One of the most exciting events in the middle of every month for monetary policy followers is the release of the Federal Reserve Board minutes from the previous month’s meeting.
The minutes of the central bank’s rate-setting committee last week provided insights on how and when Bernanke & Co. plan to end quantitative easing and tighten monetary policy. The minutes said that a few participants “thought that economic conditions might warrant action … later this year.”
But that group was shown to be in the minority, because most participants were said to be concerned that “an early exit could unnecessarily damp the ongoing economic recovery.”
In short, outside of a few inflation hawks, the majority said they did not plan to tighten until next year at the soonest, which is pretty much what we gathered from Fed chief Ben Bernanke when he held his first press conference after that meeting.
Analysts at Capital Economics told clients yesterday that they think tightening is not likely until well after that — more like 2013 — particularly if fiscal policy is tightened a lot. This is big news for investors, because the starts of rate-tightening periods are periods that can be very tricky to navigate, like ice on a steep hill.
In discussing how to go about tightening policy, nearly all Fed officials agreed that the first step would be stopping its program of reinvesting payments of principal on the Fed’s mortgage-backed securities and Treasurys. The minutes showed that the majority favored not actually selling any assets until after short-term interest rates were rising, and then on a pre-determined, pre-announced path.
The path probably goes like this: a) end QE2 next month, with no hint of QE3; b) maintain size of the balance sheet for a while but eventually start the normalization process by announcing the end of reinvestment of agency and Treasury securities; c) begin conducting regular reverse repo actions; d) change the statement’s forward-looking language by dropping the “extended period” language; e) raise the Federal Funds target rate; f) start selling assets.
My guess, based on research and intuition, is that there will not be a rate hike until at least a year past the end of QE2 — so figure potentially the summer of 2012, but most likely not until after the presidential election that year. So mark your calendars for January 2013.
Bottom line: The Fed is still on investors’ side, and that is a green light for speculation in commodities and equities. It’s going to be hard for bears to make much headway while liquidity is still firm.
Bernanke knows that his main patron, President Obama, will face stiff opposition in the 2012 election if unemployment remains above 7.5%, so he is very unlikely to make any moves that will pull the support of cheap money from U.S. businesses. And while much of that cheap money will find its way into productive uses, like new factories, a lot is going to go straight into mergers, stock buybacks and other shareholder enhancing activities. Party on.