Federal Reserve Chairman Jerome Powell has appeared to pivot in monetary policy, embracing a subtler approach that prioritizes Washington's borrowing costs over the pressing inflation woes facing the American public. Despite maintaining the federal funds rate at a relatively elevated 5.25 to 5.5 percent, the Fed has initiated what some are referring to as a 'shadow cut' by scaling back the sale of government bonds from $60 billion to $25 billion a month, a decision that could potentially inject an additional $420 billion into the money supply annually.

This shift, as outlined by FX Hedgers in their detailed analysis, has the effect of increasing inflation by roughly 2 percent, a perplexing strategy given the current reacceleration of inflation to levels between 4 and 5 percent. The underlying motive appears to be alleviating the cost of borrowing for the federal government, thereby enabling the sale of cheaper debt to foreign and domestic investors, which includes the Chinese government and Wall Street. This approach effectively means that Washington benefits from more affordable borrowing while the general populace bears the burden of heightened inflation.

The context of this decision is rooted in the Fed's response to COVID-19 when it created $6 trillion and expanded its balance sheet from $4 trillion to an unprecedented $9 trillion by amassing a portfolio of government debt and mortgage-backed securities. Such an increase dwarfs the $1 trillion expansion during the 2008 financial crisis and is a monumental escalation from the $900 billion accumulated over the Fed's first 95 years of existence. Powell had previously assured the markets that the Fed would sell off its COVID-era asset acquisitions, thereby neutralizing the surplus dollars. However, this latest development suggests a retreat from that commitment, as the roll-off program has been significantly curtailed.

Analysts are now closely scrutinizing the implications of the Fed's strategy, which seems to pivot away from traditional interest rate adjustments in favor of directly supporting federal spending. This shift towards 'fiscal dominance,' where government spending becomes the central economic driver, could have far-reaching consequences for the economy, potentially leading to a scenario where the Federal Reserve further entrenches itself in the facilitation of government expenditure to the detriment of broader economic stability.