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Posts Tagged ‘Bernanke conundrum’

Fed Statement: The Good, The Bad and The Ugly

Posted by Larry Doyle on June 24th, 2009 4:20 PM |

The Federal Reserve released its much anticipated statement on the economy this afternoon. What did we learn? Let me provide a synopsis of Bloomberg’s coverage of the  U.S. Federal Open Market Committee June 24 Statement:

The Good:

> Conditions in financial markets have generally improved in recent months.

> Household spending has shown further signs of stabilizing

> Businesses appear to be making progress in bringing inventory stocks into better alignment with sales.

> the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustained economic growth in a context of price stability.

> substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

The Bad:

> household spending remains constrained by ongoing job losses, lower housing wealth and tight credit.

> businesses are cutting back on fixed investment and staffing

> economic activity is likely to remain weak for a time

> prices of energy and other commodities have risen of late

In typical fashion, the Fed has attempted to cover all the bases and calm the markets. Were they successful? Not really. Why? The Fed remains between a rock (an exceptionally weak economy) and a hard place (providing excessive stimulus which will exacerbate fears of inflation given the explosion of the Fed’s balance sheet). The Bernanke Conundrum remains very much in place.

How have markets reacted to the Fed statement?

The Ugly:

> Bonds have sold off as the market was hoping the Fed may have provided a pleasant surprise in the form of an increase in its quantitative easing. With the selloff in bonds, interest rates moved higher by approximately 10 basis points (1 basis point is .01%) and the 10yr U.S. Treasury is now quoted at 3.7%.

> Equities also sold off with the DJIA and S&P 500 both retracing by approximately 1% after the Fed’s statement. The Nasdaq has held up given positive earnings from Oracle.

What does it all mean?

Sense on ¢ents believes interest rates will continue to work their way higher given the overwhelming funding needs for the foreseeable future (remember our funding needs this year are projected to be $3.2 TRILLION, a mere quadrupling of the last few years). As rates move higher, equities will gradually decline from current levels.


Bernanke Conundrum

Posted by Larry Doyle on June 8th, 2009 7:27 AM |

Overnight markets indicate that Treasury prices are lower and interest rates subsequently higher (remember the inverse relationship between bond prices and interest rates). 2yr Treasury notes are trading at 1.33% and 10yr Treasury notes are trading at 3.85% (both are .03% higher from Friday’s close).

If interest rates are higher, clearly that move must be an indication that economic activity is improving and equity markets should be higher overnight, correct? In “normal” economic times, perhaps that line of reasoning would hold water, but in the Uncle Sam economy, we need to go deeper.

Equity futures indicate our stock markets will open lower by approximately 1%. What’s going on? Welcome to the Bernanke conundrum! What is the riddle wrapped inside our economic enigma? How can Fed chair Ben Bernanke nurse our economy back to health while at the same time maintaining the necessary fiscal independence, integrity, and discipline of robust Fed policy?

Big Ben has used aggressive measures to backstop a wide swath of our markets. In the process, he has created a fair amount of stability but with an effective government guarantee “insurance” policy as the cost of stability. Some of these policies have lessened in size as certain sectors have normalized. However, the major Fed programs remain in place. What are these?

1. quantitative easing: commitment to buy $1.3 trillion in total of Treasury and mortgage-backed securities in an attempt to keep these rates down. Then why are rates rising? More on this in a second.

2. commitment to provide necessary liquidity as needed to support the “wards of the state” including Freddie Mac, Fannie Mae, GM, AIG, Citigroup.

These programs in conjunction with the massive deficit spending programs undertaken by the Obama administration have ballooned our expected funding needs in calendar 2009 to upwards of $3 trillion, a fourfold increase over prior years.

In my opinion, interest rates are moving up much less on any real signs of economic improvement than on these funding needs and very real signs of a monetary printing press malfunction. What’s that? With the Fed Funds rate at 0-.25%, the Fed is literally flooding the economy with cash. Where is that cash going? Is it flowing through to the economy? Not really.

The cash is pouring into the banking system to cushion and support financial institutions from the ongoing losses connected to rising defaults on credit cards, residential mortgages, commercial real estate, and corporate loans.

The market is now very clearly sending a signal to Bernanke, Geithner, Obama and team that if they want to continue their programs as designed (and they do and will), the price, that is the rate of interest, is going up. Why?

The market is very concerned that the flood of liquidity will lead to inflation if not rampant inflation and potentially hyperinflation. How does Bernanke head that off?

Withdraw the very liquidity that he has found so necessary to pour into the financial system. How does he do that?Two ways.

1. increase the Fed Funds rate: that is, make borrowing more expensive.

2. reverse the quantitative easing program so that the Fed actually sells Treasury and mortgage-backed securities into the market and takes liquidity out in the process. What are the impacts of both those maneuvers? Higher interest rates.

In fact, interest rates are moving higher already in anticipation of Bernanke being forced to make these moves. Can Bernanke “thread this needle?” What will happen if interest rates move higher?

Slow the economy, especially housing given higher mortgage rates, and lower earnings especially for financial institutions. To wit, our equity markets are lower overnight.

Nobody said this was going to be easy.


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