What Is On Bernanke's Easing Menu?

Tyler Durden's picture

As Messers Frank and Paul take on the Bernank this morning, we reflect on the four easing options that the illustrious fed-head laid out in a statement-of-the-obvious that still managed to get the algos ripping. As Goldman notes, his prepared remarks were terse (and lacking in 'easing options' discussion) - cautious on his outlook, concerned at Europe, and fearful of the 'fiscal cliff' - but his response in the Q&A were a little more revealing as he laid out his choices: asset purchases, discount window lending programs, changes in communication about the likely path of rates or the Fed balance sheet, or a cut in the interest rate on excess reserves. We discuss each below but note, just as Goldman believes, that while we think that a modest easing step is a strong possibility at the August or September meeting, we suspect that a large move is more likely to come after the election or in early 2013 (and not before), barring a very rapid further deterioration in the already-cautious near term Fed economic outlook (which we assume implicitly brings the threat of deflation).


Goldman Sachs, US Daily: For Your Consideration, the Next Set of Easing Options

The prepared remarks on monetary policy gave a brief explanation of the intended mode of operation of the "twist" (known in Fed parlance as the maturity extension program or MEP), and recapped the policy stance of the last FOMC statement. Notably, the prepared text did not include any mention of easing options, though some market participants seem to have expected this, judging from recent client conversations and the market reaction immediately following the publication of the testimony. While this omission certainly does not preclude easing at the upcoming meeting, it does suggest that further action is by no means a foregone conclusion at this stage.

As is often the case, the ritualized give-and-take with lawmakers following the prepared remarks was somewhat more revealing. Chairman Bernanke was asked in a few different ways about what would trigger further Fed easing, and what options would be on the table if the Fed chose to do more.

When asked what would trigger more easing, Bernanke said in one response that the Fed wants to see "progress towards more satisfactory labor market conditions" and in another that easing would turn on whether there is "a sustained recovery going on in the labor market or are we stuck in the mud". Of course, he also included comments on the inflation side of the mandate, which were notable for their dovish stance. Bernanke characterized inflation risks as "relatively low now" (though he noted that "not everyone agrees" with this assessment on the FOMC), and even suggested a "modest" risk of a deflationary outcome. Both the ordering of the responses, with the employment side of the mandate always coming first, and the benign view on inflation reinforce our sense that labor market data in general--and the unemployment rate in particular--will be the most important determinant of the timing and extent of further Fed easing.

Pressed to elaborate on what more the FOMC could still do to support the economy, the Chairman described a "logical range" of four monetary easing options: 1) another round of asset purchases focused on Treasuries and/or agency mortgage-backed securities, 2) use of the Fed's discount window for lending purposes, 3) changes in communication regarding the likely path of interest rates or the Fed's balance sheet, 4) a cut in the interest rate on excess reserves (IOER), currently 0.25%. The following table illustrates our estimates of the likely effect of these options, along with some pros and cons of each.

The notable new item on this list is the use of the Fed's discount window. (An IOER cut has been discussed on previous occasions and apparently rejected, so its appearance here is not new but does suggest a re-evaluation of the cost/benefit tradeoff associated with this tool. One reason for its return may be the recent "demonstration effect" of the cut in the European Central Bank's deposit rate, which does not appear to have caused significant market disruption.) At the June press conference, the Chairman responded with enthusiasm when asked about the Bank of England's "funding for lending" program, and it appears that he has something along these lines in mind -- a program of "credit easing" aimed at areas of the economy where credit availability is still constrained, residential mortgage lending being the most obvious example.

How might this work and would it be effective? The Bank of England's program creates a facility whereby banks can exchange government securities for mortgage loans, and then use those government securities to obtain cheaper funding via the repo market. The amount and cost of funding available for each bank will depend on its rate of loan growth, with funding available for a portion of the existing loan book plus all incremental lending, and costs designed to ensure that the marginal incentive for new lending is high. (For more details see Kevin Daly, "BoE/Treasury announce details of the "Funding for Lending Scheme", European Views (UK), July 13, 2012.)

Relative to the situation in the United Kingdom, it is less clear that an analogous Fed program would be effective. US housing activity is clearly improving already. Also, according to a rough estimate from our banking analysts, US banks' funding costs are about 100bp lower than UK banks on average, with a ca. 65bp all-in weighted cost of funding. So the potential drop in US bank borrowing costs from a BoE-like scheme appears more limited. This raises the question of how much additional lending to end users would be incentivized, even leaving aside the possible reluctance of banks to participate in such a program. Of course, Fed officials' ability to provide incentives is also limited by their inability to take private-sector credit risks. Thus, at this early stage, we see any such program as likely to have a fairly modest impact.

What then should we expect from the FOMC at its upcoming meeting on August 1? As previously noted, the lack of inclusion of easing options in the prepared testimony suggests a lower probability of a "big" easing step, at least on the margin. Furthermore, Bernanke has defended the recent extension of the twist as a "substantive" easing; this is one reason why we have been doubtful that another asset purchase program would follow it quickly (see Jan Hatzius, "Bernanke Preview", US Daily, July 16, 2012). The seemingly biggest easing option on the table, asset purchases, is the most controversial, and any "funding for lending scheme" probably will require somewhat more preparation and planning. This leaves a cut in IOER, which would seem very small by itself, or an extension in the rate guidance. To us, extending the current guidance that rates will remain "exceptionally low….at least through late 2014" seems the path of least resistance should the Fed choose to ease in August or September. Moving the guidance out to mid-2015 would simply maintain the nearly three-year freeze implied by the current guidance when it was originally rolled out in January.  


The bottom line: our base-case expectation is for an extension of the rate guidance by September, with a larger easing action (asset purchases or a "credit easing" program) in December or early 2013.

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FEDbuster's picture

"we suspect that a large move is more likely to come after the election or in early 2013 (and not before)"

Why wait?  There is no difference between Obama and Romney, both love the FED and Bernake.  If Bernake is going to print ("it's the only thing he knows how to do" Jim Rogers), then fire up the printing presses.  QE till it collapses the dollar.

firstdivision's picture

10year yield falling, markets rocketing up, I've seen this before...and the market was disappointed last time.

SmoothCoolSmoke's picture

It now seems the best thing for the Bears would be for the QE to happen.  That might be the final top to the markets....the last "Fed bullet" into the gut of the Bulls.......... they will linger for awhile, but soon die.

buzzsaw99's picture

I was expecting a check for $3K and instead I get this shit?

TheCanadianAustrian's picture

Part of me thinks that Ben isn't anywhere near as ignorant as he used to be. He might just genuinely believe that the next round of QE is the end. He may have done some terrible things to the global economy, and he may have been nowhere near competent enough for the job he was offered, but part of me feels sorry for him.

He might just be coping with the guilt that he's responsible for the pending collapse of the world economy, and in many ways, he might have reason to fear for his life when things really start to fall apart. This might be why he's not willing to do "official" QE until bonds falls apart or big banks start giving their employees 20 minutes to pack up their belongings and leave.

Imagine what it would do to world markets if the next suicide note we found was Ben Bernanke's.

caustixoid's picture

Feeling sorry for the willing sociopathic puppet of our banking overlords?  thinking he feels guilt? Ahhh, that's so sweet.

lasvegaspersona's picture

I likeBen

He has kept the gold price in my range for years....XXXOOOXXX Ben

bagehot99's picture

The lack of borrowing in the economy isn't because there aren't enough fucking Federal programs, FFS. This is all pushing on a piece of string. Bernanke is a complete and utter incompetent, and he's doing no more or less than attempting to get Obrezhnev reelected. Staggering.

Bartanist's picture

People don't trust the system simply because it has been proven to be untrustworthy and unrelaible. Daily new evidence appears showing that the financial systems and corporatism in general is rigged and the people in charge are criminals, working at odds with this country and its people.

... and I will still not vote to re-elect Obama because he is a liar and a fraud. He cannot be trusted either. How can we vote for someone who is so completely undeserving of trust?

Bartanist's picture

I am thinking that the answer is to disintermediate banks and allow people to borrow directly from the US government... and dissolve the Fed (wiping out the US debt it holds) so there is no question about who is in charge and who they are responsible to.

The large international banks have become untrustworthy and the people who run them are known criminals. It seems best to rectify this fundamental flaw first, then move on under another system with direct accountability and no bloated and unearned banker salaries for the US people to support.

kito's picture

US housing activity is clearly improving already....


and here folks, is why you should NEVER listen to these shortsighted manipulative inbred bank analysts, especially ones that should have been wiped from the market if not for a sudden decision to make them bank holding companies......

Mr Lennon Hendrix's picture

We have had eight diferent QEs and POMO and OT2 continue, and we are still focuesing on the "Next QE".  Bernanke is using Sun Tzu's playbook - he has his enemy (YOU) distracted on future events while he continues to war against your value of wealth.

QE Continues....

Dr. No's picture

I suggest rather than ctrl+P, he sell one oz gold coins (he can even put his face on it for all I care) priced at $42.50 (or whatever their current book price is) to US citizens.  On paper, he will think this deflationary since he is pulling money out of the economy.  However, this will decrease his balance sheet, allowing him to continue QE3 for him and his friends.  The total $ amount of QE3 will be the same as the proceeds from selling the gold.


Everyone is happy.

RobotTrader's picture

No QE is necessary any longer because many Dow stocks like INTC and HON are soaring today.


S & P 500 looks like it is headed to new 3-year highs this summer, there is no inflation, interest rates are at rock bottom, so there is no need for Bernanke to do anything right now but let the market ride.

However, the Gold Bugz are getting brutalized again.

I bet lots of guys wish they never heard of King World News, their accounts are getting destroyed with consumer and tech stocks rallying and those miserable gold stocks crashing towards the 2008 lows.

OmNamah's picture

I had told every looser here about this rally and about impending change in big global macro trends. But since I m not as big as most of the fools, you ignore me.


Every guy using zero-hedge trading will make big loss on margin account but will gain immensely in skepticism, world view, and knowledge. Zero hedge is a revolution in space of blogging for sure, not trading. Its different where emotions have no place.

Don't again say I din warn you (you can search my post of last one-two weeks). Again my views are posted here www.bubbleshort.blogspot.in

laomei's picture

It's almost as if they are all out of bullets.  Have they thrown the gun yet? Or was that ZIRP?