Fly on the Wall at the Fed — What They’re Thinking
by Jon Markman | October 25, 2011 6:00 am
One of the most important players in any market is the Federal Reserve. It controls the amount and cost of money in the system, so it naturally has to be at the center of our attention at all times.
That’s what makes the release of its meeting notes so fascinating, if you have the slightest bit of policy wonk in you at all. It’s like putting your ear to the door and hearing (albeit three weeks after policies are announced) what the grownups are talking about.
BMO Financial senior economist Michael Gregory always does a nice job analyzing Fed minutes. His interpretation of the October notes is that the Fed, at its Nov. 2 meeting, is not likely to embark on another round of quantitative easing, if only “to allow some time for the past two actions to percolate.” But he thinks more easing is inevitable, which ultimately is going to be a plus for stocks — possibly from lower levels.
Here’s a few excerpts from his study of the minutes of the Sept. 20-21 Federal Open Market Committee meeting:
- After eyeing the minutes … for clues to what the Fed might do next, having eased policy at this meeting (the $400 billion maturity extension program to be completed by mid-2012) … we judge the Fed will feel compelled to ease further, owing to an unemployment rate that should drift up a bit during the months ahead and fail to fall below 9% until the latter half of next year.
- The staff presented four policy tools, suggesting that these might be the leading candidates among all others at this stage: (1) a reinvestment maturity extension program (some call this a ”passive twist” since it involves no selling), (2) a System Open Market Account (SOMA) portfolio maturity extension program, which was adopted, (3) large-scale asset purchases (QE3), and (4) reducing the interest rate paid on reserves (currently the interest-on-reserves, or IOR, rate is 0.25%).
- In discussing QE3, ”a number of participants saw large-scale asset purchases as potentially a more potent tool [than twist operations] that should be retained as an option in the event that further policy action to support a stronger economic recovery was warranted. Some judged that large-scale asset purchases and the resulting expansion of the Federal Reserve’s balance sheet would be more likely to raise inflation and inflation expectations than to stimulate economic activity, and argued that such tools should be reserved for circumstances in which the risk of deflation was elevated.” The bar for QE3 thus remains high, particularly given inflation dynamics on the ground: ”Most participants agreed that inflation appeared to have moderated in recent months, compared with earlier in the year, as prices of energy and some commodities declined from their peaks, though the moderation was not as substantial as many participants had expected.”
- We got a glimpse into the degree of support for Operation Twist: ”Two members said that current conditions and the outlook could justify stronger policy action, but they supported undertaking the maturity extension program at this meeting, as it did not rule out additional steps at future meetings. Three members [obviously Federal Reserve Bank of Dallas president Richard Fisher, FRB of Minneapolis president Narayana Kocherlakota and FRB of Philadelphia president Charles Plosser] concluded that additional accommodation was not appropriate at this time.” Presumably everybody else, both voters and nonvoters alike, was supportive of the policy.
- As for the three dissenters, Kocherlakota stuck to his August dissent rationale, which was that no easing at all was warranted, while Fisher and Plosser believed that twisting would not be effective and could have negative consequences. Fisher argued that the FOMC ”should instead focus their attention on improving the monetary policy transmission mechanism, particularly with regard to the activity of community banks, which are vital to small-business lending and job creation.” This suggests he might be the least hawkish of the three.
This Fed team has been the most accommodating in history, and it is still scrambling for more ways to provide monetary tools to forestall deflation and recession. Nice to see that the FOMC members are on the case, but frankly it’s doubtful that they will act soon enough, or powerfully enough, to forestall the downshifting of the business cycle and, with it, deeper unemployment and erosion of home prices.
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