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The Fed Hints at Pausing Interest Rate Hikes, and That's a Good Thing: Market Recon

On this date in 1694, a Royal Charter was granted to the Bank of England. The bank was given exclusive possession of the government's balances, and was the only limited liability corporation permitted to issue bank notes. The BoE is now the second oldest (second to Sweden's Sveriges Riksbank) central bank still in operation, and is the model that most modern central banking is based on.

Understanding Monetary Policy It is right there in black and white. As plain as the nose on your face, the July FOMC policy statement reads: "For the time being, the committee is maintaining its existing policy of reinvesting principal payments". The statement adds "The Committee expects to begin implementing its balance sheet normalization program relatively soon." Clearly, the intent is to start whittling down the balance sheet as soon as possible. There are only three FOMC policy meetings left on this year's calendar. That means that we see this shift in policy either on Sept. 20, Nov. 1, or Dec. 13. There is no press conference currently scheduled for Nov. 1, and I don't know if I would consider five months to be relatively soon. Therefore, should the economy at a minimum, maintain its shallow rate of growth over the balance of the summer, I believe a tapering of the reinvestment of maturing securities at auction will commence in September.

The FOMC statement also made clear their collective disappointment in consumer level inflation. The statement reads "Overall inflation and the measure excluding food and energy prices have declined and are running below 2%." Prior to this statement, the word "somewhat" had been inserted between the words running and below. What this does is strengthen the Fed's acknowledgement of an ongoing lack of inflation, and allows them to halt the trajectory of raising the fed funds rate for the rest of the year while implementing the management of the already mentioned balance sheet. This is precisely why the U.S. dollar reversed course yesterday afternoon. This is why gold took off, and is still trading higher this morning. This, along with some nice earnings, is why the major equity indices closed records yesterday.

I often bash Fed policy. It's one of my favorite sports. The truth is that this statement reads precisely as I would have liked it to, had they asked me to write it. If the central bank follows through the way they have signaled, I must tip my cap, and we cannot complain (not yet, anyway). The balance sheet blew up to a size that I could never be OK with. September is still two years too late, and yes, this management should have begun prior to the start of raising interest rates at all in December of 2015. The work must still be done. As for pausing the schedule for raising the fed funds rate while cranking this program up, I think that necessity is obvious, unless the mission is to force recession upon the economy.

What will the market impact of this balance sheet management be? That's purely unknown...


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