Wednesday, August 11, 2010

"Economists React: Fed Takes the ‘Middle Road"

You probably noticed we didn't post anything during the run-up to the Fed announcement.
It wasn't because we are unaware or otherwise distracted.
After considering the potential for actionable news to be somewhere around zero, I mean, what can they say at this point?, we went with the story of  Russian Prime Minister Putin personally putting out two of Russia's many fires and alerting authorities on the ground (he was co-piloting a water-tanker plane) of a third.

Top that Ben.
When the occasion demanded we delivered:
From Climateer "Quote of the Day" Federal Reserve Edition:

I have two problems but only one tool.
-Ben Bernanke
Testimony to the House Budget Committee
Jan. 16, 2008

Or Dec. '07's "Central Banks to "Flood" Markets with Liquidity":

As FINTAG put it:

We've also had some serious, bordering on academic, posts. In February 2008 we tried to warn what was to come:
Doom and Gloom: What Can the Federal Reserve Do?
The short answers- Quite a bit. Not enough.
This line of thought was triggered by a MarketWatch story from a couple days ago...
this post  went on:
I was reminded of a Financial Times story from March 25, 2002:
Fed Considered Emergency Measures To Save Economy
Minutes which summarized the meeting were released last week. A full transcript will not be available for five years but a senior Fed official who attended the meeting said the reference to "unconventional means" was "commonly understood by academics."
The official, who asked not to be named, would not elaborate but mentioned "buying US equities" as an example of such possible measures, and later said the Fed "could theoretically buy anything to pump money into the system" including "state and local debt, real estate and gold mines – any asset"
I don't have the link but the the quote via my notebook is accurate, it struck me as important enough to jot down.
We now have the transcript,
Minutes of the Federal Open Market Committee
January 29-30, 2002
...At this meeting, members discussed staff background analyses of the implications for the conduct of policy if the economy were to deteriorate substantially in a period when nominal short-term interest rates were already at very low levels. Under such conditions, while unconventional policy measures might be available, their efficacy was uncertain, and it might be impossible to ease monetary policy sufficiently through the usual interest rate process to achieve System objectives. The members agreed that the potential for such an economic and policy scenario seemed highly remote, but it could not be dismissed altogether. If in the future such circumstances appeared to be in the process of materializing, a case could be made at that point for taking preemptive easing actions to help guard against the potential development of economic weakness and price declines that could be associated with the so-called "zero bound" policy constraint....
The question arises "Can the fed intervene in the Equities Markets?"
Again, two answers. 1) It's definitely something Central Bankers have thought about. 2) The Fed may need some enabling legislation which they would probably get if they requested it.
The FT reported February 21, 2002 "Japan Suspected of Stock Market Intervention".
A Google search finds 700 references to the "Stock Buying Body".
Here's a pungent one:

"We must halt this fall in shares. It's like diarrhea, we must stop it. The stock-buying body was set up precisely to absorb such selling (offloading of cross-shareholdings by banks). If February is such a month, there is no excuse for not functioning at that crucial time."Finance Minister Masajuro Shiokaw – Feb 7
More relevant to the American markets are a couple Fed papers, the first of which is astounding for its frankness: 
Monetary Policy When the Nominal Short-Term Interest Rate is Zero.
In part II we linked to a Dallas Fed paper with this rather amazing graphic:
Another paper, this one from the Dallas Fed, addresses the same issues with a distinctly different tone, e.g.

CH-47 Chinook Helicopter

The day Lehman collapsed: "Federal Reserve Accepting EQUITIES as Collateral" and "Bernanke Violates Federal Reserve Act Section 23A" let us know just how desperate the situation was.

January '09's "Out of Bullets, Throwing Rocks: Fed Keeps Rate Near Zero, Is Ready to Buy Treasuries" was posted 39 days before the market bottom.

So yeah, we do pay attention, here's the latest, from Real Time Economics:

Economists and others weigh in on the Fed’s policy statement and its decision to reinvest proceeds from its mortgage holdings.
The makers of domestic monetary policy took the middle road between doing nothing and expanding quantitative easing. Maintaining the extended period language and dampening their current assessment of the economy were non-events. The decision to re-invest maturing Agency and Agency MBS was maintaining the status quo. If the Fed had wanted to make a statement they would have added to the size of the quantitative easing. –Steven Ricchiuto, Mizuho Securities

We’re skeptical this tweak signals that, if the recovery doesn’t pick up pace soon, the Fed would now be willing to restart its asset purchase programme. We suspect it would take a much more severe slowdown than what we are seeing now before the Fed would countenance another round of quantitative easing. –Paul Ashworth, Capital Economics

The statement accompanying today’s policy release read something like the disclaimer on the back of a first class ticket on the Titanic: Warning, claims of unsinkability have not been proven. In Fedspeak, this warning translated into the expectation that “the pace of economic recovery is likely to be more modest,” contrasting with the Central Bank’s more upbeat than consensus comments in the June statement… In essence, these pay downs remove cash from the financial economy, resulting in a “stealth tightening” that makes little sense against this backdrop of uncharted waters. By pledging to reinvest these monthly billions back into the Treasury market (MBS reinvestment is somewhat impractical, as it provides excess stimulus to the housing sector, not the whole economy), the FOMC could actually keep monetary conditions more stable month-to-month, while retaining the flexibility to act through other mechanisms. –Guy LeBas, Janney Montgomery Scott

All oars are now in the water with all hands at the Fed vigorously paddling to prevent the slowing economy from going over the falls into a full-blown debt/deflation cycle. Buying the long-end of the curve alleviates to some degree the need for banks and foreign governments to finance the Federal budget deficit, but it is not clear where this freed up investment capital is going to flow. If interest rates alone were the route to recovery the housing market would now be booming rather than stagnating at “a depressed level”. Lowering the cost of borrowing at a time when no one wants to add debt in the hope of giving the economy a boost is the classic case of pushing on a string. –Steven Blitz, Majestic Research