The Fed may create policy, but it is ultimately dictated by the markets. Powell came out and reaffirmed the central bank’s fears of a hiring slowdown. Soon, the bank will no longer shrink its $6.6 trillion balance sheet, previously allowing $40 billion of mortgage-backed securities and Treasuries to mature each month without replenishment. Powell insists that the Fed needed to buy into these vehicles during the post-pandemic recovery to lower rates in a failed attempt to manipulate the business cycle.
“With the clarity of hindsight, we could have—and perhaps should have—stopped asset purchases sooner,” Powell said. “Our real-time decisions were intended to serve as insurance against downside risk.”
The Treasury is issuing record debt, and the private sector is no longer interested in purchasing. Capital is moving out of public debt, thus the Fed has no choice but to halt buying. China began selling off US debt long ago. Japan, the top foreign holder of US debt, is facing a massive default due to its own mishandling of fiscal policy. Foreign central banks have been net sellers of Treasuries for years, and domestic institutions will not absorb endless new issuance without higher yields. The Fed is stuck because it must continue expanding the balance sheet merely to fund government, but it will NEVER be sufficient because politicians spend into eternity.
The current administration believes lowering rates will fix everything. Cheaper borrowing will not entice businesses to take on more debt when they do not have confidence in the future. Borrowing costs do not matter when businesses see demand waning. The central bank has been conditioned through Keynesian lenses to lower when hiring slows.
The Fed’s tinkering will merely buy time. The central bank has lost control over the bond market, while the government’s confidence years ago caused a massive swing from public to private.