US economy has been aggressively & actively managed by the HEAVY
hand of the US Federal Reserve system since the summer of 2007, in my
opinion. During this era we have seen the Fed Funds rates slashed from
above 5% to .25% and held there for over a year.
We have seen the Federal Reserve purchase the Maiden Lane assets
from Bear Stearns. For an encore, they returned to do it again with
AIG….twice. The Fed also started a series of special liquidity
facilities, including one with that exact name. These facilities, like
the Term Auction Facility, Primary Dealer Credit Facility, & the
Term Securities Lending Faculties to name a few, were intended to
enhance system liquidity.
We have seen the Federal Reserve roll out Quantitative Easing
1.0 (buying of MBS), Quantiitative Easing “Lite” (the MBS roll off, and
replacement with US Treasuries), & Quantitative Easing 2.0 (direct
POMO operations to support treasury prices as needed anywhere in the
The sum of these actions are that the US Federal Reserve has
generated credits on its own balance sheet, which have been used to buy
up US assets at no *Actual* cost to the Federal Reserve. Their balance
sheet has more than doubled in size during this short time frame as the
Bank has injected liquidity into its member banks.
The US dollar has experienced significant pain during this process,
dropping against both other fiat currencies, but also against most
commodities. Very recently, the market has been expecting some kind of
comment on the continuation of Quantitative Easing, now expected to be
called Q.E. 3.0.
However, it now appears that the end of this cycle could be
arriving. The much ballyhooed Quantitative Easing 3.0 has not yet been
defined and, if the US economy continues to grow, may not be needed at
Federal Reserve has a unique structure with regional Presidents. This
gives the Federal Reserve a choral affect at times. Since the Fed
allows each of these regional Presidents a chance on the podium, it
gives us a chance to hear more than one voice on a topic when it
concerns the state of the economy.
Lately, the historically outnumbered hawks on the Board have been
waiting for a change in the rolls of voting members. This change has
taken place, and with it a new voice of concern over the actions already
taken has started to arise from voting members.
The first of these comments caught my eye today. It was from the
Philadelphia Federal Bank President Plosser, who announced a wish for
the Federal Reserve to change its dual mandate of growth balance with
controlled inflation, to an inflation-only focus. There are significant
ramifications to this, if it were to happen. It is very interesting in
the context of the future actions of this Fed, once we reach the stage
when we need to unwind the Quantitative Easing already in play.
Fed’s Plosser ”Headline inflation is all that matters. Core only matters to extent it helps predict headline inflation
The news flow on this Friday was fascinating, with a burst of Federal
Reserve Presidents making public comments on the same topic. It was
very obvious, that this has been under discussion for awhile, and a new
round of jaw boning is getting started. In a matter of hours, I counted
no less than 5 comments from the Federal Reserve and its new club of
hawks. The silence from the rest of the chorus was…. interesting!
“Following through on that to the tune of $600 billion,
like we’ve said, I think is appropriate,” Chicago Fed President Evans
told reporters at the regional bank’s headquarters. “I personally don’t
see as many needs for a further amount, as I probably thought last
It appears that votes are changing within the makeup of the Federal
Reserve’s voting members. This could have serious implications in the
coming months if the US economy slows down, and lack of liquidity starts
to become significant again.
Minneapolis Fed President Narayana Kocherlakota told reporters in
Marseilles that the U.S. economy would need to worsen “materially” for
the bank to consider further bond-buying.
Evans comments, along with those of Atlanta Fed President Dennis
Lockhart who said on Friday that “it’s a high bar” for the Fed to do
more, suggest the debate at the Fed has moved away from a consideration
of further easing.
It appears that Q.E. 1, lite & 2.0 will be drawing to a close by
the middle of this summer, if only for a few months, while the system
attempts to see if it is capable of standing on its own without
liquidity injections from the Fed.
“The economy is looking pretty good,” Bullard told
reporters in Marseille, France, today. “It is still reasonable to review
QE2 in the coming meetings, especially this April meeting, and see if
we want to decide to finish the program or to stop a little bit short.” Bloomberg
“The oil price increases so far is not enough to derail
the U.S. recovery at this level,” Bullard said. “If oil prices stabilize
where they are, we’ll be fine.” Prices would have to go substantially
higher for there to be a “significant and material effect,” he said.
“We have to weigh those in the decision” on whether to stop the Fed’s QE2 program earlier than planned, Bullard said.
I honestly expected that the events in Japan had green lighted the
Fed to start Q.E. III. But it appears that the shift in the votes,
along with expected massive stimulus expected to be generated in Japan,
has slowed the need. It appears that Japan will be providing the world
with liquidity, as it rebuilds its infrastructure.
When you consider that the IMF (realistically a vehicle typically
funded by the US Gov indirectly) is going to need to help bail out the
European banking and sovereign debt markets again. It is possible that
the Federal Reserve maybe be ready to firm up the value of the US
It has been the proverbial one way trade for a while now. The words
of the different Presidents of the US Federal Reserve in the last few
days, and their actions and words in the coming weeks maybe pointing
towards a change in the Bernanke Put.
If so, commodities may have a headwind in the near term, as the US
seeks to raise the value of the US dollar, which is used to price
commodities with around the world.
I expect we could see rates raised in 2011, and the start of a
possible winding down the HEAVY hand. If so, the markets will be acting
confused for a while, as major shifts in strategy take shape. The last
thing anyone expects now, is a STRONG US Dollar.
When you consider that Bill Gross has gone flat US Treasuries, and
they are supposed to be 40% or so of his bench mark, a surprise small
rate increase by the Federal Reserve would make more sense, than not, in
my opinion. In fact, you could argue it’s already long over due.
Confessions of a Macro Contrarian