Fed’s Treasury buying will come in handy as others sell

The use of “transitory" was assumed to have been consigned to the dustbin of the history of the Federal Reserve’s blunders after the Fed failed to recognize that post-Covid inflation was anything but passing. That’s why Fed Chair Jerome Powell raised more than a few eyebrows this past week when he reverted to the T word to describe the impact of tariffs, announced and anticipated, on inflation.

“It can be the case that it’s appropriate sometimes to look through inflation if it’s going to go away quickly without action by us if it’s transitory. And that can be the case in the case of tariff inflation," he said at his news conference on Wednesday following the Fed’s policy meeting, at which it held rates unchanged, as expected.

That would seem consistent with the advice to monetary policymakers proffered recently by Treasury Secretary Scott Bessent: “I would hope that the failed ‘team transitory’ could get back together and think that nothing is more transitory than tariffs."

By that, one infers he meant the transitory impact on inflation, not continual flip-flops as to when and whether tariffs would be imposed.

There was little ambiguity about Bessent’s boss’ thoughts on monetary policy. “The Fed would be MUCH better off CUTTING RATES as U.S. Tariffs start to transition (ease!) their way into the economy. Do the right thing," President Donald Trump posted on Truth Social.

The Fed’s newly updated Summary of Economic Projections points to two cuts of one-quarter percentage point in the federal-funds target rate, from the current range of 4.25% to 4.50%, by year end. That’s despite an increase in the projection for the core personal consumption expenditure index to 2.8%, from 2.5% in the SEP published in December.

The projection for 2025 gross domestic product growth was downgraded to 1.7% from 2.1% previously, which may reflect the largely technical contraction likely in the current quarter. The most recent GDPNow estimate from the Atlanta Fed is for negative 1.8% first-quarter growth, largely due to a surge in imports, including gold bars, to beat anticipated tariffs. The Fed’s projection for the unemployment rate ticked up to 4.4% from 4.3% previously; the jobless rate was 4.1% in February.

Less noticed was a slowing in the shrinkage of the Fed’s balance sheet, to redeeming $5 billion of Treasury securities a month from $35 billion previously. Powell pointed to complications related to the debt ceiling, which results in swings in the Treasury’s cash balance that in turn affect bank reserves. Reduced redemptions will mean the Fed will be reinvesting $160 billion more in the Treasury market from April to December, according to John Ryding and Conrad DeQuadros of Brean Capital.

That will come in handy, given Uncle Sam’s ongoing borrowing needs after foreign investors shed Treasury notes and bonds for the third straight month in February, according to Wells Fargo analysts Angelo Manolatos and William Gibbons. Foreigners, especially official investors such as central banks, have been reducing coupon holdings while shifting to short-term T-bills. Over the past year, foreign investors have bought $190 billion in T-bills, or nearly 31% of net T-bill issuance.

Prior to coming to Washington, Bessent criticized former Treasury Secretary Janet Yellen for relying heavily on T-bills to fund the massive $2 trillion deficit. But so far he hasn’t altered the Treasury’s borrowing plans. If he announces in May a shift to more notes and bonds, the Fed’s increased reinvestment would be welcome, given the selling of coupons by foreigners. Not to be overlooked is the administration’s emphasis on the Treasury 10-year yield, rather than the stock market, as its key financial litmus test.

Still, who knows what else might change these days in this transitory life?

Write to Randall W. Forsyth at randall.forsyth@barrons.com