{"id":1425833,"date":"2023-09-02T23:30:00","date_gmt":"2023-09-03T03:30:00","guid":{"rendered":"https:\/\/bugaluu.com\/news\/?p=1425833"},"modified":"2023-09-02T23:30:00","modified_gmt":"2023-09-03T03:30:00","slug":"there-is-no-fed-magic-trick-to-achieve-a-soft-landing","status":"publish","type":"post","link":"https:\/\/bugaluu.com\/news\/there-is-no-fed-magic-trick-to-achieve-a-soft-landing\/1425833\/","title":{"rendered":"There Is No Fed Magic Trick To Achieve A Soft Landing"},"content":{"rendered":"

There Is No Fed Magic Trick To Achieve A Soft Landing<\/span><\/p>\n

\n

Authored by Mihai Macovei via The Mises Institute,<\/em><\/a><\/p>\n

Economic growth in the United States\u00a0accelerated<\/a>\u00a0to a 2.4 percent annualized rate in the second quarter of 2023, picking up from 2.0 percent in the first quarter, and climbing well above the 1.8 percent rate predicted by economists. Many analysts are surprised that the US economy has continued to expand at a robust pace despite the Federal Reserve\u2019s (Fed) aggressive tightening on monetary policy.<\/p>\n

<\/a><\/p>\n

The Fed raised interest rates by more than 500 basis points (bps) since March 2022. And yet, the labor market remains tight with a very low unemployment rate at 3.6 percent while the Standard and Poor 500 stock index is up almost 20.0 percent since the beginning of the year. Economists are optimistic that the Fed could deliver a soft landing by\u00a0reducing<\/a>\u00a0inflation close to the 2.0 percent target while avoiding a recession. But will the Fed\u2019s magic really work?<\/p>\n

Insufficient Monetary Tightening<\/h2>\n

Since the financial crisis of 2008, the Fed had followed an \u201ceasy money\u201d policy, but during the pandemic, the Fed leaned even further into this stance. As Consumer Price Index (CPI) inflation accelerated toward 5.0 percent, Fed Chair Jerome Powell belatedly\u00a0admitted<\/a>\u00a0that inflation wasn\u2019t transitory and shifted course. In March 2022, the Fed started raising interest rates but could not prevent inflation from surging to a peak of 9.1 percent in June 2022.<\/p>\n

In 2022, it became apparent that the Fed\u2019s\u00a0tightening<\/a>\u00a0on monetary policy was not hawkish enough and that it was more concerned with avoiding a recession and instability of the financial sector. The interest rate hikes were piecemeal, and largely insufficient, as the real interest rate (the difference between the federal funds rate and the inflation rate) remained negative until April 2023 (figure 1).<\/p>\n

The current positive real interest rate of about 2.0 percent is still rather low by historical standards and likely continues to artificially stimulate growth. Headline CPI inflation, helped by declining energy prices, may have decelerated to 3.1 percent in June but remains above the Fed\u2019s 2.0 percent target. Moreover, core inflation\u2014which excludes volatile food and energy prices\u2014was at a\u00a0sticky<\/a>\u00a04.8 percent in June as wage increases sustained strong consumer spending and second-round inflationary effects.<\/p>\n

Figure 1: Federal funds rate and CPI<\/em><\/p>\n

<\/a><\/p>\n

Source: Data from the\u00a0Board of Governors of the Federal Reserve System<\/a>\u00a0and the\u00a0Bureau of Labor Statistics<\/a>.<\/em><\/p>\n

Most important, the Fed cannot rely only on interest rate hikes to tighten monetary policy. It needs to also shrink its balance sheet via quantitative tightening (QT) to reverse its previous quantitative easing, a policy of massive purchases of Treasury and mortgage-backed securities to boost commercial banks\u2019 reserves and liquidity while lowering longer-term interest rates. Quantitative easing made the Fed\u2019s balance sheet explode to a whopping $9 trillion, as of May 2022 (figure 2), and analysts\u00a0agree<\/a>\u00a0that by reducing bank reserves, QT should exert upward pressure on interest rates while curtailing lending.<\/p>\n

Figure 2: Total Fed assets (millions)<\/em><\/p>\n

<\/a><\/p>\n

Source: Data from the\u00a0Board of Governors of the Federal Reserve System<\/a>.<\/em><\/p>\n

In June 2022, the Fed started implementing its QT policy by shedding its holdings of US Treasuries and mortgaged-backed securities at a rate of $95 billion per month. But this process was undermined by the need to\u00a0provide<\/a>\u00a0liquidity to the banking sector after banks, such as the Silicon Valley Bank,\u00a0experienced<\/a>\u00a0hefty deposit runs. As a result, the Fed\u2019s balance sheet declined by around $600 billion (or about 8.0 percent) from its peak to about $8.3 trillion by the end of July 2023, although the volume of held securities outright dropped by about $900 billion over the same period.<\/p>\n

Still Abundant Bank Reserves<\/h2>\n

Some analysts\u00a0claim<\/a>\u00a0that the Fed can use QT while also providing additional liquidity to select banks in distress (i.e., have its cake and eat it too). This is obviously not true. The main purpose of QT is to withdraw bank reserves via asset sales to reduce the banks\u2019 lending capacity. But what we see is that bank reserves remained at historically high levels (figure 3) despite the Fed\u2019s attempts at monetary tightening. Since the Fed\u2019s Board of Governors reduced reserve requirement ratios on net transaction accounts to 0.0 percent as of March 2020, these reserves are de facto\u00a0excess reserves<\/em>\u00a0on top of which banks can multiply credit. This means that banks still have ample room to lend even if the Fed has hiked the federal funds rate, which may also explain the uneven rise of loan interest rates and resilience of credit activity.<\/p>\n

Figure 3: Total bank reserves<\/em><\/p>\n

<\/a><\/p>\n

Source:\u00a0Data from the Board of Governors of the Federal Reserve System<\/a>.<\/em><\/p>\n

Impact on Interest Rates and Credit<\/h2>\n

Market interest rates went up since the Fed started its monetary tightening (but not proportionally), reflecting lending maturities and other credit market specificities. The Fed hiked the federal funds rate by 525 bps between March 2022 and July 2023. The bank prime loan rate, which is one of several base rates used by banks to price short-term business loans, mirrored the increase in the Fed\u2019s key rate almost one to one (figure 4).<\/p>\n

On the other hand, although longer-term ten-year US Treasury yields rose above 4.0 percent, they went up by less than 200 bps over the same period. The same goes for other bank loan interest rates such as five-year car loans (which went up on average by 330 bps until May 2023), two-year personal loans (which increased by 210 bps), and fifteen- and thirty-year fixed mortgage rates (which rose by close to 300 bps).<\/p>\n

Figure 4: Market interest rates<\/em><\/p>\n

<\/a><\/p>\n

Source: Data on the\u00a0bank prime loan rate<\/a>, the\u00a0federal funds rate<\/a>, the\u00a0ten-year Treasury yield<\/a>, and the\u00a0finance rate<\/a>\u00a0on new auto loans from the Board of Governors of the Federal Reserve System.<\/em><\/p>\n

This shows that a majority of large and well-capitalized US banks increased loan interest rates much less than the Fed while also\u00a0paying<\/a>\u00a0close to zero interest rates on bank deposits. They can afford it because they have plenty of reserves and liquidity, which the Fed did not mop up, and they continue to lend to the economy. Although the annual growth in total bank credit\u00a0decelerated<\/a>\u00a0from close to 7.0 percent in 2022 to \u22120.9 percent in the second quarter of 2023, it was primarily driven by the decline in credit to the government, or investment in Treasury securities. At the same time, consumer and real estate loans grew annually by more than 6.0 percent and 5.0 percent respectively in the second quarter of 2023, while commercial and industrial loans recorded a small dip and remained flat in the first half of 2023 (figure 5). As lending to the private sector remained positive, it is unsurprising that economic output also continued to expand.<\/p>\n

Figure 5: Private sector credit<\/em><\/p>\n

<\/a><\/p>\n

Source: Data on\u00a0consumer loans<\/a>,\u00a0real estate loans<\/a>, and\u00a0commercial and industrial loans<\/a>\u00a0from the Board of Governors of the Federal Reserve System.<\/em><\/p>\n

Conclusion<\/h2>\n

The Fed\u2019s magic trick to achieve a soft landing while aggressively tackling inflation is only smoke and mirrors. The Fed\u2019s piecemeal interest rate hikes were not only insufficient to slow the economy down, but they also received very little support from quantitative tightening (i.e., the withdrawal of the liquidity that was previously injected into the system). Left with plenty of reserves, banks helped the economy to grow by continuing to lend while also refraining from increasing lending rates as much as the Fed. As a result, taming inflation is not yet a done deal, as core inflation remains sticky and well above the Fed\u2019s target.<\/p>\n

The money supply\u00a0shrinkage<\/a>\u00a0signals economic trouble ahead when the monetary overhang is likely to be worked out in earnest. The Fed\u2019s dovishness has just pushed forward a day of reckoning. Moreover, a steady deterioration of fiscal deficits alongside Gargantuan public projects to boost domestic demand and spur high-tech green infrastructure investment\u00a0magnify<\/a>\u00a0recession risks as the Fed may be forced to further tighten to reduce inflation pressures. Fitch\u2019s recent\u00a0downgrade<\/a>\u00a0of the US\u2019s long-term credit rating over rising public debt and deterioration of governance is just another confirmation that macroeconomic policies have been unsound for too long.<\/p>\n<\/div>\n

Tyler Durden<\/a><\/span>
\nSat, 09\/02\/2023 – 19:30<\/span><\/p>\n

\u200bhttps:\/\/www.zerohedge.com\/economics\/there-no-fed-magic-trick-achieve-soft-landing<\/a>\u00a0<\/p>\n

\u00a0<\/p>\n","protected":false},"excerpt":{"rendered":"

There Is No Fed Magic Trick To Achieve A Soft Landing Authored by Mihai Macovei via The Mises Institute, Economic growth in the United States\u00a0accelerated\u00a0to…<\/p>\n","protected":false},"author":0,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-1425833","post","type-post","status-publish","format-standard","hentry","category-news","wpcat-1-id"],"_links":{"self":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/posts\/1425833","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/types\/post"}],"replies":[{"embeddable":true,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/comments?post=1425833"}],"version-history":[{"count":0,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/posts\/1425833\/revisions"}],"wp:attachment":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/media?parent=1425833"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/categories?post=1425833"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/tags?post=1425833"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}