Jan. 6, 2022

The Fed's Subtle, But Powerful Message.

We live in an “in your face” blunt world. In which public dialog is mainly partisan and aggressive. Reports are that will be underscored today as the President takes to the podium to condemn the actions of a largely peaceful demonstration that took place a year ago on this date.

But there remains one public institution, where such coarse speech is out of place: the Federal Reserve's Open Market Committee. The Committee lives in the world of the subtle and understated.

To appreciate Fed discussions you must often read between the lines. Interprete the Fed's words in the light of their impact. The Fed after all is speaking to all the actors in the Financial World. So they seek to be measured, and reticent knowing that anything they do say can have a dramatic impact on the markets, both in this country and around the world.

It really is a tremendous responsibility.

And it's the reason that each and every release of the FOMC minutes causes the stir that they inevitably do.

Yesterday at precisely 2 pm eastern, the Fed Released its latest minutes from the meeting held virtually on Dec 14 and 15. It was as if a shot rang out in the Exchange. All the major averages began to move lower.

For the NASDAQ and the Standard And Poors, which were already lower, they both took a leg down. The S&P 500 closed off nearly 2% on the day, the NAS down over 3%. The Dow, which had been up 100 points, began falling closing down nearly 400 points.

What caused all this, was, I believe recognition of a subtle change by the Fed. Nothing you would notice on the surface, but a nearly imperceptible change in tone.

This isn't what the Financial Press is pointing to this morning. Yesterday's market reaction was not due, from my perspective to a more hawkish move by the fed toward the Taper or Raising interest rates. The reaction came from this, very carefully crafted sentence in the minutes.


"A few of these participants raised concerns that a rela-

tively flat yield curve could adversely affect interest mar-

gins for some financial intermediaries, which may raise

financial stability risks."

An interesting comment don't you think? It's presented as a kind of sidebar to the main discussion. As if a couple of analysts, over in the corner happened to drop an off-handed remark. And then for the next several sentences, the writer points out that others in the meeting disputed their thinking, and the meeting moved on from there.

But let's examine what was really said here, and why I think this could have led to yesterday's selloff.

There are three important points raised in this comment.

The first is that short-term rates have risen, while long rates have remained about the same. This has “flattened the yield curve.”

Well. Of course. To Wall Street, this is the whole point. A flat yield curve is the basis of the entire “Transitory Thesis.” The idea is that inflation is just a temporary phenomenon.

Don't worry, the fed has said to Wall Street: inflation will be over soon. And that's good news indeed to Wall Street, who are the largest borrowers in the world. Wall Street which is leveraged to the hilt. Wall Street who never met a new way to leverage investments that they didn't like.

But here, suddenly the Fed is implying that a flat yield curve is not a good thing. That long-term rates should be higher. Perhaps inflation isn't so temporary after all.

The bottom line to the Street: your cost of borrowing is going up.

Point two, the current flat yield curve could adversely affect certain “financial intermediaries.” Financial Intermediaries, who could that be? They're the major money center banks, who are the principal stakeholders in the Fed. Briefly stated, the Fed here is saying that unless we raise long rates, our member banks will be hurt.

So raising long rates has a constituency: It's the Fed member banks. The Fed is hereby cutting loose Wall Street and going to follow the interests of their own member Banks.

Finally, the most dramatic comment of all. If the Fed doesn't take this action, some of those Fed Member Banks may actually incur financial stability risks.

That's a shocker. I wasn't aware that any of the major Fed Member banks had “stability risk.” But if they are, it certainly makes sense that the Fed would provide support.

So there you have it, a subtle, sidebar comment by a couple of analysts, just talking among themselves. But they did manage to communicate that: the current level of low long-term rates is hurting some of their members. And that the Fed may have to do something about that.

And interesting off-handed comment don't you think? It certainly got Wall Street's attention.