Aug 10, 2020 - Economy & Business

The transformation of the Fed

Illustration of the raging bull.
Illustration: Eniola Odetunde/Axios

The Federal Reserve is undergoing an overhaul. Conceived to keep inflation in check and oversee the country's money supply, the central bank is now essentially directing the economy and moving away from worries about rising prices.

What we're hearing: The move to act less quickly and forcefully to tamp down on inflation has been in the works for years, but some economists fear that the Fed is moving too far from its original mandate.

  • It would be "a significant shift because the new strategy I would interpret as one that tries to deliberately engineer higher rates of inflation instead of just tolerate them should they come about," Peter Ireland, an economics professor at Boston College and member of the Shadow Open Market Committee, tells Axios.
  • "I would worry if I were on the FOMC that the Fed is just trying to do too much fine tuning. ... And that by trying to do too much the Fed does risk making mistakes like it did in the past."

Between the lines: There are other concerns with the Fed's new stance.

  • "Free market enterprise no longer exists," Scott Minerd, CIO of Guggenheim Partners, tells Axios. "The Fed by essence of what it's doing has taken control of the market."

Why it matters: "The definition of market prices is whatever the Fed says it will be," says Minerd, a member of the New York Fed's Investor Advisory Committee on Financial Markets.

  • "As long as the Fed continues to manipulate the cost of credit in the manner that it's doing, which it has never done in its history, then you have to adjust your view of the investment paradigm that we're living in."

The big picture: Keeping a lid on inflation historically has been the Fed's primary objective, but with growth and inflation readings undershooting 2% for more than a decade despite near-zero interest rates in the U.S. and developed markets around the world, things look to be changing.

What it means: That change may not only mean lower rates for longer but also more room for stimulative policies like quantitative easing (QE), which was previously an emergency program that has become a standard part of the Fed's tool kit.

  • There's also long-term potential for its new special purpose vehicles that buy corporate bonds and lend money directly to businesses as mechanisms for holding up larger chunks of the economy.

The intrigue: The idea that the Fed is controlling or setting prices in financial markets was once the fodder of conspiracy theorists and cranks.

  • But since the Fed's unprecedented intervention into credit markets in late March, it has become a general understanding stated openly by economists and asset managers, including those at high-profile investment firms like Deutsche Bank and Bank of America.
Data: Federal Reserve; Chart: Axios Visuals
Data: Federal Reserve; Chart: Axios Visuals

Yes, but: Not all of the Fed's new programs have worked as planned. After significant delays, its $600 billion Main Street Lending Program has provided less than one-tenth of 1% of its allotted funding to needy small businesses even as the Paycheck Protection program has whiffed and business closures have spiked.

Be smart: Compare that to the trillions it has used on QE and the billions it has purchased in debt from some of the country's largest companies using a backstop of taxpayer money and it's no wonder politicians and economists have called the Main Street program a "failure" and an "unmitigated disaster."

On the other side: The Fed's efforts to support large companies have helped spawn a "buy-anything market" in which even negatively correlated assets have risen together since the start of the third quarter.

  • "That creates a bit of a potential political problem for the Fed," Julia Coronado, president and founder of MacroPolicy Perspectives, tells Axios.
  • "It doesn’t feel right to people on the street, on Main Street. ... That’s one reason why the Fed is underscoring the need for fiscal [stimulus]."

The push for Congress to approve fiscal spending measures could become another political problem for the central bank, warns Boston College's Ireland, who previously served as an economist at the Richmond Fed.

  • "I do get the feeling that they’ve been more aggressive in their commentary on fiscal policy and more generally on non-monetary policy issues."
  • "In an environment where they should be concerned about preserving Fed independence, they should be conscious of the fact that in turn they stick to talking about what they’re supposed to do."
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