I'm adding myself to the long list of folks who have commented on NY Senator Chuck Schumer's choice of words to Bernanke the other day:
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Schumer is a political hack. He wants the Fed to do ‘something’ today that would give the economy a lift heading into the election. Chuck knows that the Legislative side can’t/won’t do a thing before November, so he begs Ben to light another monetary fire to help the Democratic cause. Chucky boy is an ass.
I doubt that Bernanke listens to the noise from Senators very often, but Chuck’s words got a lot of press. I'm wondering what Ben is thinking. Schumer has brought politics into the outcome of the August 1st Fed meeting. Whatever Ben decides to do, he will be accused of partisan politics.
There are many scenarios for the August Fed meeting:
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Arguments For:
a) The economy stinks, but it is not in a crisis. More “crisis monetary measures” are not justified.
b) With the 10-year already at 1.5%, the Fed can’t accomplish anything by pushing rates a few basis points lower.
Arguments Against:
The election and related political considerations will absolutely tie the Feds hands after the August meeting. The next chance for the Fed to “do something” will be in late November. If Bernanke wants to buy some insurance, he has to do something in August.
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Arguments For:
I can’t think of any.
Arguments Against.
Because there is no substance to this, there is a very strong likely hood that the markets will take a few seconds, and then puke. Bernanke knows this. He doesn’t want to lay an egg.
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Arguments For:
a) This is what the market wants to see. Failure to do QE3 will disappoint, Ben does not want to disappoint.
b) This a is “populist” approach. Ben can say that he is doing his best to allow homeowners to ReFi and prospective buyers to get a record low rate.
Arguments Against:
a) This is an “all in bet”. Even Bernanke has been questioning the efficacy of additional QE of late.
b) Senator Shelby and Speaker Boehner will say, “The Fed is printing money to play politics!”
c) Bernanke’s critics will go wild.
d) There is absolutely no certainty that another big LSAP will do a damn thing.
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Arguments For:
A small QE would create less political backlash. Ben could argue that he is being “moderate” and will, as always, be willing to do more if this modest monetary “bump” proves to be inadequate.
Arguments Against:
a) A “half a loaf” is going to fail miserably. Bernanke wants monetary policy to jack up stocks, as he thinks this creates jobs. Stocks would nose dive if this is the result. Bernanke understands this.
b) Both Blues and Reds would be upset. Schumer will be pointing at Bernanke and saying, “He didn’t do his job!” At the same time Ron Paul would be calling for Ben’s head on a platter.
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Arguments For:
a) This appears to be a modest step. As such, it would be less susceptible to criticism.
b) The small change in the deposit rate would achieve something that Bernanke has been shooting for a long time. Returns on short-term money would go negative. Three and Six month Bills would certainly be negative. One-year paper would trade around flat.
c) Germany and Switzerland are already in negative territory. Other, smaller bond markets like Finland and Sweden are also in the red. For the US to follow suit would not be that big a surprise. Bernanke could blunt critics by saying he had done less than Europe - an 1/8th in the US versus 0% for the ECB.
d) The change to negative yields, (regardless of how small), will force money to move around. There are trillions in money market funds, Trillions in short term Treasury paper, and trillions more on corporate balance sheets. All of this is now going to be looking at negative returns.
e) With the first rungs of the yield curve in the bucket, the longer maturities would be dragged down. The Ten-year would move toward 1%. This result would be similar to the (hoped for) outcome of a large LSAP.
f) Bernanke could still say, “The Fed has more it could do”, as the deposit rate could be cut again (to zero) at some point.
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I hope that the Fed sits tight, and does nothing. But that seems unlikely. Bernanke knows that the economy is now decelerating, and that his hands get tied after the August meeting. So “something” is more likely than “nothing”.
It’s hard to predict what might happen if Ben pushes rates into negative territory. It could end up resulting in an orderly market transition from cash, to high-risk securities like stocks and junk bonds. The virtuous cycle of higher stocks leading to higher spending and more jobs might be the result. But I doubt it.
Arguments Against:
a) The knee jerk reaction to negative rates might be positive, but in a short period of time the market will come to realize that negative rates are not going to force people (more) into dividend stocks. Quite the opposite, it will scare the crap out of them.
b) This is not good for the banks (who cares); but the financials are still a big chunk of the S&P.
c) This move will likely cause more “unwanted inflation”. If China or India is faced with negative returns on their reserves, they might be inclined to just buy commodities with the billions of cash they are sitting on. Prices of grains, beans, copper, coal and oil come to mind. Gold would be on the list as well.
d) If three-month bills went from +8bp to -7bp you might think that it wouldn't matter. The change is so small on a relative basis. I think of it as stepping off the edge of a cliff.
The entire global financial system is based on fiat money and the presumption that the money has “value” as a store of wealth. Nearly every action by the Fed over the past few years has led to the debasement of money. In the final stage, the issuers of money debase it to the point where it is no longer desirable to hold. I see the move to negative rates across the globe as a tipping point, one that will be damn hard to reverse once undertaken.
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