The Fed May Scale Back Stimulus

by Pierre G. Villere

The Federal Reserve Bank may very well have a more direct influence on our business lives than any other federal agency, and it is does so quietly in the background while wielding an enormous economic stick. It has a number of tools and mechanisms at its disposal to manage inflation and promote employment, the most well-known of which is the ability to set interest rates across the board. High interest rates of years past served to bring inflation under control, and until the onset of the Covid pandemic, it held inflation at its stated target of around 2 percent. When the pandemic struck, it reached into its toolbox and unleashed another mechanism, which is known as its open market operations (OMO). This involves the Fed buying or selling Treasury bonds in the open market, and this practice is similar to directly manipulating interest rates in that OMO can increase or decrease the total supply of money, a move which also affects interest rates. The logic of this process is rather simple.

If the Fed buys bonds in the open market, it increases the money supply in the economy by swapping out bonds in exchange for cash to the general public. Conversely, if the Fed sells bonds, it decreases the money supply by removing cash from the economy in exchange for bonds. Therefore, OMO has a direct effect on money supply. OMO also affects interest rates because if the Fed buys bonds, prices are pushed higher and interest rates decrease; if the Fed sells bonds, it pushes prices down and rates increase. So, OMO has the same effect of lowering rates when increasing the money supply, or raising rates when decreasing the money supply, which is a direct manipulation of interest rates. 

While the Fed has been flooding the market with liquidity throughout the pandemic, the rise of the Covid Delta variant has complicated the economic outlook by creating renewed risk of a sharper economic slowdown at the very moment some officials were ready to reduce, or taper, the pace of monthly bond purchases. Growth in consumer spending slowed in July to 0.3 percent, less than a third of June’s spending increase of 1.1 percent and less than economists had projected. Spending on services grew, while spending on goods declined. And of course inflation is growing strongly, although Fed Chairman Jerome Powell is convinced that it will fall back when the economy settles down to normal, a view we share. 

The Fed has a tricky balancing act and has done a great job of managing the economic impact of the pandemic. Based on recently reported metrics, it is having a positive impact on the concrete industry. 

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.