Bernanke Takes a "Leak"
How about Bernanke's communication policy? The most important development for monetary policy in the last four years comes from a planted story in the Wall Street Journal on a Friday night. While I'm not surprised, I'm still disgusted. Press leaks to favorite journalists are no way to run this show.
The WSJ/Hilsenrath article confirms that the Fed is in the process of changing course on it's QE policy. America has reached "Peak QE", from now on it will be downhill for this policy. May will probably be the last month where $85B of securities are sucked out of the market.
The Fed's new plan is to taper off QE over the balance of the year. Unlike the endings of QE1 & 2 the sunset for QE3 will be a bit of a surprise for markets. The stated intention (according to Hilsenrath) is to change the amounts of POMO purchases on a month to month basis. Reading through the lines, I get the impression that Bernanke is going to lower the QE buys one month, but should the markets react negatively, he would increase the purchases the following month in an effort to "rebuild confidence".
I don't see this new policy working at all. It's the predictability of POMO that gives QE it's market clout. When the predictability is replaced with uncertainty, the markets will not like it. What I find particularly galling is that the Fed believes that it can micro manage US (and global) capital markets. The Fed thinks it can reduce QE one month, but if markets swoon as a result it will just turn around and ratchet up the buying the following month. By doing so, the Fed can manage the markets. I say, "Not a chance".
The market's reaction to the Fed's change in policy will be interesting to observe. I expect that there will be some weakness in equities next week. There should be some back-up in rates across the curve, and I think the dollar will move higher (especially the Yen). But I don't see a blowup in the markets. The "Bernanke Put" is still alive for the time being.
The timing of the change in policy is interesting. Bernanke is no dope, he knows what the bond market is facing over the next five months, he knows that the bond calendar is very favorable for a wind-down of QE.
In two weeks the debt limit will be reached. After that date there will be a big reduction of new Treasury debt issued. Under normal conditions, the Treasury would have about $200b of wiggle room on the debt limit before there is a crisis. But in the summer and fall of 2013 the Treasury will reap an additional $60b of revenue from (incredibly) Fannie and Freddie. Based on this, I think the debt limit will not be a problem until sometime in October. So the reality is that over the next six months or so, there will be a shortage of new issue Treasury paper. This fact gives Bernanke the opportunity to reduce QE without a a big sell off in the bond market.
Then there is ZIRP. This policy will continue for a long time yet. The fact that the near-end is pegged at zero means that the long-end can't get out of control. And finally, there is the inflation outlook - this looks to be tame for the next few months.
The ten-year may back-up to above 2% (currently 1.90%), but I don't see 2.5% coming at at anytime in the immediate future. Towards the end of the year, when the debt limit is increased (it will be) there will be a flood of new issue paper and QE will be a non factor. That's when the bond guys will be looking at supply and demand, and running for cover.
There is one element of this that gets a chuckle from me. Last week, two hedge fund guys, Stan Druckenmiller and Paul Singer made comments about the risks of QE and the distortions the policy creates. Paul Krugman jumped all over the hedge fund types who appose more QE in a series of blog posts. (Link and Link)
PK did his best to discredit Druckenmiller and Singer. PK said that those who appose Bernanke are just a bunch of stinkers who are short bonds and want to make money. PK's rant is pretty amusing, he even takes a shot at gold investors. The final line of one of the posts was interesting. PK was attempting to highlight the "greed factor" that he thought was the real reason behind money managers opposition to continuing QE. In his usual snarky way, PK attempted to convince his readers that Bernanke Bashers had to have evil intent, that or they were gay, or suffered child abuse. I thought this line was obnoxious:
So anyway, the phenomenon of Bernanke rage is interesting. It probably has something to do with sexual orientation or childhood trauma, right?
My message to Krugman:
The WSJ article today was planted by Bernanke, and approved by Yellen. Clearly, these two also see that QE is a policy that has high risk and marginal returns. The article confirms what Druckenmiller and Singer were saying. They were right - you were wrong. Do you have the integrity to admit that? Or are you going to suggest that Bernanke also has sexual orientation issues, or suffers from childhood abuse? If an elected official had used these words (even as a nasty joke) they would be called on the carpet. The words "Shit Heel" come to mind.
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