Market Brief — Wednesday 9/26/18

The Federal Reserve raised the Federal Funds rate by 0.25%, as expected, and the stock market had the proper reaction. When the Fed tightens the money supply by raising interest rates, stocks should fall, and Treasury bonds should rise. All major stocks indices were down slightly, and Treasury bonds rallied off their recent bottom.

The Fed expects GDP growth to be 3.1% this year, 2.5% next year and slightly over 2% through 2021, even though their projections contradict the growth rate of the money supply. Every 0.25% increase in the Federal Funds rate decreases the money supply by approximately $60 billion. With the growth rate of the money supply 0.2% above the level where the economy experiences recessions and depressions, today’s rate hike is putting our economy one step closer to its next recession.

The Fed took the word, “accommodative” out of its press release, but when a reporter challenged the removal of this, Chairman Powell admitted policy was still accommodative.

The Fed remains perplexed about why wage gains aren’t filtering down to the rank and file employees but they remain optimistic it will.

The Fed believes the economy has been performing well primarily due to the gradual increase in the Federal Funds rate and their regular communications about monetary policy. In reality, ten years after the Great Financial Crisis, our economy is still on emergency monetary life support.

When asked about inflation, the Fed doesn’t believe we will experience a jump in inflation, even though Powell said the Fed wasn’t sure why inflation remains low. Even though the Fed doesn’t know why inflation remains low, they still expect inflation to increase. Perhaps Chairman Powell should study the effects of a zero-interest rate policy on long-term inflation expectations.

Chairman Powell did indicate the Fed was seeking the right balance of interest rates to keep the economy growing. The Fed continues to practice financial alchemy with the same adverse results in the end.

Federal Funds rate projections indicate another increase in December and three increases next year, with the expectation the Federal Funds rate will be normalized around 3.5%. When asked why 3.5% was the neutral rate, Chairman Powell said the Fed felt 3.5% was the appropriate long-term rate for the economy. In truth, it is Wall Street who has said 3.5% is the appropriate rate. Remember, the Fed never does anything Wall Street hasn’t already previously blessed.

What nobody seems to factor is the Fed’s balance sheet unwind. While the Federal Funds rate is now between 2.00-2.25%, when factoring the total balance sheet unwind, the Federal Funds rate at the end of September will be 3.38%. At the end of October, the implied Federal Funds rate will be 3.58%. With 10-year Treasury yields at a touch over 3%, the yield curve is inverted, meaning short-term yields are effectively higher than long-term yields. When the yield curve inverts, it is a sign there is something wrong with the financial system.