Fed Raises Policy Rate Of Interest, Stock Prices Rise

The Federal Reserve raised its policy rate of interest for the first time in several years and indicated that at a future meeting it would discuss reducing the size of the Fed’s securities portfolio.

The Fed said it was tightening up its monetary policy.

And the stock market rose three days in a row.

The S&P 500 Stock Index closed at 4,262 on Tuesday.

On Friday, the S&P 500 closed at 4,463.

The S&P 500 rose by about 6.1 percent during the week.

Wow!

This doesn’t seem like what should happen in the stock market after the Federal Reserve indicated that it was tightening up the monetary screws.

Investors seem to take the Fed’s actions in a positive vein and translated these actions into higher stock prices.

What’s going on here?

The Federal Reserve should tighten up on monetary policy more often!

Analysis

Since the start of January this year, investors have been expecting the Federal Reserve to “taper” its monthly purchases from $120.0 per month.

The Federal Reserve also signaled investors that it was going to start raising interest in order to fight off inflation.

This was about all the guidance that Federal Reserve officials gave the public.

But the stock market peaked in early January and has been trending downwards ever since. For example, the S&P 500 index hit a new historical high on January 3, 2022. The S&P 500 has been falling since.

So, what did this mean to the investment community?

Apparently, it meant something different early in January than what that investment community believes now.

Let me just give you three cases.

First, the Federal Reserve did begin to taper its purchase of securities around the start of the year.

Since December 29, 2021, the end of the last banking week in December, the Fed, in the eleven weeks since that date, has only purchased, outright, $220.0 billion in securities.

On the old schedule, the purchases would have been around $300.0 billion.

So, the Fed has reduced the amount of purchases it would have made under the old plan, but the Fed has still purchased around $220.0 billion in securities. This total, $220.0 billion, was, around the time of the Great Recession, a little less than one-fourth of the total assets of the Fed.

That is a hell of a lot of money to be pumping into the economy.

So, for the first three months of 2022, the Fed was still inserting a lot of liquidity into the commercial banking system and the stock markets.

Second, the total securities on the Fed’s balance sheet at the end of the last banking week, March 16, 2022, were about $8.5 trillion.

When the Fed started buying $120.0 billion in securities every month, the total amount of securities on the Fed’s balance sheet was around $4.8 trillion.

So, in a little less than two years, the Fed increased the size of its securities portfolio by almost $4.0 trillion.

Four trillion dollars is a lot of excess money floating around the banking system looking for a home. How much must the Fed reduce the portfolio to achieve some control over the “excess reserves” in the banking system?

Investors now see that to return to a more restrictive monetary position, the Fed may have to reduce the size of its portfolio by quite an amount.

The largess of the past year has been enormous. To control the “excess” may take quite a bit of work.

Third, even if the Federal Reserve raises the policy range for the Federal Funds rate six times in the next year, as has been suggested by some Fed officials, the effective Federal Funds rate will still be substantially below the actual rate of inflation.

In other words, the real rate of interest…reducing the nominal rate of interest by the actual rate of inflation…will be in negative territory.

As is well known, negative real rates of inflation are not restrictive. Borrowing money is still excessively cheap.

Looking at the above situations one can argue that the monetary stance that the Fed is moving into is not very restrictive at all.

I believe that investors did their homework on this and decided that the stock market remained a very good place to invest their monies.

And so, the stock market took off.

Bitcoin

Some additional support for this conclusion is that as the price of stocks went up this week, the price of Bitcoin also rose as well.

One of the things we have been tracing over this past year or so is the fact that the correlation coefficient between the Standard & Poor’s 500 stock index and the price of Bitcoin has risen to about 0.56.

When stock prices rise, the price of Bitcoin also rises. When stock prices fall, the price of Bitcoin falls.

Ever since the Federal Reserve made its policy announcement on Wednesday, the price of Bitcoin has risen right along with stock prices.

Other Things

There are, of course, other things that have been happening during this time period, but none of them are as conclusive to me as the movement in the stock market following the Federal Reserve statement following the meeting of the FOMC.

Some analysts pick on the words of Jerome Powell, Chair of the Board of Governors of the Fed. Mr. Powell’s public statement on Wednesday stressed how strong he believed the economy was and how strong U.S. labor markets were.

Yet, what Mr. Powell cited was known before Wednesday and was available during the falling stock prices previous to the Fed’s actions.

This argument just doesn’t work with me.

The stock market has been declining. Investors were focused upon what the Fed was going to do and when it was going to do it.

Now that the Fed has given some indication to the investment community of how it is looking at what its role over the next several months might be, the investment community has responded: the Fed is not really tightening up at all.

Yes, it is raising its policy rate of interest. Yes, it is talking about reducing the size of its securities portfolio. And yes it seems to be talking tough.

But in my mind, and, seemingly, in the minds of investors, the numbers just don’t support the talk.

During his tenure at the Federal Reserve, Mr. Powell has attempted to act in a way that will help him…and the Fed…to avoid downside mistakes.

This is how we got where we are now.

Investors seem to be saying that what Mr. Powell is doing right now is not going to make the situation any better.