How The Fed Is Managing The Economy.

Today the Federal Reserve Open Market committee, the Central Bank's chief interest rate setting body, will conclude their 2 day meeting. There will be 8 of these meetings scheduled throughout the coming year. And this is the first one.

Today the Federal Reserve Open Market Committee, the Central Bank's chief interest rate-setting body, will conclude their 2-day meeting.

There will be 8 of these meetings scheduled throughout the coming year. And this is the first one.

Now the FOMC wields a great deal of power and influence over the nation's financial system. When they raise interest rates, as they did a couple of years ago, it becomes more expensive for individuals and businesses to borrow. This slows down business activity.

On On the other hand, when the FOMC lowers rates, credit becomes less expensive, and the incentive for consumers and corporations to borrow is increased. This helps business activity.

Today, we live in a world where many of the competing central banks have actually dropped their interest rates BELOW zero, providing the most incentive ever to borrow.

In fact, it is currently estimated that there are $13 Trillion in negatively yielding bonds globally.

The FOMC has chosen to remain positive in its interest rate policy. And I think this is wise.

The long term effect of negative rates has not yet been demonstrated. But I believe the impact on savings especially, will hold dire consequences for those economies who have chosen to go down this path.

For now, at least the FOMC has chosen to take this option off the table. In fact, at their last meeting in December, the FOMC stated that they do not expect to change interest rates at all in 2020. They have set the short term rate currently at 1 3/4%.

But what is very clear is that the Fed is continuing to support the economy. It's just doing it by utilizing a different strategy. And you can see this other strategy by looking at the Fed's Balance Sheet. This shows the securities owned by the Fed.

When the Fed provides liquidity the number of securities on their balance sheet expands. When it draws liquidity out of the system the number of securities on their books declines.

If you look at the Fed's Balance Sheet, you will see a complete round turn over just the last couple of years.

Reacting to the Great Financial Crisis of 2008, the Fed had been a steady provider of liquidity for the economy. By the beginning of 2018, the Fed had built a balance sheet which contained a remarkable 4.4 Trillion Dollars.

At the point the Fed put on the financial brakes. Hard.

They withdrew about 650 billion dollars from the system, by selling off their bonds. This brought the Fed's Balance Sheet back to a level last seen 6 years before.

But many of us saw this as too much too quickly. And the economy started to falter. If the Fed didn't relax this move there was a very real danger that the economy would slide into a recession.

Fortunately, the Fed reversed itself. In what Chairman Jerome Powell labeled a “mid-course correction.”

The Fed once again started adding liquidity to the economy. And you can also see that in the Fed's Balance Sheet, up about $40 billion in the last couple of months.

Most of this comes from the Fed's recent actions in the Repurchase Market. As you know the Repo market really exploded beginning last September, and since then it has fallen to the Fed to supply liquidity, to this overnight financing vehicles used by large banks and hedge funds.

So today at 2 pm we will get the latest decision by the Central Bank's interest-rate committee, called the Federal Open Market Committee.

By all indications, this should be a non-story as the action has moved over to another venue, the Repo Market. And as far as the interest rate is concerned it should stay right where it is at 1 3/4%

Start listening to GDP: The Accountant’s Puzzle
Start listening to GDP: The Accountant’s Puzzle