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IPFS News Link • Congress-Congressmen

Congress, Not The Fed, Is The New Driver Of Financial Markets

•, by Howard Wang

The chart below may surprise you. Since the start of the pandemic, the ups and downs of the markets have exactly tracked changing inflation expectations.

Why is this significant? While the Fed can control short-term or long-term interest rates, they cannot directly control inflation. They can only influence inflation by changing interest rates, which are already anchored at close to zero. So the Fed is largely helpless in stimulating the economy and the markets. It is now in an era where it must rely on Congress bills in order to enact expansionary monetary policy.

Up until 2008, the Fed controlled the economy and the markets through short-term interest rates. By setting expectations of future short rates, the Fed can also indirectly influence long rates, thus impacting the financing rates of capital transfers over various time frames.

This approach was effective until 2008 when short rates hit zero and the Fed could no longer use this lever. In 2009, the Fed had to move further out on the yield curve and began to directly control long rates by buying bonds via quantitative easing. Because of the size of the bond market, these operations had to be in the $trillions in order to be effective. But ultimately it worked to lower borrowing rates and discount rates, propping up the economy and boosting financial assets.