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Forex Blog - Enigmatic Fed

Enigmatic Fed


What is the Fed doing now?  Few claim to know.  And those who claim to know don’t seem to agree.  I don’t pretend to know what the Fed is doing with monetary policy apart from being the bank of first and last resort – all doors are open for nearly all comers carrying a bank holding company license and one very large insurance firm wrapped inside in even larger shadow hedge fund. 


But when Bill Gross the Bond King says the Fed is now targeting the 10-year yield under 3.10% and street economists at highly respected institutions say the Fed is following monetary conditions of which the 10-year yield is one among a number of components it suggests the Fed’s pledge to be transparent and keep the public much less markets informed is a bit disingenuous.  If PIMCO and top US investment bank can’t agree on what the Fed is up to, Houston we have a problem. 


Okay I give the Fed credit for telling us its policy tactics from TALF to bond buying operations – we know what the Fed does (to execute monetary policy) but we do not know anything about the current framework for policy.  At first the Fed’s expansion of its balance sheet along with measures to support the flow of credit was called “credit easing” as opposed to “quantitative easing.”  Then the Fed at the March FOMC meeting announced it would buy US government debt outright as well as a lot more MBS issued by the agencies which seemed to some to cross the line to “quantitative easing.”  But without a quantitative target is it really quantitative easing or simply debt monetization? 


Then we learned from FOMC minutes that the Fed is knocking around the idea of targeting inflation – something Bernanke has favored since he first served as a Governor of the FRB.  At a monetary policy conference In Tennessee a few weeks back, where Don Kohn and Bill Dudley dutifully made the case for an inflation target Paul Volcker essentially went postal at the idea and suggested if there is any lesson of the current crisis is that monetary policy should not be shackled by an inflation target that may or may not be relevant for smoothing business cycles and is subject to change in the face of real world financial and real stability demands. 


Does a more formal inflation target in the midst of unconventional monetary policy meet the standard of quantitative easing? 


And then there is the larger question.  Is the Fed independent in light of its heavy hand in fiscal policy (like buying Treasuries outright, picking winners and losers in the banking and financial sector alongside the White House or embracing massive deficit spending?)?   


While no central bank has a complete playbook or much history to draw upon on how to conduct unconventional monetary policy, one would think that at this late stage of the crisis and policy response if the Fed was the least interested in communicating its policy framework and approach we would not be hearing such divergent points of view on what is happening with monetary policy.  Nor would we need to wait for the next insider financial journalist to have a one on one with Bernanke or Kohn to find out what the Fed is thinking. 


It may be too much to ask but how about the Fed end Wednesday’s FOMC meeting with a press conference and come clean on what it is doing – and not simply details on the components of unconventional or credit-flow-related policies.   It might help sentiment and confidence if the guessing games and veil of uncertainty is lifted.  The Fed policy burka needs to be removed. 


I suspect it might help some members of the FOMC better understand what the Fed is doing as well – not all attending the inner sanctum board meetings are much more aware of the policy approach than the rest of us. 


I thought the Bernanke 60 Minutes segment was a good first step to real policy transparency.  But the 60 Minutes frankness in hindsight looks more like an anomaly than a new burka-less Fed. 


I watched Greg Ip of the Economist and Neil Irwin of the Washington Post on CNBC earlier today and they were clearly briefed in recent days by senior Fed officials on what the Fed is thinking.  Nothing against Greg or Neil, but deep background is not an acceptable substitute for policy transparency.  Fed needs to move to a BOE standard on transparency and disclosure and the sooner the better.  On the question of independence, well that is a problem the BOE shares and I see no way around it…time heals everything. 


Frankly I am skeptical that the Fed is ready to disclose more.  Instead Wednesday’s markets will be trading on the degree of optimism on the economy the Fed has signaled in the statement (in its assessment of economic conditions).  Based on Ip and Irwin today, the Fed is extremely cautious about being early on calling a bottom and recovery.  Maybe this reluctance has something to do with the Fed’s abysmal track record in forecasting the real economy in the last 24 months. 


Count on the Fed remaining an enigma. 


Bank Stress Tests - No Bank Left Behind


When President Bush and Senator Kennedy came together early in 2001 to pass the No Child Left Behind legislation to restore the health of public education (and public trust on the issue of a first rate education for a first world nation), there was some sense that at last something constructive would be done to close the educational quality gap in the country.  However, what ended up happening was that schools who did not measure up to the standardized tests began teaching the test so as to remain a credited school.  Teaching to the test yielded many passes when in reality schools should have failed and should have been shuttered.


It reminds me of the bank stress tests the US government is conducting (not sure who – the Fed is involved, but who else?  FDIC?  SEC?) -  a failing school spending the year to teach the test for a pass and remain open.  Treasury and Fed officials said even before the tests started that none of the 19 large banks tested was insolvent.  Moreover none would be allowed to fail if found insolvent.  The stress tests are pretty meaningless if there is no pass-fail outcome.  Instead we are expected to be told who needs capital on May 04.  Well banks were notified last Friday and by Monday evening the WSJ learned that BAC and C need capital (it did not say the others do not need capital).  So much for May 04 (who knows this could be deliberate to ease the blow on markets of more capital needy firms next week – get the two most needy out of the way with a deliberate leak). 


Banks that need capital will have 6 months to raise it, presumably privately if possible, or face the wrath of government scrutiny – conversion of government held preferred to common, replacement of bank leadership and the old fois gras force feed if needed. 


And yes Goldman raised $5bln in a rights issue this month and successfully.  But is this really a clean private capital raising effort when the firm benefits from billions of dollars of FDIC backed debt (at a huge discount to market price) or $10bln in TARP funds?  And of the remaining 19 there are only a few that could follow Goldman’ lead with a stock offering.


It is also clear that the Obama administration can’t go back to the TARP well again – Congress, short of another off the charts financial crisis, will not authorize more federal dollars (taxpayer liabilities) to the banks.  So the $700bln is it and this means most banks that need significant capital infusions and can’t raise capital privately at a reasonable cost will see US government warrants on convertible preferred shares exercised and converted to common equity (boost TCE).  But this is an exercise in buying time – for PPIP to get going (good luck – supposed to start up in May), bank “risk free” interest income from a steep curve to grow, to allow time for Congress to pass legislation creating a large financial firm wind-up authority/mechanism and maybe for Congress to forget about the $700bln authorized in 2008 to buy toxic assets from the banks (but used instead as direct capital infusions).   This unavailability of new TARP funds may pressure the government into accepting TARP funds back from stronger banks like Goldman and Northern Trust before the crisis has passed and before flow of credit is fully restored. 


Which leads me to GM restructuring…why is what is good for GM is not good for US banks?  If the GM restructuring works (de facto bankruptcy and government restructuring) just maybe the White House will decide that the zombie banking model currently in place will get shelved for the GM model.


Lastly the worst case scenario in the current stress tests rest on the assumption that the economy is indeed no longer falling off a cliff nor will it again ahead.  In this environment I think any stress test that does not include at least one more cliff dive is no stress test at all but more like the consensus forecast.  And what charge-off rates are in the stress tests for credit cards?  HELOCs?  Commercial real estate?  Commercial loans? Student loans? Auto loans?  Household deleveraging is just beginning.  Capex outlook?  Who wants to expand capacity when the outlook for demand is so uncertain?  Moreover, the fiscal stimulus bill ($787bln) is not being spent quickly (hard to do) and not filling the hole left by the private sector and may not until much later this year.  The massive budget in the legislative process does not go into effect until October. 


I don’t see an early end to the financial or economic crises on the horizon despite the green shoots (all of which indicate a slowing in the rate of decline or inflexion point, which is no turning point).  Not suggesting selling the rally in risk assets now – loads of pent up bottom pickers around from real and spec communities to drive risk assets up more.  But how sustainable is the rally in risk assets without a supportive real economic recovery and there is no sustainable real recovery when banks everywhere and US households have much more deleveraging ahead?  I am skeptical, very skeptical.


David Gilmore   


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