Bianco on Fed Action

Today’s FOMC Meeting

  • – Fed Likely to Signal Economy Improving, Keep Interest Rates Low
    Federal Reserve officials may today indicate their $1 trillion injection into the economy is helping to revive growth without requiring an increase in interest rates from near zero, economists said. Policy makers will probably maintain their commitment to keeping rates low for an “extended period,” said Laurence Meyer, vice chairman of Macroeconomic Advisers LLC in Washington and a former Fed governor. They may also start a discussion about altering the wording of their policy statement, to leave them more leeway to signal a change in the future. Chairman Ben S. Bernanke and his colleagues are reluctant to raise rates until the labor market shows signs of recovery, even though a report last week showed the economy resumed growth after 12 months of contraction. The Fed isn’t yet willing to signal that it’s ready to join central banks in Australia, Norway and Israel in pushing borrowing costs higher.


In our new product Market Talk (free trial), we discussed today’s FOMC meeting.  We believe the change in language is a big deal.  Last week Steven Beckner commented that the Federal Reserve would not change the wording of its statment, prompting us to respond:

Simply put, Beckner is offering the opinion of the “mainstream” Federal Reserve officials (Bernanke, Kohn and Dudley).  Our guess is he fails to incorporate the views of Governor Warsh (op-ed WSJ, the next day) and Bank Presidents Plosser (Philadelphia), Bullard (St. Louis), Lacker (Richmond) and Hoenig (Kansas City).  This group has all made explicitly hawkish statements since the last meeting (September 23).  Our guess is that the hawks are very uncomfortable with the current stance of Federal Reserve policy.  This should not be a shock given the unprecedented and inconceivable actions of the Federal Reserve over the last year. How could everyone agree?

Are these hawks so uncomfortable with FOMC policy that they are willing to dissent?  If so, they will get their language change (and inch the Federal Reserve closer to an exit strategy). Or, are they so afraid of the monster they unleased that they are all talk and no action?

And back on October 26, we noted this Goldman comment:

  • Barron’s (Oct 26) – RANDALL W. FORSYTH: Language Lessons at the Fed
    Goldman Sachs opined in a research note in the wake of the Financial Times article Friday that “we believe that there is still little appetite for tightening any time soon among ‘mainstream officials,”‘ as the FT article put it. Goldman inferred that meant Fed Chariman Ben Bernanke and other FOMC members close to him. But even if rates are held steady, a modest change in the FOMC’s verbiage “may be an acceptable price to be paid for avoiding dissents over the next few months,” Goldman’s economists added. Ultimately, they conclude, the policymakers’ decisions will depend first and foremost on economic data. Goldman thinks slower growth and further significant declines in core inflation next year are likely to preclude rate hikes until late 2010.

CommentThe “mainstream officials” mentioned above are Bernanke, Kohn and Dudley.  Is Goldman suggesting Bernanke is throwing the dissenters a bone by changing the verbiage of the statement in exchange for their votes?

All might not be well at the Federal Reserve given the deep divisions about policy. It appears they are trying to fool everyone into believing they have everything under control, while the opposite might be the case.

Prior Fed Comments:

What Will The Federal Reserve Do?

  • The Wall Street Journal – Fed’s Path to Higher Rates Begins to Take Shape
    What will a Fed tightening cycle look like? When will it begin? Fed officials don’t have answers to either question yet, and investors would be wrong to think they do. But the contours of what a rate-boost cycle could look like are beginning to come into focus as the Fed’s next policy meeting approaches Tuesday and Wednesday. Three points emerge: First, an internal debate on tightening policy and how to communicate that to the market is only just beginning, and most officials don’t believe the economy is near healthy enough yet to move toward tightening. Second, don’t count on a tightening cycle to look like the last one. And third, the behavior of financial markets could take on added importance this time. In the weeks ahead, officials are likely to begin elaborating on the economic outlook and speaking more directly about how that will affect their decisions about interest rates. Fed Vice Chairman Donald Kohn took a step in that direction in a late September speech, in which he pointed to how hard it will be to fill in the blanks for investors.


Let us parse the passage above.

Fed officials don’t have answers to either question yet, and investors would be wrong to think they do.

Translation :  The Federal Reserve doesn’t know what to do and those that think they have a clue are mistaken.

First, an internal debate on tightening policy and how to communicate that to the market is only just beginning, and most officials don’t believe the economy is near healthy enough yet to move toward tightening.

Translation:  The Federal Reserve is having a civil war among it members.  Many are very worried about this policy but are being bullied to follow the Bernamke, Kohn, Dudley mandates.  “Most officials” are Bernanke, Kohn and Dudley and the other members are supposed to shut up and follow their lead.

And third, the behavior of financial markets could take on added importance this time.

Translation:  The Federal Reserve is scared to death that they are creating the third big asset bubble of the last dozen years.  The problem is, as Don Kohn said last month, they do not understand the monster they have unleashed:

Our limited knowledge of the determinants of asset prices and their effects on credit has made it more challenging to respond to the crisis and explain our actions to the public. … More generally, while most of the literature on the effects of monetary policy assumes that the federal funds rate is the single relevant tool for monetary policy, the financial crisis has shown that a wide array of policy measures, acting on the prices of different assets, may be needed in extreme circumstances. The research literature that could help gauge the potential impact of these measures–and the exit from them–is disappointingly sparse.

  • The Financial Times – Wolfgang Münchau: We must not be too late with starting the Big Exit
    Central bankers all over the world are asking themselves the same question: when is the time to start the Big Exit? It surely cannot be now, or can it? I suspect the right answer is: perhaps not now, but earlier than you think.  Exiting will be a multi-stage process. The technical details will differ from one central bank to another. For the European Central Bank, I would expect the programme to begin with a withdrawal of long-term refinance operations, to be followed by a tightening of the conduct of ordinary liquidity policies. And before the ECB starts raising its main short-term interest rate, it will first raise the deposit rate – at which banks can deposit surplus cash.  There is plenty else to do before raising rates. So it will take time. Given the bubbles that are already building up in several markets, this may well be too late. Ronald McKinnon*, professor of international economics at Stanford University, recently made a convincing case for a moderate increase in US interest rates. He argued that this would help the money markets to return to normal, put a floor underneath the dollar, and help China stabilise its economy. His arguments appear sensible to me. His advice will not be heeded.  I would add two further reasons why the time to raise short-term interest rates should be drawing nearer. The first is that the extremely low level of nominal interest rates in combination with central bank asset purchase programmes has led to a mighty bond market bubble that could inflate further if nominal interest rates remain at levels close to zero. Even if real interest rates are not excessively low, what matters here are nominal rates.
  • Forbes – Bert Dohmen: Smoke, Mirrors and ZIRP
    A zero interest rate policy is the only way that Wall Street can create the temporary illusion that all is well. Don’t fall for it.
    There is very little, if any, investment buying. In my view, we are seeing a mini-bubble in the stock market, fueled by ZIRP, the “zero interest rate policy” of the Fed. Bubbles eventually lead to pain and tears, although they usually last longer than even the bulls expected. However, right now, all the professionals think they can be the first ones out of the exit. They thought the same in 2007 and 2008. And we know how that ended. Do you think you can exit in time?
  • Forbes – The Amnesia in Financial Markets
    A surfeit of money has led to loony prices in the financial markets. Sound familiar?
    There’s such a desperation for yield now, you have to wonder if people have learned any lessons” from the crash, says Berwyn Income comanager George Cipolloni, who has loaded up on junk but shunned lower rated issues. The sickly Bs are expensive now, with prices up 43% so far this year. As for why risky assets are in vogue, look to Fed Chief Ben S. Bernanke. The $2 trillion he has pumped into the economy and his zero interest rate policy may have spared us a second Depression. But by pushing rates down everywhere, he has driven investors looking for extra yield to the riskiest paper and allowed them to lever up these bets cheaply. The last time the monetary spigot was wide open it led to a credit bubble, a stock bubble, a private equity bubble and a housing bubble–and we all know how that ended. But instead of fear we seem complacent. One sign: The VIX Index, which measures investor expectation of stock volatility, is back down to the level of October 2007, when shares were near their highs.
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