I like most got the Fed
wrong today. Last week I took heat for alluding to the risk of Fed
announcing it would start buying Treasuries today based on the Hilsenrath
article in the WSJ. So what did I do? I put the car in reverse and
joined the crowd â€“ for all the â€śrightâ€ť reasons. Dudley met with the buy side and said just weeks ago it was not a good
idea. And we learned after the January meeting that the Fed had cooled to
the idea. And since when does the Fed follow the BOE on one weekâ€™s
success of Gilt buying.
Okay off with the myopic
ticker glasses and at 30,000 feet (at 3,000 feet) these are no ordinary
times. The message the Fed delivered today is that things are still
horrific. And anyone listening to Liddy of AIG testify in Congress, he
and the Fed (implied) agreed that not paying the retention bonuses to AIG FP
could bring down the firm and the financial system (eye opener that this firm
is still that vulnerable). These are extraordinary times and require
extraordinary policy. And donâ€™t lose sight of how badly markets have
failed and how much of a role there is for the government to support capital
and aggregate demand.
So why is it nearly all
in? Because a $3trln balance sheet at the Fed is still small relative to
the total economy, distressed assets, semi-distressed assets and the scale of
the problem. I would think that before we are at the other side of this
crisis the Fedâ€™s balance sheet will approach $10trln. North of $5trln
today would have been all in for me. Donâ€™t get me wrong this is very
big. And very helpful. I am now going to refinance.
The dollar is the shock
absorber to this move â€“ or better by-product. Yields across the curve are
now less attractive relative to the rest of the world and the dollar will
suffer. But a $3trln balance sheet at the Fed is not hyperinflation or
the basis for a run on the dollar. If anything the UK proportionately is in deeper from a policy response
than the Fed and cable is above where it was before the BOE announced it would
start QE and buy Gilts. And I think the UK economy is far more vulnerable to deflation than the
US economy â€“ concentrated in finance and housing and
diminished natural resources (North
Moreover, the pressure on
the ECB is building to follow the lead of its cohort c banks to QE or face an
appreciating euro. Too bad JC Trichet and his inflation apostles are
going to have a religious conversion drilled into them by a rising euro for an
export-led (German-led) economy. I think you have to think a bout
selling euros above 1.35 and surely with stops to sell higher through 1.40
(staged). This could turn into a damned if they do and damned if they
donâ€™t for the euro (lower on both fronts as proactive US policy supports the dollar in FIFO scenario).
Lastly, I would say anyone
talking about a ZWD outcome for the USD should be flogged (verbally).
There may be a time when the markets sell the exit strategy and the USD from
reflation, but first we have to see the death of deflation and it is here, it
I would be remiss if I did
not address the poor handling of the message by the Fed â€“ walking people out on
buying Treasuries in December, walking them back in January and then walking
them out and back and out again in the last week (post BOE QE Mar05).
The Bernanke Fed has been cursed on the message front from the get go â€“
remember Bernanke spoke to CNBCâ€™s Bartiromo in what he thought was off the
record in his first few weeks on the job only to learn it was on the
record. For those who trade on the inside noise the answer is stop.
Never say never rule is in full force and the times are so extraordinary that
the officials do not know what they will do next.
At risk of sounding
contradictory, Bloomberg today reported that Fed and Treasury officials are
considering using TALF to buy bad assets from the banks. Clearly this is
not the intended purpose of TALF (not really structured for this). In
todayâ€™s FOMC statement all the Fed said about TALF, due to start Thursday with
a Nissan issued ABS (can hear the shrill from Washington already), was it may expand the type of collateral
it will accept for those who participate in the program (makes me think of
Aitkenâ€™s quality collateral constraint worry).
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