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Jerome Powell sets the record straight

This week Jerome Powell explained the viewpoint and priorities of the Federal Reserve going forward. Let’s break them down:

The Fed is committed to the 2% inflation target

Powell started off the speech immediately reinforcing that the Fed is committed to a 2% inflation target and will continue to enact policy intended to reach this goal. The real kerfuffle around Fed policy going forward was ignited by increasing CPI inflation in March, rising 0.4% compared to February and bringing the annualized number to 3.5%. Though the Federal Funds Rate increases over the past year have led to disinflation—which describes the reduction in the rate of inflation—we are yet to see the Fed near their 2% goal.

Rates will remain unchanged for now

There will be no cuts at this time. With inflation running hot and the labor market still performing well, there was no real need to cut rates at this meeting. Wall Street is expected to see multiple cuts this year, predicting that reduced inflation and slower economic growth would steer the Fed toward rate cuts. Neither of those scenarios have played out to the point where the Fed feels comfortable cutting rates. Now Wall Street firms are reformulating their predictions, with many predicting two rate cuts but also preparing for a scenario where the Fed does not cut at all this year.

Wall Street sees rate cuts as a positive because it makes it easier for businesses and consumers to borrow money. When it is easier to borrow money, businesses and consumers spend more which should boost the economy. Higher interest rates means less borrowing and likely less spending which will lead to less economic growth.

Slowing the reduction of treasury securities

The Fed will slow the pace of treasury securities rolling off its balance sheet. Treasury roll offs will decrease to $25 billion per month, down from $60 billion per month perviously. The rolloff of Treasury securities allows treasury rates to increase. Why does this all matter? Think of it this way, Treasury yield and price move inverse to each other. So when the price of the Treasury goes up, the yield goes down. As the Fed allows more of these Treasuries to roll off without buying more, the yield of Treasury’s in general should increase. Higher yields and lower prices makes Treasuries more attractive for investors, who put more money into Treasuries instead of the stocks and bonds issued by companies—pushing up the cost of borrowing for these companies. The increased costs of borrowing makes these companies less likely to borrow money, which means less spending by these companies to so they can conserve cash. All this reduced spending leads to—you guessed it—lower rates of economic growth. With the Fed slowing their reduction of Treasury securities from their balance sheet, they are effectively hoping to reduce the rate at which Treasuries become more attractive. The detailed explanation to why these Treasuries are rolling off could cover a whole newsletter, if not an entire book since the beginning of this story is so crucial to where circumstances are now.

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