The Fed Stops Pretending

Well, it didn't take much and it didn't take long. After years of delays, a tentative start, many cautious pauses along the way, and a top speed that never really hit cruising velocity, the Fed has taken the first available off-ramp on the road towards policy "normalization." In a speech on Tuesday this week in Chicago, Fed Chairman Jerome Powell delighted Wall Street by signaling that the Fed may soon deliver the gift that investors had been hoping for...the first interest rate cut in almost a decade.

While many savvy economists should have seen this coming, as late as October of last year, almost no one in the financial world thought that the Fed would so easily abandon its long-held bias without a gale force recession blowing them off course. But, in reality, all it took was a light breeze to force a 180-degree turnaround.

Throughout much of 2017 and 2018, the Fed had presented a tough posture. They argued that the economy had finally improved enough to remove the "unconventional" policies that it had implemented following the Great Recession of 2008. These moves, which included zero percent interest rates and the direct purchases of trillions of dollars of mortgage and Treasury bonds, had never been tried before 2008. But since the financial crisis was unprecedented, and the ensuing recession so severe, the Fed was prepared to do anything to prevent a replay of the Great Depression. And while the Fed started tightening policy as far back as 2014 (when it began slowing its bond purchases), by just about anybody's measure, policy remained stimulative. The Fed admitted throughout its tightening cycle that it still had a long way to go to get to "neutral," but it was apparently determined to get there.

By early 2018, with GDP growth approaching 3%, the stock market rocketing to all-time highs, and the unemployment rate dipping to the lowest in generations, it appeared as if the Fed's plan was on track. The Fed cited these benign conditions as reasons to continue down the road towards neutral and to throw away the monetary crutches that had supported the economy since 2008. To that end, the Fed clearly indicated that it planned to raise interest rates continuously throughout 2018 and 2019 (bringing rates to approximately 3.5% by 2020) and to chip away at the Fed's $4.5 trillion balance sheet through "automatic" $50 billion per month bond sales. It indicated that this "quantitative tightening" would last for years.