Not so long ago a $700 billion deficit over half a year was presumed to be shocking, but now, goodness knows, anything goes. No one in Washington brings up the deficit anymore unless they want to declare that Something They Don’t Like will break the bank or bankrupt our grandchildren. Demands for fiscal restraint ring hollow when put about by those who have displayed none.
This commentary has suggested for some time that there was no return to the halcyon days of 5% interest rates that characterized the norm prior to the financial crisis of 2007-08. In the last few months, we have seen ourselves unhappily confirmed in that prediction. With the current administration’s narrative lurching bizarrely between proclaiming that the US economy is the strongest ever and declaring that 2.5% interest rates are bringing on financial Armageddon, the Fed has lost its freedom to act and is now adrift on a sea of hope. We are only a slight downturn away from seeing the same people who stridently insisted that Quantitative Easing (QE) would cause hyperinflation under the previous administration demanding that the Fed engage in it once again. We take little solace in being proved right, however, since higher interest rates are the key to higher returns on our savings. As an owner of financial assets, you should always remember that the first approximation of long-term returns for the future are the interest rates of today.
Along with pursuing a policy of modest, gradual increases in the overnight interest rate, under Chairman Powell the Federal Reserve has also begun to reduce the size of the central bank’s Treasury portfolio. This second part of a process which was supposed to “normalize” our monetary regime after the hasty, unprecedented moves made during and immediately after the financial crisis. The Fed has done this not by selling its holdings into the financial markets, but merely by not buying new bonds when the old ones matured. As with the very modest and halting increases in interest rates, this policy, which has been dubbed Quantitative Tightening, or QT (a play on the previous policy of QE) is now being blamed in some circles for last year’s weakness in credit and equity markets. Once again, the fact that this scapegoating is largely the work of those who adamantly reviled QE as monetary debasement will come as little surprise to the readers of this commentary. However, when we examine the actual numbers, we can see just how inconsequential QT has been on either the supply of longer-term Treasuries or the Fed’s position in them.
One must squint very hard and with an open imagination to see any reduction in the Fed’s position. In fact, the Fed has purchased over $135 billion worth of Treasuries in the last twelve months, including $15 billion in long-maturity notes and bonds. So while some of the purchases made during QE have been redeemed, nothing in the numbers suggests a paradigm shift in Fed policy, as one might believe from the prevailing narrative in the financial press.
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