- The stock and bond markets responded positively to the release of the minutes from the Federal Reserve's March meeting.
- The appears to be very little demand pressure in the money markets these days and with slow economic growth this weakness in demand will continue.
- Focus should be less on what is happening to short-term interest rates than on whether or not the Fed continues to taper its purchases through the rest of the year.
This was the headline of the market report on "Stocks and Bonds" in the New York Times.
The stock market rallied on Wednesday after minutes from the Federal Reserve's latest policy meeting showed that the central bank was more supportive of keeping interest rates very low than many investors had expected.
The article continues, "'People are taking solace in the idea that the Fed may be more accommodative than previously thought, for longer than previously thought,' said Steve Sosnick, equity risk manager at Timber Hill/Interactive Brokers Group. 'That's giving the lift to stocks.'
The Federal Reserve is in a transition to new messaging. This, apparently, is connected to the change of the leadership at the top of the Fed…whether or not it was explicitly intended.
The awareness of this switch and the possible effects of the switch was recognized internally. Discussion took place at the last meeting of the Fed's Open Market Committee meeting concerning the possible impact of this change. Victoria McGrane and Alexandra Scaggs make note of this in the Wall Street Journal.
The minutes (of the Fed's meeting) underscore that Fed officials had not become more impatient to raise rates, a message Ms. Yellen and other members of the Fed's policy committee have reinforced.
But, the initial reaction was that higher rates were in store sooner than had previously been expected. McGrane and Scaggs note that "Investors and analysts initially viewed the Fed's March session as marking a turn toward more 'hawkish' or restrictive policy despite contrary assurances…"
So, "Traders on Wednesday cheered the minutes' positive tone. Stocks extended their gain after the documents were released at midafternoon."
There are two points I would like to make concerning this performance. First, as I reported on Monday in my "Federal Reserve Watch" post, there seems to be very little demand pressure for short-term interest rates to rise.
In the Federal Funds market there is absolutely no pressure at all. The demand for funds is minimal and even the fact that the Federal Reserve is reducing the amount of securities it purchases every month produces no problems concerning the supply of funds to the banking system. The effective Federal Funds rate for January through March was in the 0.07 percent to 0.08 percent range.
This is the thing that we need to look for in the short-term end of the money markets…demand pressure relative to the supply of funds that are available.
The policy of the Federal Reserve is to supply a substantial amount of reserves to the banking system every month until the current policy of tapering is completed…which won't end for quite a few months now.
The Federal Reserve will not be restricting the addition of reserves to the banking system nor will it be decreasing the reserves in the banking system any time soon. That is, we should not expect the Federal Reserve to restrict the supply of funds to the money markets in the near future.
If this is the case, then only a rise in the demand for funds could create a rise in short-term interest rates. As of this moment, there is no indication that the demand for short-term funds is increasing or does it seem likely to increase to any degree in the near future.
And, if demand pressure did start to put pressure on the money markets, it would seem to me to be a good thing. It would be a sign that the economy was picking up speed and the demand for bank loans was increasing. Even this scenario seems to be some ways off in the future because of all the excess reserves that exist within the banking system at the present time.
Furthermore, given the weakness that does seem to exist in the economy and the projections for the future growth of the economy…note that the Federal Reserve just reduced its forecast for the growth of the economy (see my post)…it does not seem likely that, anytime in the near future, the Fed will actually want to remove reserves from the banking system to cause short-term interest rates to rise.
My picture of monetary policy for the rest of the year is this…the Federal Reserve will continue to taper its purchases of securities in the open market. This will be the dominant thing the Fed does and it is the thing that investors and analysts should keep their eyes on.
This policy stance will still mean that the banking system is still going to get an additional $180 billion of new bank reserves during the remainder of this year, if the Fed continues to reduce the amount of securities its purchases every month by $10 billion until it gets to zero purchases.
I don't see sufficient loan demand building up during this time to put much pressure…if any…on the money markets. Hence, I don't see market conditions that would contribute to any significant rise in short-term money market interest rates.
My second point is this…all this "information" being provided by the Federal Reserve about its targets and about its projections just causes more market volatility than would otherwise be the case. This is a takeaway from the earlier times. In more "normal" times, the Federal Reserve did not want to supply too much information on its goals and objectives because this impacted market expectations and when things did not work out exactly as planned the market jumped around much more than was necessary. Some degree of uncertainty was beneficial because it meant that market participants had to search a little for understanding what was going on.
In one sense, I can understand why Mr. Bernanke wanted to provide more information to the financial markets during the crisis. It was very important for the Fed to signal that it would be around and it would continue to supply substantial funds to the market and it would continue to support extraordinarily low short-term interest rates for a long time.
That was during the crisis, however. Now, it seems to me that we are getting back to a situation in which too much information is not necessarily good for the conduct of monetary policy. Investors and markets will produce their expectations any way. But, if the Fed just tries to add certainty to what it is doing it will just create situations in which expectations will be disappointed and more volatility will be produced.
The Federal Reserve is continuing to taper its purchases of securities. The big uncertainty for the future, I believe, is how the Fed will continue to do this and then, once tapering is over, what will the Fed do with all the excess reserves that are in the banking system?