Suncor Energy Inc T.SU

A Lesson on Monetary Policy

[Experienced]

What exactly is the Fed doing and what are its main tools?

Most of the focus in the press and the financial reporting community focusses on the Fed and what it does in in terms of setting the federal funds rate.  In reality, the federal funds rates only directly affects short term interest rates since the federal funds rate is the interest rate that the banks get for overnight deposits with the Fed.  That said, the federal funds rate is often used a benchmark for longer term rates such as mortgages but this is up to individual banks as to whether they pay attention to it or not.

The other tool the Fed has is to buy or sell longer term bonds in the open market.  When they buy these bonds, they are effectively printing money out of thin air and the press calls this monetary easing.  These actions do have a direct impact on longer term interest rates.

So how do we get inflation?

Inflation comes from a combination of two things. The scarcity of a particular thing or things and the growth in the money supply.  Growth in the money supply comes from the amount of money that is printed by the central bank (The Fed) and what is called the velocity of money or in simple terms the speed at which money changes hands.  The speed that it changes hands is directly influenced by the rate of growth of the economy.

Sooo...just focussing on the money supply, through quantitative easing, the Fed has been printing a lot of money over the past number of years (about 7 trillion dollars since late 2008).  Over the past couple of years since the COVID meltdown in March 2020 the economy has grown at a quick pace and so this plus the printing of alot money by the Fed has massively increased the money supply and hence created inflation.  The outsized rise in the stock market has reflected this increase in the money supply.

Where do we go from here?

Well, you guessed it.  The Fed is now selling bonds and increasing its discount rate.  The selling of these bonds reduces the amount of money in circulation and the higher interest rates reduce economic activity and this results in a contraction in the money supply.

The Fed hopes that it can find the right balance between these forces to get the right amount money supply to cool inflation without sending the economy into a recession.  The problem is that nobody knows what the right amount is and the Fed historically has pretty much gotten it wrong every time since it was started in 1913.

In a recent post, Obscure posted a number of questions.  What this list of questions serves to illustrate is that world has gotten very complicated with many conflicting forces and making it even more difficult if not impossible for the Fed to find the right balance to cool inflation without causing a recession.

All of this makes it difficult for the stock market to figure out what to do and hence we see a lot of day to day volatility.  For some people like Migraine who is skilled in options trading and leveraged investments, this volatility presents an opportunity to make a lot of money.  For most people that is not the case.

Each investor will in one way or the other make decisions on how to handle this situation but in a way the root of the decision either conscious or not will be whether he/she thinks the Fed will get it right or not.

[Obscure1]

"the Fed get it right?" Surely you jest

[jx7000]

Well under Greenspan, the Fed was never wrong because everything he said was shrouded in ambiguity; that kept the talking heads busy for days usually.

[Experienced]

Yes he was a master of ambiguity!!! Can't think of anyone who was better at it than him!!!

[mrbb]

the part i don't get is biden removing gas tax for next 90 days, that mean maintain or increase gasoline/diesel consumption, then the oil price dropped, weird.  

[jx7000]

Brandon couldn't care less about the price of fuel. He just wants to minimize the damage in the Nov. mid-term elections and then watch out if the Dems survive in the House (unlikely).

[mrbb]

brandon has plenty of money for ukraine, $40 billion so far sent to prolong the war.  Meanwhile, Zelensky believe we need to send more money.   

[mrbb]

it doesn't matter, there are too much debt and money printed already that can't be paid back.  The best the fed can do is pretend to extend as long as possible, we will end up like japan as the best scenario or worst because at least for japan, they make stuffs while US is a net consumer using printed USD   Puny rate hike won't do much to curb US's 8.6%(real is +15%)