One of the most important days on the calendar is little more than a week away: May 4. Next Wednesday, Federal Reserve Chair Jerome Powell may very well deliver a Keynesianesque double-feature, announcing various asset bubbles will be popped and a nail in the coffin is to be delivered into the economy, courtesy the Fed.
This economic one-two punch would come in the form of another rate hike followed by reducing the $9 trillion balance sheet by up to $95 billion a month.
From Powell’s mouth to our own ears, last week he said:
Fifty basis points will be on the table for the May meeting.
Until it’s officially announced, don’t assume anything from the Fed; but a Fed’s Fund Rate approaching 1% is noteworthy. With US Debt over $30.4 trillion, raising rates increase interest costs of the nation’s debt obligation as well as rate sensitive products like mortgage, auto, business and margin loans. Share buybacks may also start looking less attractive.
Raising rates is one thing; draining money out of the market is another. Still, the Fed has made it abundantly clear, according to the latest meeting minutes that:
Officials “generally agreed” that a maximum of $60 billion in Treasurys and $35 billion in mortgage-backed securities would be allowed to roll off, phased in over three months and likely starting in May.
Should all go according to plan, the Fed will remove $95 billion a month from the system. To make matters more interesting, CNBC tells us:
Markets expect the Fed to increase rates a total of 250 basis points this year.
Should the Fed combine a 50-bps hike along with a $95 billion reduction of the balance sheet, then (after successive rate hikes and asset reductions) this time next year, interest rates will be close to 3% and over $1 trillion will be removed from the system.
A quick napkin calculation shows interest payment on the US debt would approach $1 trillion annually. Yet, the Fed only holds $5.8 trillion of the outstanding $30.4 trillion debt. Contrary to popular platitudes, we don’t owe the debt to ourselves. As for shrinking the balance sheet by over $1 trillion in one year, this carries a heavy consequence. Since Fed asset purchases suppress rates, what will this mean for the bond market and interest rates? Consider the stock and housing markets which benefit from the Fed’s Miraculous Monetary Tampering that made credit both abundant and cheap.
What planners call “Quantitative Tightening” (QT) is nothing new. The Austrian Business Cycle explains how credit expansion eventually leads to the boom-and-bust cycle. Even if the data shows the economy is strong and unemployment low, the mere cessation of the Fed’s easy money policies are enough to cause a bust. Without support from the central bank, all the supposed strength in the economy will whittle away. When the Fed engages in credit contraction, it only exacerbates the inevitable crash.
As of today, this is conjecture. Next week it may be fact. Fortunately the entrepreneur thrives in a world of uncertainty, placing calculated bets where possible, being rewarded when successful. It’s difficult to imagine a painless finale to all of this. Prepare accordingly. And if possible, capitalize on any opportunities.
