In testimony before the House Financial Services Committee today, Fed Chairman Bernankenstein confirmed in his own words what I have been writing for months. Here’s how Marketwatch.com put it:
Just two weeks after completing a second extraordinary effort to juice the moribund U.S. economy, the Federal Reserve is contemplating more “untested” steps, the head of the central bank said Wednesday.
Federal Reserve Chairman Ben Bernanke says the central bank is examining several untested means to stimulate growth if conditions deteriorate, even though the central bank believes the temporary shocks holding down economic activity will pass.
Here are his exact words:
Even with the federal funds rate close to zero, we have a number of ways in which we could act to ease financial conditions further. One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels. Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally. Of course, our experience with these policies remains relatively limited, and employing them would entail potential risks and costs. However, prudent planning requires that we evaluate the efficacy of these and other potential alternatives for deploying additional stimulus if conditions warrant.
He also laid out the strategies for reducing the size of the Fed’s balance sheet, including not rolling over maturing securities for starters. These are non starters in my view. The Fed will never be able to reduce the size of its balance sheet. In fact, it will need to begin expanding it soon. Here’s what I have been writing in the Wall Street Examiner Fed Report.
The Fed will announce its POMO schedule for the next month on Wednesday at 2 PM. The purpose of these operations will be to replace maturing GSE paper and MBS paydowns to keep the total size of the balance sheet level at roughly $2.65 trillion. This should translate to operations averaging about $2 billion, per week. That is a drop in the bucket and will put the Primary Dealers, and hence the financial markets, on a starvation diet. The PDs will be left to absorb the bulk of $120-$150 billion in Treasury supply each month with no help from Dr. Bernankenstein. He’s now experimenting with starving his monster to see what happens. It will be ugly.
As a result, the Fed will almost certainly take steps to help the dealers absorb the supply sooner rather than later. QE3 anyone? There are two questions. How long will Bernanke take to react, and what form will that reaction take. This is a man who never tries the same thing twice. It will be interesting to see where his wild, unhinged imagination will take us next.
They Can Run But They Can’t Hide
Based on his Congressional testimony today, it would seem that Dr. Bernankenstein is following the script perfectly.
Originally posted to the Wall Street Examiner’s Email Bulletins.
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