Former Senate Banking Chairman Phil Gramm contends the Federal Reserve has less control over rates than any time in its history.
The central bank is trying to raise rates and reduce its balance sheet amid worries over an economic slowdown and turmoil in financial markets. The Texas Republican and former chairman of the Senate Banking Committee blames "monetary excesses" of the Obama administration for the current predicament.
In a Wall Street Journal article co-authored with Thomas S. Saving, a former director of the Private Enterprise Research Center at Texas A&M University, Gramm notes the intensifying debate over whether the Fed should be raising interest rates.
"Extraordinarily, this debate is occurring at the very moment the Fed — shackled by its bloated asset holdings and the resulting excess reserves of the banking system — has less ability to control interest rates than it has had in its entire 105-year history," Gramm wrote.
"[T]he danger posed by the Fed's bloated asset holdings and the resulting massive level of excess bank reserves is that with a full blown recovery now under way, the demand for credit will accelerate and force the Fed to move quickly to raise interest rates on reserves or sell securities to sop up excess reserves," Gramm and Savings wrote. "A small error by the Fed in following market interest rates could cause a large change in the money supply."
"While the Fed is not forever shackled by the monetary excesses of the Obama era, the sheer size of its asset holdings virtually guarantees that the Fed will feel the yoke of the massive excess reserves in the banking system for the remainder of this recovery," Gramm wrote.
Meanwhile, some of the most accurate gauges of economic health are pricing in lower Fed rates for the first time in more than a decade, Bloomberg reported.
The little-known near-term forward spread, which reflects the difference between the forward rate implied by Treasury bills six quarters from now and the current three-month yield, fell into negative territory on Wednesday for the first time since March 2008. Two-year yields dipped below those on one-year paper in December.
“This is a crystal ball, it’s telling you about the future and what the market thinks of the Fed and what it will do with its policy rate,” Tony Crescenzi, market strategist and portfolio manager at Pimco, said in an interview with Bloomberg TV. “The market is predicting a rate cut at the beginning part of next year.”
Fed economists said looking at forward rates relative to those on current Treasury bills has served traders well in the past.
“When market participants expected -- and priced in -- a monetary policy easing over the next 18 months, their fears were validated more often than not,” Eric C. Engstrom and Steven A. Sharpe wrote in a research paper dated July 2018.
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