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Explore: What Has the Fed Been Doing in the Shadows?

What Has the Fed Been Doing in the Shadows?

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On the surface, many investors and market observers feel that the Fed just recently began to tighten monetary policy with a rate hike in December of last year. However, by looking at the Wu-Xia shadow fed funds rate1, the tightening cycle has been underway for quite a bit longer – since mid-2014, in fact.

While many people may believe that the Fed only tightens or loosens policy by explicitly hiking or cutting its target rate, the shadow rate reflects other, indirect action/inaction as well. For example, between the trough in mid-2014 through the end of 2015, the rate in this model surged 3% (300 basis points) as the Fed ended its asset purchase program and paved the way for an eventual target rate hike through firmer forward guidance.

This shadow tightening by the Fed that started around the middle of 2014 makes even more sense when looking at currency movements. It was around this time that the US dollar began its sharp ascent versus major currencies, serving to weigh on economic growth and put a damper on our economy.

If you are concerned about the Fed’s hawkish tone from the minutes for the April meeting that were just released earlier this week, you may be late to the worry party — by two years.

For more detail, check out a more in-depth article from Bloomberg here.

1https://www.frbatlanta.org/cqer/research/shadow_rate.aspx?panel=1

Photo Credit: 401(K) 2012 via Flickr under CC BY-SA 2.0 (http://401kcalculator.org)

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