Loose Interest Rates Remain Loose, Mostly

As the Federal Reserve incrementally raises interest rates, you’ll see many stories about monetary policy getting tight and the potential threat that poses for the economy in general and the bull market in stocks in particular.

As usual, you should discount the conventional wisdom. What’s really going on is the Fed is getting “less loose,” not “tight” and there’s ample room for the Fed to stay along this path without risking a recession or a bear market. The banking system is full of excess reserves from the Fed. Until the Fed eliminates those excess reserves or lifts the rates it pays banks on those reserves above the rates on loans, policy will remain loose.

As expected the Fed stayed on track for a third rate hike in 2017. The Fed’s “dot plots” indicate the odds of another rate hike later this year is only a 50-50 proposition.

The Fed’s statement as well as Fed Chief Yellen’s press conference indicates the Fed will stay on course to start unwinding its bloated balance sheet later this year. The best guess is another rate hike in September followed by six months of balance sheet reductions before rate hikes start again in March 2018. However, don’t be surprised if the Fed embarks on balance sheet reductions a little earlier while moving a September rate hike to December. Either way, the Fed would be moving in the right direction.

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