Doubting the Fed’s decisions

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It’s HOST NICK EICHER. It is now time for our weekly discussion and analysis of business, markets, and the economy. Bahnsen, an experienced financial analyst and advisor, is here now to answer your questions. Good morning, David.

SPECIAL GUEST, David BAHNSEN: Hello, everyone! It’s nice to see you again, Nick.

In other words, the Federal Reserve’s announcement last week that it plans to raise interest rates by a quarter-point each year for the foreseeable future came as no surprise. Looking ahead to 2023, the Fed appears to be indicating six of these, which translates to an additional half-percent. Then there is the possibility of a 3% increase. which, after years of artificially low rates or zero rates, appears to be a significant sum of money.

When COVID began two years ago, the Fed Funds rate was already one percent lower than it is today. If COVID continues for another two years, the Fed Funds rate will still be one percent lower than it was when COVID began. In addition, the Fed’s funds rate of 1.5 percent represents a negative real rate. Even so, the Federal Reserve isn’t about to implement some heavy-handed, Volcker-like policy to reverse interest rates. In fact, we’re talking about the complete opposite. What’s more, the Fed futures market doesn’t believe any of the Fed’s projections for the next two years.

Fed officials claim they will return the Fed Funds rate to its previous level of two, two and a half, or three percent, but futures markets are pricing in a stay at one and a half percentage points. And the Fed has been wrong for the past 13 years, according to the futures market. To be clear, I’m saying that the Fed has been incorrect in its predictions of Fed policy. Okay, If you think about it, that’s a pretty incredible statement.

To put it another way, they’re saying what they think will be the economic truth by using real prices, real money, and real skin in the game. Furthermore, I don’t believe that Fed officials who forecast an unrealistically low-interest rate in the future are telling the truth. I believe they are sincere, and I believe they intend to carry out their plans. It is true, however, that the Fed sees itself as an enabler of the government’s spending, the economy, and risk assets. And I don’t believe they have the courage to go through with the necessary steps to bring monetary policy back to normal.

EICHER: So, David, what else can you tell us about the Fed’s decision? We’ve heard about ending quantitative easing, reducing bond purchases, and “tapering” bond purchases, but I’d like to hear more about getting rid of the bonds the central bank has accumulated over time, not just stopping new purchases.

BAHNSEN: When we talk about the Fed’s tapering announcement, we’re referring to their policy instrument of adding liquidity to the financial system, which is the winding down of their bond purchases. And so, about six months ago, they basically told us that they were done with that. Some other analysts and I have concluded that the Fed’s balance sheet should return to $6 trillion over the next few years, and we believe that this is something it must do. Currently, it stands at $9 trillion, which means that a reduction of $3 trillion must be made to the balance sheet in order to reach the goal of six. Bonds purchased with money that does not exist must be sold to the market for $3 billion dollars. Tightening monetary policy in this manner. It is my firm belief that the Fed will not raise rates at the same time it does this. As a result, I believe that the Fed funds rate will rise to 1.5% in the next two years, which is what I expect to happen. with a total of six 25-basis-point increases. It’s only when they leave it there that they get off the zero-bound interest rate. In that case, they won’t go for a second round, as they did in 2018. That’s too much for the credit markets to handle. And they discovered this in 2018. At this point in time, I believe they will be trying to reduce their balance sheet in order to raise the interest rate. When it comes to two years from now, what could possibly happen? What’s the worst that can happen? Although geopolitics, business cycles, and credit markets all have the potential to derail this plan, I believe this is what the Fed intends to do right now. Moreover, I believe they’re on a tightrope.

EICHER: There you go! David Bahnsen is a chartered financial analyst and advisor. Subscribe to his daily email newsletter at dividendcafe.com. In another year of excellent service, David. That’s a good thing. And we won’t speak again until the year 2022 has passed on the calendar. So, thank you and a joyous holiday season to you and yours!

BAHNSEN: Thank you for your kind wishes, Nick, and of course to all of our listeners.

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