Since Sunday March 15th, 2020, when the Federal Reserve (Fed) took emergency action to cut rates to 0.0%, one thing has become abundantly clear – this is not your Grandmother’s Federal Reserve.
St. Louis Fed President, James “Jim” Bullard, was recently on a panel where he reminisced about Federal Reserve chairs of economy’s past. He mentioned the Volcker era (Fed chair from 1979 to 1987), a time known for rampant inflation, with YoY CPI peaking at 14.8% in March of 1980. Volcker was largely credited as the mastermind behind taming inflation back then, but operated in a very different fashion than the Fed we know today. Legend has it that when Fed Chairman Volcker was asked for advice on how to be an effective central banker, he gave a one-word answer, “mystique.”
This alluring mystique is probably what created the market’s obsession with decoding the Fed’s message. As fixed income investors we mark off our calendars when Fed officials are scheduled to speak and hunt for breadcrumbs in their language that might help us decode their intentions. By having a pulse on the Fed’s intentions, we can make better educated decisions on what’s to come and manage risk accordingly. At IR+M we don’t believe in making macro/interest rate bets, but having a firm pulse on where the market is headed can help us manage a plethora of other risks in the portfolios.
From 1987 to 2006, Alan Greenspan was at the helm of the Fed. In his book, “The Age of Turbulence,” he claimed that the media was desperate for any type of insight into what the Fed was thinking. During a time where stock prices raced to the moon, there was a lingering fear that interest rate hikes would ruin the party. CNBC went as far as creating the “briefcase indicator,” that measured the girth of Greenspan’s briefcase on the day of FOMC meetings. The idea was that a fat briefcase meant monetary action was on the horizon. We later learned that the size of his briefcase was more correlated with whether or not the chairman had packed a lunch.
Today, with TVs on every wall and computing devices literally in the palm of our hand, we are flooded with information. Market participants are privy to seemingly every event that could potentially impact interest rates and/or asset prices. Current Fed Chair Powell is excellent about laying out the Fed’s current thinking. Throughout the COVID crisis he made the Fed’s intentions abundantly clear. All the while, he constantly reminds the market that the Fed’s future actions are highly “data-dependent.” That seems like a fair comment, but it still manages to frustrate media personalities who are always looking for a step-by-step playbook. Even in the press conferences that follow each FOMC meeting, Powell has become excellent at stating the facts and making sure the Feds message is crystal clear.
With unemployment comfortably below 4% and inflation stubbornly well above the Fed’s 2% target (we can leave the “transitory” jokes aside for another blog post), are we about to see a pivot in the Fed’s candor? In Chair Powell’s eyes, with the Fed Funds rate (Fed funds) currently in the 3-3.25% range, we are now closer to a terminal Fed Funds rate, though he indicated more aggressive tightening is to come. After the July FOMC meeting, Powell indicated that he is prepared to dial down communication and limit guidance to more of a meeting-by-meeting occurrence. At this week’s press conference, he reiterated the Fed “will continue to make our decisions meeting by meeting and communicate our decisions as clearly as possible.” We are still a long way off from “mystique,” and uncertainty abounds. Powell continued with “projections do not represent a Committee decision or plan, and no one knows with any certainty where the economy will be a year or more from now.”
All of this sounds like a step in the right direction, right? Fed funds closer to “neutral” and less need for government intervention should be an encouraging thought for our economy. In the height of the COVID crisis, the Fed committed to buying $120 billion in securities per month, between Treasuries and Agency Mortgages, to help facilitate market liquidity. Today, the Fed is embarking on quantitative tightening, where they are willing to let up to $95 billion roll off their balance sheet, another sign that the Fed feels the market is on better footing.
So, what’s the problem? With inflation still north of 8%, a healthy constituency of investors aren’t convinced we are out of the woods yet. US consumer balance sheets seem to be trending in the wrong direction, leading us to wonder which direction the Fed will go – will they communicate their decisions as clearly as possible as they stated at this week’s meeting, or will they pivot back to what they said in July that they will dial down communication? Only time will tell…
Sources: Bloomberg as of 9/22/22. The views contained in this report are those of IR+M and are based on information obtained by IR+M from sources that are believed to be reliable but IR+M makes no guarantee as to the accuracy or completeness of the underlying third-party data used to form IR+M’s views and opinions. This report is for informational purposes only and is not intended to provide specific advice, recommendations, or projected returns for any particular IR+M product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Income Research + Management. “Bloomberg®” and Bloomberg Indices are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by IR+M. Bloomberg is not affiliated with IR+M, and Bloomberg does not approve, endorse, review, or recommend the products described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to any IR+M product.