franckreporter/iStock via Getty Images
The Federal Reserve raised the discount rate for the first time in several years and indicated that at a future meeting it will discuss reducing the size of the Fed’s securities portfolio.
The Fed said it was tightening monetary policy.
And the stock market rose for three days in a row.
The S&P 500 stock index closed at 4262 on Tuesday.
On Friday, the S&P 500 closed at 4463.
The S&P 500 is up about 6.1 percent for the week.
Stock prices last week (Wall Street Journal)
Wow!
This is not like what should happen in the stock market after the Federal Reserve said it was tightening the monetary screws.
Investors seem to have taken the Fed’s actions positively and have translated these actions into higher stock prices.
What’s going on here?
The Federal Reserve should tighten monetary policy more often!
Analysis
Since early January of this year, investors have been expecting the Federal Reserve to “cut” its monthly purchases from $120 per month.
The Federal Reserve also told investors that it was going to start raising interest rates to fight inflation.
That was pretty much all the guidance Federal Reserve officials gave to the public.
But the stock market peaked in early January and has been on a downward trend ever since. For example, the S&P 500 hit a new all-time high on January 3, 2022. Since then, the S&P 500 has been falling.
So what does this mean for the investment community?
Apparently, at the beginning of January, this meant something different than what this investment community now believes.
Let me give you three cases.
First, the Fed did start cutting back on its purchases of securities around the start of the year.
Since December 29, 2021, the end of the last banking week of December, the Fed has only bought $220.0 billion worth of securities in the eleven weeks since that date.
According to the old schedule, purchases would have amounted to about $300.0 billion.
So the Fed has reduced the amount of purchases it would have made under the old plan, but the Fed still bought about $220.0 billion worth of securities. This amount of $220 billion during the Great Recession represented a little less than a quarter of the total assets of the Fed.
That’s a hell of a lot of money to pump into the economy.
Thus, during the first three months of 2022, the Fed was still pumping a lot of liquidity into the commercial banking system and stock markets.
Second, the total stock of securities on the Fed’s balance sheet at the end of the last banking week, March 16, 2022, was about $8.5 trillion.
When the Fed began buying $120.0 billion in securities every month, the total amount of securities on the Fed’s balance sheet was about $4.8 trillion.
Thus, in a little less than two years, the Fed increased the size of its securities portfolio by almost $4.0 trillion.
Four trillion dollars is a huge amount of extra money circulating in the banking system in search of a home. How much should the Fed shrink the portfolio to gain some control over “excess reserves” in the banking system?
Investors are now seeing that in order to return to a more restrictive monetary stance, the Fed may have to significantly reduce the size of its portfolio.
The bounty of the past year has been enormous. It may take quite a bit of work to control the “excess”.
Third, even if the Federal Reserve raises the policy band for the federal funds rate six times next year, as suggested by some Fed officials, the effective federal funds rate will still be well below the actual rate of inflation.
In other words, the real interest rate…reducing the nominal interest rate by the actual rate of inflation…will be in negative territory.
As is known, negative real inflation rates are not restrictive. Borrowed money is still prohibitively cheap.
Looking at the situations above, it can be argued that the monetary stance the Fed is moving towards is not at all very restrictive.
I think that investors have done a good job on this and have decided that the stock market remains a very good place to put their money.
So the stock market took off.
bitcoin
Some additional support for this conclusion is that as the share price rose this week, the price of bitcoin also rose.
One of the things we’ve been tracking in the past year or so is the fact that the correlation coefficient between the Standard & Poor’s 500 stock index and the price of bitcoin has risen to about 0.56.
When stock prices rise, the price of bitcoin also rises. When stock prices fall, the price of bitcoin falls.
Since the Federal Reserve announced its policy on Wednesday, the price of bitcoin has surged along with stock prices.
Other things
There are, of course, other things that happened during this period of time, but none of them are as compelling to me as the movement in the stock market after the Federal Reserve announcement after the FOMC meeting.
Some analysts are picking on the words of Jerome Powell, chairman of the Fed’s Board of Governors. Mr. Powell’s public statement on Wednesday highlighted how strong he thinks the economy is and how strong the US labor markets are.
However, what Mr. Powell was quoting was known prior to Wednesday and was available during the fall in stock prices prior to the Fed’s action.
This argument just doesn’t work for me.
The stock market is going down. Investors were focused on what the Fed was going to do and when it was going to do it.
Now that the Fed has given the investment community some insight into how it views its role over the next few months, the investment community has responded: The Fed is not really tightening at all.
Yes, he raises the discount rate. Yes, we are talking about reducing the size of the securities portfolio. And yes, that seems to be talking tough.
But in my opinion, and it seems to be in the opinion of investors, the numbers just don’t back up the talk.
During his tenure at the Federal Reserve, Mr. Powell tried to act in a way that would help him… and the Federal Reserve… avoid wrongdoing.
This is how we got to where we are now.
Investors seem to be saying that what Mr. Powell is doing right now will not improve the situation.