The U.S. Federal Reserve Bank’s (Fed) policy mistakes (tightening too far and/or too fast) have had a hand in every recession since WWII. The last time the Fed raised rates in 2004-2006, they increased the short-term interest rates by 25 bps 17 times in a row, or a total of 4.25%.
Today, the chances of a policy mistake are exacerbated by both the prospects of interest rate increases and the reduction of the trillions of dollars of Quantitative Easing (QE) the Fed injected into the system from 2008-2014. Quantitative Easing is when a central bank purchases government securities from the market in order to lower interest rates and increase the money supply. To simplify, QE in the U.S. involved the Fed buying trillions of U.S. Treasuries and Mortgage Backed Securities. This means the Fed has been a buyer of massive proportions, thus driving bond prices up and interest rates down. Since 2014, the proceeds of any of these bonds that matured or were "called" have been used to buy new bonds in the open market and thus the simulative effect has been ongoing since 2008. Now the Fed has proposed to reduce their balance sheet as outlined in the chart below. You can see the beginning balances with U.S treasuries and Mortgage Backed Securities and the reduction of purchases from 2014 through today. Instead of being a buyer in the bond market, they will become a seller. However, too much selling will drive bond prices lower and interest rates higher across the yield curve.
The Fed is walking a tightrope. If they reduce the QE too fast and/or increase the Federal Funds Rate too far too fast like last time, then interest rates across the curve could rise too far, too fast and cause the next recession. While we cannot predict the outcome, we can urge caution and hope the new Fed Chairperson, Jerome Powell, follows the “slow and steady wins the race” philosophy.
Disclosure: The views and opinions expressed in the referenced articles are those of the writer and may not be the opinion of Beaumont Capital Management. The information above, and the referenced data, is provided for informational purposes only.