• Fed holds overnight rate range steady at 5.25% – 5.5%.
• Retains assessment that “the economic outlook is uncertain.”
• “Lack of progress” toward 2% inflation goal more confident of inflation reaching 2%.”
• Rate cuts pushed further into the future.

Not enough

The Federal Open Market Committee got right to the point in today’s press release. “In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.” They are saying: 1) Wow, we thought inflation would be going down by now, and 2) Forget rate cuts anytime soon. They did leave the easing bias in place, suggesting that their next rate move, whenever that may be, will be lower. 

Push rates

Instead, they are going to try to slow the recent rise in long-term interest rates by increasing the amount of Treasury bonds they buy each month. That program is called “Quantitative Tightening” by the economists. Each month the Fed has tens of billions of dollars in Treasury Bills and Notes maturing out of its portfolio.

The QT program meant that $60 billion per month of Treasury securities were not being replaced. Those funds were drained from the banking system as excess reserves. Today, the Fed announced that the QT cap would be lowered to $25 billion. In other words, starting in June the Fed will reinvest $35 billion per month more into Treasury securities than it had been for the past year. That buying will aid bond prices, which lowers their interest rates. Much of this additional buying will be done at Treasury auctions, which lowers the supply of Treasury debt in the market. 

Analysis

We think it’s about time the Fed recognized inflation was not going away. Our base case for FOMC rate moves is “Too late, Too Fast and/or Too Far” (TLTF2). In the current inflation cycle, the Fed was a year late, went too fast and probably too far (too soon to tell). The +5% short-term rates the Fed put in place last July have hit the housing markets hard. Consumer spending has slowed from a year ago pulling the economy from a comfortable third gear down to second gear. While pockets of the economy have taken tough hits thanks to the rapid rise in rates, much of the damage has been offset by higher spending from the administration.

We would point out that the Fed has never been successful in beating inflation by leaving rates alone. In his press conference opening statement, Chairman Powell did not repeat the line “rates have likely peaked for this cycle.” That suggests the Committee may be open to reversing their easing bias and raising rates if inflation persists into next year. 

Summary

By increasing its monthly bond purchases, the Fed is trying to lower longer-term interest rates. We understand the rationale given by the Fed, that lowering QT lowers stress in the funding markets. The three-legged stool of Treasury General Account, Fed balance sheet and Reverse Repo Program are opaque to most of us. Regardless of the rationale, the effect is to lower the costs of the administration’s deficit spending.

Lower rates are what Wall Street wants, and of this writing, bonds and stocks were reacting favorably to the prospect of slightly lower interest rates.

Inflation remains an issue, and we believe it will remain in the 3% area. The easiest path to reach the Fed’s magic goal of 2% is to have a “hard landing” recession. Given the amount of spending by the administration this election year, we ascribe low odds to a recession.

Please let us know how we can help you.

Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here. 

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