As the stock market plunges, a star fund manager says the Fed is making a mistake by focusing on rates. Here’s what Scott Minerd says he should do instead.

The Federal Reserve is under pressure as the market plunges ahead of its first rate-setting meeting of 2022, and at least one star fund manager says the central bank could be making a policy mistake by focusing on raising rates.

Scott Minerd, chief investment officer of Guggenheim Investments, said the Federal Open Market Committee, which kicks off its two-day policy meeting on Tuesday, must focus on trimming its balance sheet by about $9 trillion, which it says he favored anomalies and bubbles. in asset markets.

“Despite all the hype around the Federal Reserve (Fed) raising short-term rates, policymakers may miss the best opportunity since the Great Financial Crisis to ‘normalize’ monetary policy,” Minerd writes, in a shared client report. with MarketWatch before its wider distribution.

Market-based projections imply that the FOMC will raise federal funds rates, which currently range between 0% and 0.25%, at least three times in 2022 and other economists and market participants forecast. an even more aggressive plan to raise rates by the Fed as it tries to quell a surge in inflation that is at least partly born of supply chain bottlenecks, shortages of labor and a recovery in demand as consumers attempt to emerge from COVID-induced lockdowns.

Minerd, however, argues that the Fed should be obsessed almost exclusively with shrinking its balance sheet, which currently stands at around $8.7 trillion.

See: First Federal Reserve meeting of 2022 looms as risk of inflation beyond policymakers’ control rises

The CIO says the shrinking overall balance sheet, which has helped inflate values ​​in everything from stocks to cryptocurrencies such as bitcoin BTCUSD,
could be better managed by reducing the supply of liquidity that the market has benefited from.

“Changes in the money supply are a powerful driver of economic output, asset prices, and inflation,” Minerd writes.

“Interest rates are the by-product of monetary liquidity, economic output and inflation expectations. Short-term market rates can be manipulated by changes in the money supply,” he wrote.

Minerd says one of the negative ramifications of the size of the Fed’s balance sheet was the reverse repo rate, a key artery of global financial markets.

The Fed’s reverse repo program allows eligible businesses, such as banks and money market mutual funds, to store large amounts of cash overnight at the Fed at a time when rates Short-term financing has fallen to almost nothing and where to find accommodation for the money has become more difficult.

The program had almost no participants in early April last year, and few since the pandemic began in spring 2020, but demand surged in May 2021.

“This facility now has a daily volume of over $1.5 trillion,” Minerd writes. “Any rate increase program will require the Fed to increase the interest rate paid on RRP transactions by the amount of the target overnight rate increase,” he said.

“Essentially, the Fed will set an artificial rate that is not set by market forces,” Minerd said.

In other words, free-flowing liquidity has created artificial levels for rates that are not determined by market forces.

Minerd says that without the ability to accurately discern the state of the market through mechanisms like the RRP, the Fed is essentially flying blind.

“Without market forces, the Fed will not have the ability to recognize what the true demand for money would be if interest rates were allowed to float freely and thus create a signaling mechanism to indicate the true interest rate of balance,” he wrote.

Minerd said a dramatic rate hike would destabilize the financial system and railed against suggestions that the Fed should focus on “shock and awe” tactics by offering a 50 basis point hike, instead. than the 25 basis points that the markets value.

Economists, in fact, expect the Fed to scale back its asset purchase program, ending that program as early as March, raising interest rates up to three times and shrinking its balance sheet.

Read: Is the market collapsing? No. Here’s what’s happening to stocks and bonds as the Fed aims to end the era of easy money, analysts say

Minerd would encourage the Fed to focus on its balance sheet. He says controlling money supply growth may be more influential in resetting policy and a better tactic for the central bank than interest rate increases.

Minerd’s comments come as the S&P 500 SPX Index,
the Dow Jones Industrial Average DJIA,
and the Nasdaq COMP composite index,
fell to new lows amid a disastrous start to the year for Wall Street investors. Meanwhile, the yield of 10-year treasury bills TMUBMUSD10Y,
was around 1.72%, retreating from recent highs around 1.9% but still significantly up from the end of 2021.

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