Federal Reserve Watch: Seriously, The Fed To Tighten

It didn’t make the front page of the Wall Street Journal, but it did make the front page of the Financial Times.

“Fed to make ‘rapid’ cuts to balance sheet next month!”

This is from the front page of the Financial Times.

The source of this news is the speech given by the Federal Reserve governor, nominated to become vice-chair, Lael Brainard, on Tuesday. The full speech can be found here.

The specific words:

“the (FOMC) will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.”

“I expect the balance sheet to shrink considerably more rapidly than in the previous recovery….”

“The reduction in the balance sheet will contribute to monetary policy tightening over and above the expected increases in the policy rate reflected in market pricing and the Committee’s Summary of Economic Projections.”

“The Committee is prepared to take stronger action if indicators of inflation and inflation expectations indicate that such action is warranted.”

“We are committed to bringing inflation back down to the 2 percent target, recognizing that stable low inflation is vital to maintaining a strong economy and a labor market that works for everyone.”

Furthermore, several members of the FOMC have publicly stated that the Fed needs to increase its policy rate of interest by 50 basis points a couple of times this year and not just push the rate up by 25 basis points.

The Financial Times article also provided the following information:

Economists expect that the Fed will reduce its securities portfolio by about $105.0 billion each month, $60.0 billion coming from the portfolio of Treasury bonds and $45.0 billion coming from the portfolio of mortgage-backed securities.

So, there you have it.

At least it is a start.

And The Reaction

Well, on Tuesday, stock market prices closed down.

The S&P 500 Index dropped from a close on Monday of 4,583 to Tuesday’s close of 4,525.

Stock prices had been rising as investors appeared to be believing that the Federal Reserve was not really tightening up.

I wrote two blogs last week examining this fact. Last week stock prices were rising and there seemed to be sufficient evidence that the Fed was not, in fact, doing that much tightening.

Since then it seems as if members of the FOMC are speaking out, attempting to show that they really meant it when they raised the policy rate of interest at the last meeting of the FOMC and talked about future changes to the Fed’s balance sheet.

This morning, Wednesday, April 6, the futures market showed that the S&P 500 stock index was going to drop for the day.

At the market opening on Wednesday, the S&P 500 futures index was down by about 50 points.

And, people keep talking about what Fed chair Paul Volcker did back in the 1980s, when the Fed really tightened up on monetary policy, the effective Federal Funds rate rose to above 21 percent when examining the current scene.

Although these discussants were not suggesting raising the Funds rate to above 21 percent again, there was a lot of talk around the need for the Fed to react relatively harshly in order to stop inflation rates that were at a 40-year high.

It appears as if members of the FOMC are responding to this concern and have stepped up their “vocal” guidance in order to get investors moving in the right direction.

How Tight?

Now, we are looking at the other side of the coin.

Over the past decade or so, the stock market has moved with the monetary stance of the Federal Reserve.

Investors have been very sensitive to what the Federal Reserve is doing and that is one of the concerns one can express about the current situation.

If the Federal Reserve really does begin 50 basis point increases in the Federal Funds rate and if the Federal Reserve really does begin to reduce its securities portfolio by $105.0 billion per month, what will happen to stock market prices?

The bets are on that stock market prices will drop, and may drop significantly.

But, what else is out there?

If the Federal Reserve follows this path, what with happen in the SPAC part of the market.

I have just written an article on SPACs and the difficulties that are being experienced in this space.

I have also written about the disequilibrium conditions in many other areas of financial markets as the Fed’s largess has strained investors’ willingness to find more and more areas where they can find a decent return.

Furthermore, there are the markets for crypto assets. I have written about how the capital value of cryptocurrencies has tracked the stock market. Coinbase has estimated that the correlation coefficient between the S&P 500 index and the capital value of cryptocurrencies is 0.56. The price of cryptocurrencies closely follows stock prices.

If the stock market drops in the near future, what is going to happen to prices in the area of cryptocurrencies?

How will this impact to move to monetary digitization?

This is a very uncertain time!

So, let’s see what happens to stock prices in the next week or so.

Will the efforts by members of the Fed’s FOMC convince investors that the Federal Reserve is really serious in its efforts to break the back of inflation and get inflation back into stable control?

If investors are convinced, then stock prices will drop.

If investors are convinced, corporate debt loads are going to become very stressful.

If investors are convinced, the prices of crypto assets may really tank.

Then, the question arises, about the future direction of the Fed. Can the Fed really stand a substantial drop in stock prices?