The crystal ball worked this month. On September 4th I wrote that “the Fed may send a message with one 0.50% cut,” which is exactly what they did this week. The largest rate reduction in 16 years is Fed chairman Jerome Powell’s attempt to get in front of a softening job market. In plain English, our central bankers have just shouted “we mean business.”
I get it, but the breathless media buildup to this latest meeting reminded me of the selection of a new pope. I expected The Wall Street Journal to explain the significance of white or black smoke. Yes, the Fed funds rate is very important, but it is not the only means by which our central bank influences economic activity. The Fed increases and decreases the money supply by buying and selling commercial paper, bills, notes, bonds, mortgages, and other fixed-income securities. When the Fed buys bonds, the cash that it pays increases the money in circulation. When it sells bonds, or lets them mature, it reduces the supply of money, thus slowing economic activity. You do the same thing when you go to the grocery store and buy something. The store receives money, and you receive goods. You have increased the store’s supply of cash while reducing your own. If you return your goods, the store’s cash goes down and your funds increase.
With small pauses, the Fed had been buying bonds and increasing the cash in circulation since 2008. For a little over two years, the central bank has been reducing the assets on its balance sheet, thus pulling cash out of the economy. Recently, they have indicated their intention to slow down that process, which means more money in circulation. The chart below is explanatory.*
We still do not know how much the Fed funds rate will ultimately be reduced. Whatever the number, there are oceans of cash in the economy, as the chart illustrates. Unlike the rest of the developed world, our central bank has the dual mandates of controlling inflation and preventing unemployment. For now, Fed policy is supportive of jobs and therefore of stocks. In the October newsletter, I shall discuss in detail several factors that could derail today’s aggressive rate-cut predictions.
Source:
* Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets (Less Eliminations from Consolidation): Wednesday Level [WALCL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WALCL, September 18, 2024. https://fred.stlouisfed.org/series/WALCL#. Accessed on 09.19.2024.