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The Fed Chair Takes the Middle Road

Stock MarketsAug 29, 2021 09:00AM ET
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© Reuters. The Fed Chair Takes the Middle Road

In a much-anticipated speech at the Jackson Hole meeting, Federal Reserve chairman Jerome H. Powell took the middle road in setting the nation's monetary policy from now on: tapering the bond-buying program but not hiking interest rates.

Here's the key quote from the chair's speech:

"At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks."

"Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test."

"We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time (our bolding). We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis."

"Middle Road" Defined

To understand how this "middle road" approach will work, we must recall two kinds of monetary policies functioning these days: conventional monetary policy and nonconventional monetary policy.

Conventional monetary policy works through the money market. The Federal Reserve buys and sells short-term government securities, such as T-Bills, to set a desired level of the Federal Funds Rate. That's the rate at which banks borrow funds from each other to meet overnight reserve requirements. It's a benchmark rate for setting the Prime Rate that banks use to assess their short-term lending rates.

The nonconventional monetary policy of Quantitative Easing (QE) works through the capital markets. The Fed buys and sells long-term government and government-back securities, like Treasury Bonds and Mortgage banks, to set the pace for long-term rates.

Modern monetary policy supplements and augments traditional monetary policy, especially when short-term interest rates have hit the "zero-bound," as has been the case in many economies, including the U.S., in recent years.

Now, it becomes clear what a "middle road policy" means: the Fed will roll back its intervention in the capital market, but it will continue its intervention in the money market.

Bottom Line

While both policies are intended to help the Fed achieve its dual mandate of stable prices and maximum employment, they have a big impact on financial markets, for obvious reasons. Short-term and long-term interest rates are key variables in almost every asset valuation model.

That's why Wall Street pays such close attention to everything the Fed does with these two policy instruments. And judging from the performance of major equity indexes on Friday, Wall Street likes the Fed's middle road, at least for now.

Disclaimer: The information contained in this article represents the views and opinion of the writer only, and not the views or opinion of Tipranks or its affiliates, and should be considered for informational purposes only. Tipranks makes no warranties about the completeness, accuracy or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. Tipranks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by Tipranks or its affiliates. Past performance is not indicative of future results, prices or performance.

The Fed Chair Takes the Middle Road
 

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Shiv yadav
Shiv yadav Aug 29, 2021 3:17PM ET
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