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Your Lead, Mario


Quite contrary to my expectations, not to mention those of a majority of investors and analysts, I think, Ben Bernanke’s Federal Reserve confronted the recent weak economic data and delivered almost exactly nothing.

The Fed didn’t even extend the “at least through” language. Changing “at least through late 2014” to “at least through mid-2015” was probably the smallest token gesture the Committee could have made. The language, originally perceived to be a ‘promise,’ has become a bit of a joke since the projections by members of the FOMC indicate that many of them don’t take the promise as representing any kind of commitment, merely a projection that they don’t all agree with. As such, it has zero policy value since buying 2-year notes on the basis of what the pointy heads suggest they think will be their policy a year from now would be just plain stupid. And yet, the Fed didn’t even incline its head with a small nod in this direction.

Wall Street Journal columnist Jon Hilsenrath must feel used. His column last week suggested strongly that Fed officials “find the current state of the economy unacceptable” and that they “appear increasingly inclined to move unless they see evidence soon that activity is picking up on its own.” Wall Street assumed that Hilsenrath wasn’t engaging in unsubstantiated guesswork about policy, but that the suggestion was being run up the flagpole.

Guess not.

There is certainly no evidence yet that “activity is picking up on its own.” The ISM Manufacturing Index remained just barely on the shady side of 50.0, when a bounce was expected; this included a drop in the “Employment” subindex to the lowest level since the end of 2009 (see Chart below, source Bloomberg). The data will keep on coming, of course, but so far there haven’t been any signs of imminent dawn. Indeed, the Fed continues to see “significant downside risks” in the global economy.

I admit that I thought they would do something more than merely change the non-binding promise language, and I was surprised they did not. I thought they would cut the Interest on Excess Reserves (IOER) rate back to zero. That doesn’t mean, however, that I thought cutting IOER is the right thing to do. Monetary policy here is impotent with respect to growth, and while they can push inflation higher or lower with policy the move they should make is probably to start pulling back on liquidity once Europe is clear of danger. They should not wait until money velocity begins to rise again.

But that isn’t what they will do. The Fed doesn’t believe that it is impotent with respect to the Unemployment Rate, so even though they are firing blanks at a charging enemy with no apparent effect, I fully expect them to keep on firing. It’s odd, as an analyst, to try and get into the “Fed’s brain” and think intentionally wrong, but I suppose it’s what actors and actresses do when they’re getting into character. It’s just that my liberal arts education didn’t include a thespian turn.

If I am in character as the Fed chairman, I’d be thinking it’s awfully dangerous to wait before firing my next blank bullet. Gasoline prices are back on the rise, with retail unleaded back above $3.50 (see Chart, source Bloomberg), joining agricultural produce. This means headline inflation, which currently appears tame, is unlikely to stay that way for very long. If the Fed wants to ease policy in late September, they may have to do it with less-accommodating price data.

It is possible that the Chairman is afraid to do anything unusual, like cutting IOER, unless he has a presser scheduled so that he can explain it to us poor benighted folk? This could be the case, but it doesn’t explain why they didn’t do anything.

Could it be that, with the ECB meeting tomorrow and that body very likely to ease more aggressively than the Fed anyway, that the Fed chief wanted to let Draghi ‘hold serve’? This seems strange, but it’s plausible.

In any event, investors seem to believe there is another monetary policy shoe to drop. While yields backed up slightly with 10-year yields +5bps (1.52%) and stocks dropped a trifle (S&P -0.3%), commodities actually rallied after the Fed announcement! Almost certainly, the market will get something from the ECB tomorrow, but I suspect stocks and bonds are clinging too desperately to that eventuality and I expect any rally on the news will be short-lived.

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  1. bixbubba
    August 1, 2012 at 6:24 pm

    I can’t help but think that the market is hoping for something Mario can’t deliver. A simple cut in in the Refi or even a negative depository are not what the doctor is ordering. And anything else would be open warfare with any German politician that ever hopes to be re-elected, and probably the Bundesbank too. When you say “ease more agressively”? What do you think they can actually do?

    • August 1, 2012 at 9:35 pm

      I actually think an IOER cut for the Fed would be a bazooka-like move, but you’re right, now that the ECB has already gone to zero and flushed a lot of that money, another refi cut wouldn’t do much.

      However, the ECB – unlike the Fed – can buy public securities in private companies, including corporate bonds and even equities. I don’t expect that tomorrow, but … it would be big.

  2. bixbubba
    August 2, 2012 at 7:48 am

    Tough talk, not much action. We are back to the same script: “l’Euro è fissato!” “Nein!”

    • August 2, 2012 at 7:53 am

      Yeah, looks like the Bundesbank won this round, for all of Mario’s talk about directing the ECB’s firepower on the problem of keeping the Euro together. No Fed assistance, no Bundesbank assistance…guess he was feeling a bit exposed out there alone.

  3. bixbubba
    August 2, 2012 at 8:00 am

    I guarantee he would have at least liked to have dropped the refi a notch just to keep the peasants from rioting. I mean, that would have made he look at least a tiny bit less impotent. But I bet he was smacked down even on that.

    If I had more guts today I would put in a big long europe/short US equities trade. The euro markets are taking. Ours is still looking pretty complacent.

    • August 2, 2012 at 8:11 am

      Sort of interesting the Euro is getting creamed. It SHOULD get creamed if the ECB prints, but it’s getting creamed because they didn’t and so investors are afraid of a Euro breakup! Makes you wonder why anyone was long Euro to begin with if both cases were bad for it.

  4. bixbubba
    August 2, 2012 at 8:31 am

    The technical term for this kind of market is “meshuga”. The trader’s question, at this point, is how many more times they can yell “l’euro è fissato” before the market says “nein.” Could this have been the final wolf cry?

  5. Marshall Jung
    August 2, 2012 at 9:56 am

    Looks like Bill G. has been reading your blog. “The cult of equity may be dying, but the cult of inflation may only have just begun.”

    http://www.pimco.com/EN/Insights/Pages/Cult-Figures.aspx

    • August 2, 2012 at 10:12 am

      Yes, I saw that! I don’t know Bill, but I do know just about everyone on their TIPS/inflation team. It’s a good group. Not as creative as Enduring Investments, mind you, but I can tell you they think in inflation space and they ‘get it.’

  6. bixbubba
    August 3, 2012 at 9:43 am

    “If I had more guts today I would put in a big long europe/short US equities trade. The euro markets are taking. Ours is still looking pretty complacent.”

    Sigh…if only I had more guts..

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