The Fed Awakens

I got the following from a friend at J.P. Morgan just a few minutes ago. You might have had something like it hit your inbox as well.

WASHINGTON – Federal Reserve officials said Wednesday they expect a more gradual pace of short-term interest rate increases in coming years than they did three months ago.

They also tweaked very modestly their views on the outlook for the economy, according to forecasts released after the conclusion of the Fed’s two-day policy meeting. Officials made small changes in their views of future economic activity, and they still don’t expect to achieve their 2% inflation rise target until 2018.

Clearly not a surprise and in line with what I’ve recently been saying. I think the Fed is going to be raising rates a lot more slowly than even they project. When you look at the “dots,” the median projection for the Fed funds rate is 3.75% in the much longer run.

Side bet? I think we see 0% again before we see 2%. I’ll take the overs on that bet, thank you very much. If you make the number 3%, I’ll even give you odds.

Today’s Outside the Box is from my friend Danielle DiMartino Booth, who used to work at the Dallas Fed for Richard Fisher. She has gone out on her own and has begun to write occasional pieces that seem hit my inbox at least weekly. The cover a wide range of topics, but many of them deal with the Fed.

This morning she wrote:

What if it really is all about reinvestment and not one teensy quarter-point rate hike? Over the next three years, some $1.1 trillion in Treasurys could roll off the Fed’s balance sheet if reinvestments were to cease. Tack on the potential for mortgage backed securities (MBS) to prepay and/or mature and you’re contemplating a figure that approaches $2 trillion.

Make no mistake, shrinkage of the Fed’s balance sheet to half its current size is much more feared by market participants than a slight tick-up in interest rates. Taking the step to not reinvest would increase the supply of Treasurys and MBS available to investors and reduce the Fed’s support of the economy. The higher the supply on the market, the lower the price and hence, higher the yield, which moves opposite price.

I should note that she predicted the Fed would expand its overnight reverse repo program to the tune of $2 trillion, and the Fed has done just that. That should be enough to cover most contingencies for the next few weeks; and, as Danielle explains, that move has a great deal more impact on the markets and your returns than an itsy-bitsy 25-basis-point increase in short-term rates.

Danielle weaves a story about what will really happen over the coming year, based on her knowledge of what Fed members are likely to do and what the markets may force them to do. If you are not much interested in Federal Reserve policy and how it is created, her writings might seem to take you deep into the weeds; but given the importance of Fed policy to the markets, maybe this one time you should pay attention to what goes on behind the curtain. I think this makes a great and timely Outside the Box.

My schedule is usually busy, but it has become hectic. I have over 120 people helping me as research associates for the book I’m writing, Investing in an Age of Transformation.I’ve outlined some 27 chapters, 24 of which have teams working on the research and writing. Each team needs its own regular 30- to 45-minute conference call. Plus, there are calls with individual researchers on some of the minutiae.

I am really impressed with the knowledge level and skill and enthusiasm this intrepid group of volunteers brings to the table. This is going to be so much more than the book I would have written all by my lonesome.

Have a great week. It seems that most of us in America (from the calls I’ve been making) have seen unseasonably warm weather so far this winter. I can’t remember a December this nice in Texas. The long-range forecast says Christmas Day is going to be 72° and sunny. I was talking to friends in Detroit yesterday and they were marveling that there would be no snow for Christmas. Not that they were complaining. It’s fabulous to be able to walk to local restaurants and entertainment venues in a light jacket in the middle of December. However, this being Texas, I know the weather can change on a dime, so we just enjoy the good times as they come along. Kind of like oil booms.

Your enjoying his month of global warming analyst,

John Mauldin, Editor
Outside the Box