coming in at 5.08 percent.

What's the future? Two more increases at 25 basis points a move?

Then we get the policy rate up to 5.50 percent to 5.75 percent.

Will it go to 6.00 percent? Will it go higher?

How strong is the economy going to stay?

How long will the Biden administration generate more government debt in order to continue to stimulate the economy?

Right now, the Congressional Budget Office estimates that $24.6 trillion in new government debt will be generated in the next 10 years to pile on top of the existing $31.4 trillion of debt that now exists.

Will financial markets be able to sustain this amount of government debt?

How high will the Fed's policy rate have to go?

Can inflation be stopped, given this scenario?

Just how long can quantitative tightening last in this environment?

Right now, it seems that the future of Federal Reserve policy depends upon what Mr. Biden and the federal government do with its budget over the next few years.

This battle between fiscal policy and monetary policy cannot last. It is not good for the country. It will only make things worse.

But, who is going to step up and do something about it?

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