Middle ground
With the impact of its tightening still not apparent, the Fed opted for another modest rate hike.
A compromise pleases no one completely, but the Federal Reserve had to take the middle ground at today's policy-setting meeting. Despite reports of a growing divide among FOMC participants as to the proper course, there was no evidence of dissension in the meeting statement. Far from it. Their hike of the fed funds target range by 25 basis points to a 22-year high of 5.25-50% was unanimous. It’s that they simply don’t know where the economy is situated and are wisely being cautious.
Economic growth is more robust than expected and inflation is declining at an uncertain pace—factors arguing for tighter monetary policy. But the Fed is mindful of another uncertainty—the timing of the lags with which monetary policy affects economic activity. If the Fed was successful at accelerating the transmission of policy with its rapid pace of hikes last year, then they certainly haven’t gotten the impact that they desired. But if the lags are more traditional—12 to 18 months, if not more—then a wave of policy restriction has yet to hit. This is more likely, as policy only stopped being accommodative in the second half of last year. And therefore the compromise make sense: being open to more tightening but allowing upcoming data to show the way forward. Chair Jerome Powell pointed to the fact that the Fed will have a trove of economic data before its next FOMC meeting, which is not until September.
The Fed raised the metrics that the Fed uses to implement monetary policy in kind, most notably adjusting the rates on the New York Fed Reverse Repo Facility and Interest on Reserves to 5.30% and 5.40%, respectively. The Fed should be pleased with how well the market has absorbed a recent deluge of Treasury supply without any corresponding impact on the functioning of the funding markets. The Treasury Department has issued over $700 billion in bills since the suspension of the federal debt limit in early June. This rapid replenishing of Treasury’s cash balance, boosting its coffers more than $500 billion—had the potential to put downward pressure on bank reserves. To the Fed’s relief, we are sure, that increase was offset by a material decline in the use of the Fed’s Reverse Repo Facility, as money fund investors were finally able to redeploy some assets into other types of investments. As a result, bank reserves did not decline as feared.