How Much Gas Does the Federal Reserve Really Have Left?

by ETFguide | August 29, 2011 4:21 pm

The good news is the Federal Reserve stands ready to help if the U.S. economy acts worse than expected. The bad news is the U.S. economy needs help.

Thus far, the Fed’s monetary trickery has helped to inflate U.S. stocks and U.S. Treasuries, but not much else. Fed Chairman Ben Bernanke actually went on record to say his private organization’s bond buying program could boost U.S. employment by about 700,000 over the next two years. Is he serious? If creating jobs by purchasing bonds is such a great panacea, why haven’t the 7.2 million pre-recession jobs suddenly returned?  

If we were to choose a theme song for the Federal Reserve, the 1977 hit song “Three Little Birds” by Bob Marley would be it. The lyrics are immensely reassuring, not to mention repetitive. The song’s main chorus says, “Don’t worry ’bout a thing ’cause every little thing gonna be all right.” Unfortunately, everything is not all right.

Fishing in Jackson Hole

As he does most of the time, Bernanke did not show his hand at the annual Jackson Hole, Wyo., retreat for economists. His basic message was that the Fed has “monetary tools” to fix whatever needs to be fixed.

For skeptics like us, we respectfully doubt the Fed’s potency. Since the onset of the financial crisis three years ago, its own actions have undermined its own effectiveness, strength and credibility as an institution in dealing with future meltdowns.

The next Federal Open Market Committee meeting is scheduled for Sept. 20-21. What should we expect? More of the same posturing and double talk, with a few new nuggets of meaningless data.

Fed’s Buying

Since late last year, the Federal Reserve has been the largest buyer of U.S. Treasury debt. The QE2 bond buying program which gobbled up $600 billion in U.S. Treasuries ended on June 30. This caused some observers, like PIMCO‘s (NASDAQ:PTTRX[1]) Bill Gross, to speculate that Treasury prices would fall sharply without the Fed’s continued supportive buying. Is the appetite for U.S. Treasuries by foreign buyers and other market players enough to overcome the Fed’s exit? On paper, the logical answer is “no.” However, if a pending collapse in Treasury prices is the consensus view, as it seems to be, it probably won’t happen.

For sure, the Fed’s the artificial involvement in the U.S. Treasury market remains intact. Regardless of whether they stop buying, the majority of their $3 trillion balance sheet is stuffed with U.S. paper. And furthermore, they could very well continue future purchases, as they’ve already alluded to.

Confluence of Factors

We know the Fed’s “work” at propping up the Treasury market and keeping interest rates low isn’t done. Regardless, forces larger than the Federal Reserve are taking shape.

Although the public’s attention has been fixed on distracting headlines, a confluence of other factors will drive the future price of stocks, bonds and interest rates.

  1. PTTRX:

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