Fed Running Out of Bullets

“Fed To Hold Rates Near Zero” is the news headline today.

It is not really news. What were they supposed to do? They can’t increase the rates. Zero is as low as you can go.

There were about six notable items in the announcement.

1. The description of credit conditions changed. December 16, 2008 read: “markets remain quite strained and credit conditions tight.” January 28, 2009 reads: “credit conditions for households and firms remain extremely tight.” The key word is “extremely”. I am glad the Fed is on the same page as the rest of us now.

2. They are very worried about deflation. This is a big one. December 16, 2008 read that the Committee expected inflation “to moderate further in coming quarters.” That’s hugely different from January 28, 2009: “inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.” This also gives extra emphasis to keeping interest rates low for a long period of time as well as expanding the balance sheet for a longer period of time. In short, they want to stamp out deflation.

3. Looks like they will buy long-term Treasuries. In December, they were “evaluating the benefits”. Now on January 28, 2009 they say “The Committee also is prepared to purchase longer-term Treasury securities…” Buying Treasuries will reduce interest rates. But hey, the 10-year bond is trading at 2.6%. It is already rock bottom. What we need is a reduction of risk premia. That can only happen if they buy risky assets.

4. Other notables are the fact that they ” are likely to keep the size of the Federal Reserve’s balance sheet at a high level”. Again, that spells inflation. Expect to see longer-term inflation expectations (as reflected in inflation-indexed bond) to increase.

5. There is no change in the all available tools language. Both December 16, 2008 and January 28, 2008 use the identical language: “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” No news here.

6. It was a split vote. In December, it was unanimous. However, I don’t think the split is that notable. Lacker simply preferred to target Treasuries rather than the credit programs.

Overall, the announcement today did not offer any new ideas. That is disappointing.

Image courtesy of MicksGuns.com

Image courtesy of MicksGuns.com

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2 Responses to Fed Running Out of Bullets

  1. Nancy Andrews says:

    Dr. Harvey: what do you make of the Leading Economic Indicator index rising slightly in Dec? possibly good news? Second, the approx $1 Trillion in upcoming Alt-A and Option ARM resets — what % do you believe will default, and will this next wave of foreclosures do the same thing as the first wave of sub-prime foreclosures, or have the losses already been built into current devaluations? Many thanks for your perspective, Nancy Andrews

  2. camharvey says:

    The LEI is no news. All of the data that goes into the LEI is known before the LEI release. I view this particular number as noise. There is no economic indicator that points to a recovery. There is one financial indicator, the yield curve. However, I will reserve discussion on that one for a post in the next few weeks.
    You can make rough calculations on the amount of write down still necessary going across all assets: subprime, alt-a, prime, commercial real estate, commercial loans, etc. You need to do the same thing on securitized assets. [I would prefer not to go asset class by asset class in this comment.] I’d say another trillion – which is dangerously close to the entire capital of the U.S. financial system. As to whether the losses have been built in, the answer is yes and no. It really depends on the security. Some CMBS seem to have more built in that could possibly occur. Other assets no. In a market like this, there will be wide divergence from fundmental values mainly because of the uncertainty about what is the fundamental value! It presents great trading opportunities.

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