FED POLICY: NOT EXACTLY "TIGHTENING"
The Fed has stated that it intends to “remove accommodation” in the coming months by reducing its bond buying program, then implementing a series of interest rate hikes. The Fed Funds is projected to increase from its current 0%-0.25% range to 2.50% in 2024, but it does not appear that the Fed considers this rise as “restrictive” or “tightening.” Why? Inflation is not expected to be higher than these rates either. While the media have typically referred to the Fed projections as “tightening,” history shows us that restrictive monetary policy, the type that slows economic growth, requires a positive real rate. In all of these projections, the real Fed Funds rate remains negative or close to zero.
So what’s up? The Fed is trying to avoid fueling any acceleration of inflation while keeping growth stable. Basically, they’re easing off the gas on the economic car, but they’re not tapping the brakes. They clearly expect inflation to fall back on its own and want rising interest rates to meet inflation as it falls. Inflation is still considered a temporary phenomenon which will dissipate as supply/demand issues stabilize. They may also want to raise rates before monetary inflation becomes an issue. As I’ve discussed in other posts, inflation remains a supply/demand imbalance problem not a monetary one.
What this means for markets is more uncertainty in 2022. First, current stock market valuations are largely tied to extremely low interest rates and may not react well to even a small increase in rates. Bond yields may not back up as much as feared. Likewise, inflation-hedging assets may underperform. On the other hand, the Fed could be completely wrong. The pandemic may keep supply issues from stabilizing even as growth stalls and inflation stays high, causing the dreaded stagflation. Maybe monetary inflation has already begun, but we can’t see it yet.
The Fed is making a bet. 2022 may be more uncertain than 2021 depending on the outcome. In the New Year, we’ll see if they are right.
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