All Eyes on the Fed

For nine of the last fifteen years, few people thought about the Fed. Sure, we discussed QT and QE, but the Federal Reserve held interest rates at zero year after year. In 2017 and 2018, they lifted rates and it was all anyone talked about. Then they cut them to zero and the noise went away. Now, with rates headed up, all eyes are again on the Fed, and investors are parsing every word of its statements and the Powell press conferences.

As of Friday, the futures market expects a quarter-point rate hike on Wednesday, but then a series of rate cuts that start in the third quarter.

Why the market expects rate cuts is unclear. The next key inflation print – the consumer price index for April, which arrives, May 10 – is coming in hot. At the same time, longer-term bond yields are drifting down, and stock prices have been rising. That’s not a tightening of “financial conditions” that some models of monetary policy watch. And we have yet to see the kind of weakness in the labor market that would get the Fed to stop hiking rates.

At the same time…yes, banks are in some trouble because of mismatched liabilities and assets…but the Fed has used the FDIC and a bond buyback program to wall off these problems.

Meanwhile, too few policymakers or investors are following what’s happened to the M2 measure of the money supply. After surging about 40% in the first two years of COVID, M2 hit a plateau in early 2022 and then started dropping last summer. M2 is down 4.1% in the past eight months, the steepest decline since the early 1930s.