The Fed’s Quantitative Tightening Is Sending Signals of an Impending Recession

As the U.S. economy continues to be impacted by various factors, including the pandemic, inflation, and the Fed’s monetary policy, investors and analysts are closely monitoring the Federal Reserve’s quantitative tightening. Questions abound around whether interest rates will be raised, for how long, and how high the effective Federal Funds rate will climb. New figures from the Fed show that quantitative tightening is continuing, causing securities held outright to decline by $587.9 billion since March 16th, 2022, and reserve balances with Federal Reserve banks to decrease by $865.4 billion in the same period.

The Impact on the M2 Money Stock

Another area where the Fed’s actions are being felt is in the M2 Money Stock. By May 2022, the M2 money stock had reached its recent monthly peak, but in January 2023, the year-over-year rate of decline in the M2 Money Stock was 1.7%, having declined for five months. Historical research has shown that a slowdown in money stock growth impacts the economy with a long and variable lag. These signs show that the U.S. economy is in trouble, a recession may be looming, and investors are starting to get edgy.

Why Quantitative Tightening Matters

The tightening of the Fed’s monetary policy aims to increase interest rates, which is expected to slow down economic growth, reduce spending, and suppress inflation. However, as the numbers show, it is not impacting all areas of the economy equally. In addition, the erratic movement in “excess reserves” held by commercial banks makes it challenging to accurately predict the long-term impact of the Fed’s actions.

Related Facts

• The Federal Reserve’s “reverse repurchase agreement” account is used to help keep the money markets calm and the Federal Funds rate steady.
• The U.S. Treasury Department’s “General Account” management is impacting bank reserves and the overall money markets.
• A slowdown in the money stock growth can have a long and variable lag time before it fully impacts the economy.

Key Takeaway

Investors and analysts must closely monitor the Fed’s actions, monitor the impact of quantitative tightening on the economy, and be prepared for any potential recessionary signs.

Conclusion

The Fed’s quantitative tightening signals that an impending recession may be on the horizon and investors must be prepared. While the impact of the Fed’s actions is complex and the long-term effects are yet to be seen fully, the signs of a slowdown in the money stock growth and the decline in securities held outright and reserve balances with Federal Reserve banks mean that the U.S. economy is facing a rocky road ahead.