Knight Capital's Take On The FOMC Minutes

The Fed’s minutes from the December 14, 2010 meeting seem to echo our own concerns (see our “Three Threats, One Risk” report published October 6, 2010).  Though noting evidence of growth and an improving “tone” to the labor market, the Fed did not feel that the apparently improving economy warranted any change in QE.  The Fed noted that the housing market and debt problems in Europe could curb growth – further noting the impact on LIBOR funding.  The rise in unemployment was troubling to policy makers as they noted that the rise came with a backdrop of depressed labor force participation and employment-population ratios.  Further stresses come from the depressed housing market, employers' continued reluctance to add to payrolls, ongoing efforts by some households and businesses to delever, and precarious state and local municipalities’ balance sheets.  Deflation is also not totally off of the Fed’s radar either (recall it was a buzzword just a few months ago), as some participants noted that with substantial resource slack persisting, underlying inflation might fall further below the levels that the Fed desires.

The most interesting comment was that some members indicated that they had a “fairly high threshold” for making adjustments to QE2.  To our minds, this statement is twofold with respect to its meaning to the market.  First, it establishes that Fed members will not ease back on the QE program at the first hint of progress.  Their examination of past QE efforts (notably Japan’s) has led them to believe QE works and that mistakes are often made by not flooding the market with easy money fast enough.  Thus the probability of adjusting the strategy midstream is very low in our opinion.  Second, the Fed has become more of a political animal, whether it wants to be or not.  Policymakers have to weigh the fact that with new legislators entering office, the ease with which additional QE can be deployed has dropped drastically.  All the more reason to adhere strictly to the program already in place.

From Brian Yelvington