Submitted by Atlas Indicators Investment Advisors on April 22nd, 2022
Our economy is hardly flying on one engine, but the international radio distress signal seems appropriate. Why? May is right around the corner, and the Federal Reserve will likely begin tightening its monetary policy during the period. On Wednesday, the central bank unveiled its plan to shrink their balance sheet. While they were explicit in acknowledging no final decisions have been made, they are leaning toward shrinking their balance sheet by $95 billion per month. This would be in addition to changes to the overnight lending rate which is widely expected to increase by another 0.5 percentage point at their next meeting.
During the beginning of the pandemic when Americans were forced from work, the central bank used its balance sheet to support the economy. This pattern continued into even 2022, ultimately resulting in the bank buying roughly $4.5 trillion in bonds and mortgage-backed securities. Now they want to bring the balance sheet level down from roughly $9.0 trillion to probably something in the $6.0 trillion range. No small feat. To do so will pull cash out of the system and impede economic growth, allowing them to slow inflation.
They’ve only attempted this once before in their 108-year history. From 2017 through 2019, they charted a course to reduce their balance sheet but didn’t make their scheduled destination. Instead, disruptions in the money market system forced them to start buying assets again after pulling just $700 billion out of the economy. The goal is much bigger this time.
The Federal Reserve is trying to orchestrate a soft landing. That is, they are attempting to bring down inflation by slowing the economy without forcing it into recession. It remains unclear what maneuvers are required to complete such a feat. Instead, they are toying with untested processes to unwind experimental policies. In even the clearest skies, this would be a difficult task, but Atlas believes they are increasing the complexity by doing so into an already slowing economy. Nevertheless, their landing gear is down, so let’s hope the runway is clear and smooth, while keeping our seatbelts fastened.
