A Dilemma Of The Fed’s Own Making | Danielle DiMartino Booth & Joseph Wang
May 2, 2022
45:23
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Quick takeaways
The Federal Reserve risks losing credibility by not recognizing the rapid economic slowdown and the widening credit spreads, which may force the Fed to change course.
Tightening monetary policy and quantitative tightening measures can lead to stress in the housing and credit markets, making it difficult for companies to borrow money and negatively impacting the economy.
Deep dives
Powell's credibility on the line as he sticks to transitory narrative
In an upcoming FOMC meeting, Fed Chair Jay Powell's credibility is at stake as he continues to insist on the transitory nature of inflation. His handling of the economy's strength is also in question, especially considering recent announcements from private employers like Amazon reducing headcount. Powell's insistence on labor strength is seen as contradictory to the knowledge of lagging indicators and the potential dangers of economic instability.
The dangers of tightening in the current economic environment
As the Federal Reserve considers tightening monetary policy, concerns arise regarding the potential ripple effects on the US economy, particularly in the housing and credit markets. Weakening demand in housing, with a decline in second-home purchases and rising property taxes, can lead to stress in the real estate market and impact professionals in the industry. Furthermore, tightening measures, such as quantitative tightening (QT) and higher interest rates, can put pressure on credit spreads, making it difficult for companies to borrow money and adversely affecting the economy.
The challenges of managing liquidity and quantitative easing (QE)
The Federal Reserve faces the dilemma of managing liquidity and the potential impact of quantitative tightening (QT) while keeping a watchful eye on credit markets. While the reverse repo facility is popular and absorbs liquidity, the standing repo facility has minimal interest from banks due to adequate liquidity regulations and cash levels resulting from quantitative easing. The balance between supply chain-driven inflation, credit market risks, and the need for liquidity management presents challenges for the Federal Reserve as it navigates the current economic landscape.
The importance of emerging markets and potential risks
Emerging markets have become a crucial factor in assessing global financial stability. With more emerging market countries experiencing debt trading that suggests they are on the brink of default, concerns about financial conditions arise. The interrelatedness of markets and the impact of shifts in commodity prices and geopolitical events, such as the conflict between Russia and the West, can have wide-ranging effects on credit spreads, emerging market debt, and global liquidity. These risks and potential crises highlight the significance of monitoring and understanding emerging markets' vulnerabilities.
Danielle DiMartino Booth, founder and CEO of Quill Intelligence, joins Jack Farley and former senior Fed trader Joseph Wang to share her outlook on this week’s FOMC meeting. Booth argues that the Federal Reserve’s lateness to fight inflation has caused it to lose a lot more credibility, and makes the case that it risks to lose even more credibility if it fails to recognize that the economy is slowing rapidly. Booth notes that credit spreads are widening rapidly and argues that it will be a credit market blow-up, not an equity market drawdown, that forces the Federal Reserve to change course. Wang and Booth discuss how rising mortgage rates will deter the Fed from shrinking its holdings of mortgage-backed securities (MBS), and they each give their take on the continued sell-off in Treasury bonds.Follow Danielle DiMartino Booth on Twitter @DiMartinoBooth