Chart of the Day: Fed Quantitative Tightening Showtime – Will Jeremy Powell Deliver?

For the second time in the past decade, the Fed (the Federal Reserve Bank) will try to shrink its balance sheet to some “reasonable” size, a process known as Quantitative Tightening (QT). Though this event has been highly telegraphed to the markets, the general public may be asleep to what it means to main street.

What QT means, in theory, is that the Fed’s balance sheet will shrink by $95BN or so every month for the foreseeable future as existing TSYs ($60BN/month) and MBS ($35BN/month) mature. See the current Fed balance sheet in the chart below from the source data here.

The QT is an effective interest rate hike, as the Fed will no longer be buying the US credit to keep buoyant the low rates as it has in the past. One can see in the above chart, that the Fed hasn’t even started QT and its rate hike cycle, and the economy is already starting to choke.

This QT is on top of the scheduled rate hikes telegraphed by Fed commentary. According to JPM, here’s what to look for: the market continues to price according to Fed guidance (50bps hikes in June and July; 50% of maximum QT pace). Currently, the market has a ~50% probability of a 25bps hike in Sept and a 50% probability of a 50bps hike. The market then prices in 25bps in both November and December.

In short, if Powell holds to his guns, interest rates are going to skyrocket significantly.

So what is causing the urgency? Biden realizes that politically inflation at 40-year highs will be a key issue in the upcoming midterm elections – he must be seen doing something. In a rare meeting with the chairman of the Federal Reserve, Illegitimate President Biden said that the White House’s fight against inflation starts with respecting the Fed’s political independence. Do you believe this?

Both Biden and Powell – who met for the first time since Powell’s reappointment, along with Treasury Secretary Janet Yellen – have said it’s the Fed that is charged with containing prices rising at the fastest pace in 40 years. But, even Janet Yellen said that the Fed made a major policy misstep – see here the slippery slope of bad policy and excuses from the Fed in a timeline.

Currently, the Fed is hiking interest rates at the fastest clip in decades in an effort to battle inflation, with more to come as Powell says the central bank won’t back off until it sees prices coming down. Coming down to what they were before, or temporarily stop rising and stay at the higher plateau?

Last quarter’s (2022 Q1) GDP was negative at -1.5% annualized decline. Atlanta Fed’s latest estimate for the next quarter (2022 Q2) is +1.3%, but each revision keeps going down. Most economists are predicting a significant slow down in jobs coming. So Biden will not only need to worry about inflation but jobs as well very soon.

Ever since going off the gold standard (i.e., a fixed monetary system) back in the early 1970s, the US and the globe have been drowning in the delusion that one can create money from thin air with no consequences – it’s called Modern Monetary Theory (MMT). More importantly, it is a gold mine for politicians. The cycle goes as follows.

1. Spend, borrow, and inflate – first, borrow excessive amounts of money to create programs for “the people,” which in a sense are vote-buy schemes. The net result is inflation.
2. Combat inflation by raising rates –  the Fed raises interest rates to cause the rate of inflation to go down. However, this does not mean prices will go back to what they were. Prices merely stabilize at the new higher plateau. Politically, politicians can then say they have stamped out inflation.
3. Jobs suffer, reverse rate increases, and then rinse and repeat – the rising interest rates will start to make the job picture become wobbly, though not falling off the cliff. One thinks the Fed is independent, but eventually, they will succumb (or be part of the scheme) to the political pressure. At this point, the Fed reverses course and recycles back to step one. Note that there may be cycles within larger cycles that can change specifics.

This pretty much describes what the US economy has been doing for a long time. Politicians will try to jerry-rig the events and timing for their benefit of course. They will also have “reasons” why they needed to deficit spend. Today is no different. The overall result is the rich get richer, and the middle class begins to disappear – the poor don’t matter. See an example in the chart below. Note that wealth inequality started to rise at the implementation of MMT back in the early 1970s when we went off the gold standard.

The Biden administration is at step two above and by the midterms at step three. One big phenomenon with this economic system is that in each cycle the stakes get bigger and the consequences get worse – until an eventual collapse. See an example of this in the chart below that shows successive recoveries take longer and/or have less economic output as each cycle occurs in historical time.

To answer the question of whether Jeremy Powell will stick to his guns and do what is right for the American people. The answer is – of course not – he has little choice. The Biden-Powell meeting was merely to discuss the timing of how they will try to manipulate the economy for their own benefit.

The US has not really seen a hard recession since 2008. It was often described as the worst recession since the Great Depression. Will the next US recession follow this successive worsening trend and make the next recession the worst yet again? Is this, in the end, what awaits the average main street American?

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 RWR original article syndication source.