As always happens, about a week after Goldman telegraphs the need for QE3, which they did last Friday, the WSJ's Fed mouthpiece Jon Hilsenrath reaches out to the media and proceeds to give the secret QE handshake. Now in its third iteration. In an "exclusive" interview with the Fed's last tree monetary affairs committee, Donald Kohn, Vince Reinhart and Brian Matigan, Hilsenrath observes that according to these masters of the universe the chance of another recession is 20-40%, which we are confident is a given at 100%, but more importantly, he quotes Don Kohn who "said the Fed still has some options to support the economy, but "they're kind of limited." He said he expects the central bank, which holds a policy meeting Aug. 9, to wait and see whether the recovery is really losing steam before taking any action. If that's the case--and inflation is coming down--then he would give "very serious consideration" to a new round of bond purchases, he said." Well, the 30 Year is at 2011 lows, TIPS are screeching, and stocks are plunging: all indications that the market anticipates deflation. Looks like the only wildcard is whether the FOMC will determine next Tuesday that the economy has slowed down. Which it has. We believe the August 9 statement will be very interesting to most, and will result in some quite serious market volatility, as ever more are pricing in hints of an imminent resumption of LSAP or, in the least, Operation Twist with the confirmation likely to come at this year's Jackson Hole meeting, as we predicted back in April.
From the WSJ:
In an exclusive interview this week with The Wall Street Journal, Donald Kohn, Vincent Reinhart and Brian Madigan--the last three directors of the Fed's powerful monetary affairs committee--put the risk of a new economic contraction at between 20% and 40%. Madigan and Kohn said the Fed should consider a third round of bond purchases only if inflation slows from recent elevated levels and if the economy continues to underperform. But they cautioned a new purchase program, dubbed QE3, wouldn't represent a cure-all.
Reinhart, who said he gives Congress "a very low grade" like most Americans, believes the odds of a credit downgrade by rating companies haven't changed following the debt deal. Standard & Poor's was looking for 10-year budget cuts of $4.0 trillion to confirm the U.S.'s top-notch AAA rating.
Madigan, who advises Barclay Capital and teaches at Georgetown University after retiring from the central bank a year ago, said the Fed's $600 billion bond purchases that ended in June had a "relatively modest" positive effect on the economy. "Purchases of that order of magnitude could be helpful at the margin," he said in his first public interview since leaving the key position at the Fed.
"We're flying the plane slower and closer to the ground, so we're less resilient to adverse shocks," said Reinhart, who puts the odds of a new
recession at 40%. Following a financial crisis, seven out of 15 countries studied by Reinhart have experienced two recessions over a 10-year period.
Most important were Kohn's remarks:
Kohn said the Fed still has some options to support the economy, but "they're kind of limited." He said he expects the central bank, which holds a policy meeting Aug. 9, to wait and see whether the recovery is really losing steam before taking any action. If that's the case--and inflation is coming down--then he would give "very serious consideration" to a new round of bond purchases, he said.
Kohn noted the deal leaves lots of uncertainty over the path of fiscal policy, making it harder for the Fed to decide what to do with monetary policy. The debt deal doesn't specify what happens to the payroll-tax cut enacted in January and passes on the key long-term decisions of cutting the deficit to a bipartisan committee.
While more bond purchases could help the U.S. economy at the margin, Madigan said that providing more explicit guidance on how long the Fed's short-term interest rate remains close to zero--another easing option mentioned by Bernanke--wouldn't be so effective.
The irony is that we all know the Fed knows one thing and one thing only: printing, and any of its infinite variations, which can be named anything but which do nothing to change the fact that the Fed will i) continue to push risk assets higher, ii) continue to take on ridiculous duration risk: its DV01 now is about $1.5 billion if not more, and iii) issue its daily Conviction Sell Price Target on the USD as zero in the medium- to long-run.
Everything else is much overused foreplay and strategically placed mirrors.