The Silver Bullet - No. 9

The Limits of Monetary Magic

What is a magic trick?

At its essence, it is to distract the public with one hand, while doing something else with the other.

The Limits of Monetary Magic

May 2024

In this tightening cycle, the Federal Reserve has focused its rhetoric on front-end interest rates, as the active tool of monetary policy.

It is not working. Higher front-end rates only reduce demand in a few areas of the economy. Fiscal spending remains above average, and supply bottlenecks are likely to come back.

Meanwhile, the Fed is keeping its balance sheet largely intact, while announcing a reduction in the pace of quantitative tightening at its latest press conference.

Why are central banks pretending to tighten with one hand, while easing with the other? And what are the consequences for investors?

The short answers are delusion, divergence and dispersion. For now, there’s smooth sailing in financial markets and in credit.

But over time, the Fed’s magic trick could backfire.