The Fed lowers the Fed funds rate – big whoop.

The Fed lowers the Fed funds rate – big whoop.

The Fed just lowered its Fed funds target rate by another 25 basis points. I was actually surprised. Although the market had anticipated the fall – and two more before year’s end – I thought the Fed would hold the rate steady. First, the inflation numbers are not looking good and keep edging up. Second, several members of the Open Market Committee had indicated that they favored a hold. It was no surprise that Stephen Miran, the president’s lackey on the Board voted for a 50 basis point drop. But none one pays any attention to him. Only one other member voted to hold. The rest voted for the 25 basis point drop. Actually, I don’t think that the move will have any measurable impact on the economy. In fact the markets actually fell after the announcements. I guess the drop in the rate shows Trump’s influence. After all the threats and bellicose tweets, Powell voted to lower. I was surprised that Lisa Cook did as well. Had I been Cook I would have voted for a 50 basis point rise. Of course the two other Trump appointees, Waller and Bowman, who have been listed as among the finalists for Fed chairman voted for a decrease. Actually I am somewhat surprised that they did not vote along with Miran for a 50 basis point fall. Now there is considerable doubt if the Fed will continue to lower the rate even in the face of rising layoffs and increases in unemployment. No matter Stephen Miran will still vote for a 50 basis point fall– else he might not get his job back at the Council of Economic Advisors.

Another thing to watch is that the Fed has stopped running off its gigantic portfolio of securities. Currently the portfolio sits at $6.6 trillion down from a high of $9 trillion. Recall during the 2007 recession the bolstering of the market by purchasing commercial paper and mortgage backed securities was to keep the market from collapsing. The Fed did the same during Covid. Then the Fed began a gradual runoff of its portfolio – and I do mean gradual. When the Fed purchased the securities it did so by supplying the banking system with reserves and when those reserves are excess reserves they influence the Fed funds rate. Indeed, prior to the fed lowering the rate, the fed funds rate had actually been moving up within the Fed’s target range. 

The Fed shrinks the portfolio by letting the maturing securities run off which in essence decreases bank reserves which raises the Fed funds rate. Oops. So it is of little surprise that the Fed is pausing the runoff of the securities portfolio. Also consider that the Trump administration is working at cross purposes by continuing to increase the deficit. When the Treasury issues new debt it drains bank reserves which once again raises the Fed funds rate. Thus, the Fed had little choice but to stop the run off of its portfolio.

The Fed had been allowing up to $35 billion in mortgage securities and $5 billion in Treasurys to roll off the portfolio every month. Now that has slowed to only $20 billion a month. In the end the Fed would like to get back to only holding Treasurys. I gave my students last semester a basic problem. If the Fed had a portfolio of $8 trillion and reduced it by $20 billion a month, how long would it take for the portfolio to reach zero – assuming no interest accumulation of the remaining bonds? Only one person could do the math. What is interesting is that Trump appointees Waller and Bowman are in opposite camps. Bowman wants the runoff to continue but to lengthen the period while Waller voted against the decision to slow the runoff.

I wonder how much of this Miran understands. When one looks at the finalists for the Fed chair, if it is not Waller or Bowman, the person appointed to fill the vacancy coming in January will also be nominated to be chairman once Powell’s term expires. In addition to Waller and Bowman, those are Kevin Hassett of the president’s National Economic Council, Kevin Warsh former Fed governor and Rick Rieder, chief investment officer of Black Rock. I know absolutely nothing of Rieder but I think Black Rock’s CEO may well be the most dangerous person on the planet. I believe that Warsh is too independent to be appointed by Trump and Waller and Bowman are there as mere courtesies. I think Hassett would be the most pliable to Trump and would toe the line at least for a while. Then if Powell decides to resign from the board when he leaves as chairman, that will give Trump another opportunity to appoint another lackey. He would then have four of the seven governors. They, in turn can determine the composition of the reserve bank presidents. Times could get even more interesting with the question being how long does a lackey stay a lackey?