A full trading day after the release of the Fed minutes has brought us some reasonably significant changes in market levels. S&P –1.5%, Gold – 3.5%, Crude –1.5%. Apparently, the confirmation that it is on hold surprised the market. (link)
I’m not surprised. Bernanke understands that upping the anti with more QE would send the price of crude through the roof. The deflationary effect on the consumer economy of another dollar increase for gas would far outweigh any positive consequences that another LSAP would have produced.
Some random thoughts: (Warning, I stray from side to side on this.)
- I see that the Fed has been put in check by the global price of crude. While this is not checkmate, it forces the Fed to move to the defense. The language from the Fed meeting confirms it. For the past four years, the Fed has been on the offense. It has had no opposition from the markets. The subtle change in the Fed’s position is a major change in its strategic advantage. To me, this represents a significant change of events.
- While this represents an important strategic change, the reality is that the short-term monetary consequences are negligible. ZIRP will linger on for at least another year. As as a monetary stimulus, ZIRP has much greater consequences to the global economy than do QEs, TWISTS etc. It's as if the Fed has shifted from fifth gear down to fourth. It's still speeding ahead. The shift to fourth is more about gaining some additional traction over a rough spot, not about a change in velocity.
-Bernanke has said that if there were to be a new TWIST, the operation would be “sterilized” by reducing very short-term cash liquidity (2-14 days). The Fed would have to do that because they have no more medium term paper to swap against long-dated paper. It is faced with an operational constraint to extending TWIST. The result is the necessity to drain short-term liquidity to complete the swap.
I think the sterilized swap is a stupid terrible idea. Yes there is a lot of cash around. But if Ben thinks he can suck up 0b of cash and not have a consequence, he is mistaken.
The financial markets have been running on dirt cheap money (0.1%) the past few years. I wonder if some folks with white spats haven’t whispered to Bernanke, “If you quit on QE we will be okay. But whatever you do, don't give up on the high-octane liquidity!”
- IMHO if the US economy is buying up 15m cars (annually) it is not in crisis, and does not need emergency monetary measures. I’m not ignoring high unemployment. I’m saying the problem is structural. Hot money can't fix this problem and hot money is causing other problems. The question is, “Is the Fed thinking like this too?”
The Fed has a dual mandate: Price Stability (PS) and Maximum Employment (ME). If Bernanke had been asked the question at any time over the past three years,
“Between the two mandates, how are you allocating your efforts?”
Bernanke would have answered:
“99% to ME and 1% to PS.”
What would Bernanke’s answer to this question be today? Would he say:
“95% to ME and 5% to PS.”
Or would he say:
“We’re back to 60 - 40”.
Answer: It isn’t 99 - 1 any longer, and we’re still a long way from 50 – 50. But the needle has moved on this measure. This too is very subtle, but not insignificant.
- As Bernanke withdrew one card from the deck, he has inserted two jokers. These jokers can be played by Ben anytime he likes it. He just needs an excuse. I wholeheartedly agree with the sentiment that all it would take was a 20% correction in the S&P and we would have QE3 in a NY minute.
Think about that. It’s insane, but it’s also true. The economy can’t expand unless the S&P steadily rises. What was once cause and effect is now effect and cause.
- Bernanke has a bad sense of timing. He iniated QE2 in response to an “invisible wall”. He launched Operation Twist in response to a slowdown he (and others) thought was coming last summer. Neither of those “slowdowns” actually happened. It was just the New Normal ebb and flow of the economy. Bernanke missed the signs.
I wonder if Ben is suffering another bout of bad timing. He is sailing a big ship and it is on fast forward. He is sending out signals that he going to slow the ship down. Definitive evidence that the ship is slowing will come when/if the Fed announces that it will not extend Operation Twist. (The White Spats folks are insisting it’s coming in June).
If the Fed does not renew TWIST, then the history books will say that this was the turning point of a move away from monetary accommodation. Those books may compare the timing of the Fed's transition to the fateful tightening steps the Fed made in 1936 that precipitated the second leg of the Great Depression. Funny thing about those history books.
- Absent a blow up in the stock market, I don’t think that Operation Twist will be renewed. That will be a big surprise to the folks with the spats. The likes of Morgan Stanley and PIMCO are loaded up for a new MBS TWIST.
I believe that the deep thinkers on Wall Street are missing the political angle on this. Bernanke’s hands are tied by the election. If he comes forward in May with a New Twist program that will last through November 15th, the Republicans will (rightly) call foul. Bernanke does not want to take the resulting flack. It would tarnish his and the Fed’s image.
- There will be no more QEing or TWISTING until after Christmas. By then, the fiscal time bombs that are set to go off on Jan. 1 will make any steps the Fed takes irrelevant.