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Tuesday August 3, 2010 - 19:28:22 GMT
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Fed to up morphine dose next week...all show and not much dough (FXA)

Fed to up morphine dose next week...all show and not much dough.


We may think of the Fed Chairman as Helicopter Ben but the Hilsenrath article today in the WSJ smacks of toy remote helicopter drop, not the Chinook variety one associates with the US economy facing down deflation. 


Reinvesting some $200bln in maturing mortgage backed securities in the next roughly 18 months to head of a double dip, or even a hard landing is frankly insignificant.  And according to the article the Fed seems to favor using the proceeds to buy medium-term Treasuries and not more MBS from Fannie and Freddie where the asset purchase program has kept mortgage market open and sort of flowing.  I can’t imagine this size buying of Treasuries would make a hill of beans difference to market rates ahead if the Fed goes ahead with it.   


I also can’t help but think that the Hilsenrath article would ever have been written unless it was highly likely that the Fed will decide to use maturing MBS to buy UST…okay it was in very minutes from recent FOMC meetings but the article today – a week ahead of the next FOMC meeting is about as loud a broadcast of a policy change one can get. 


Which leads me to the next line of thinking…spoon feed the markets in preparation for the start up of the real life Chinook.  Indeed Hilsenrath said the Fed may also be using the (possible) policy change as a precursor to much more significant efforts to pump money into the economy.  Maybe the Fed can save some face here by letting it fly that in the future the central bank of the US will not be supporting GSEs, bringing it very close to being an agent of fiscal policy…buying Tsys does that too but not as directly and blatantly…also not as politically charged as GSE MBS. 


I can’t help but think that the Fed doing this in step is aimed at preparing markets for the really big helicopter drops that lie ahead…if the economy looks headed back into the ground nose first. 


Bullard and the WSJ article make a point out of the Fed having to move more aggressively if there is another shock like EZ debt crisis and banking woes.  This seems a little pathetic…the EZ banking and debt crisis apparently has had very little real effect on growth in northern Europe, especially Germany.  How queer that it would be more impactful on the US than Germany?  Reading FOMC minutes and statements of late and hearing Trichet press conferences one wonders if the Fed and ECB are talking about the same European event.


Instead of coming clean and simply stating $1.25trln of MBS and GSE debt purchases and $300bln in UST purchases has not killed the deflation virus.  It surely follows that another $200bln in the next 18 months won’t be much more than a slight turn of the flow valve on the morphine drip bag.  I think the issue ahead for the Fed (perhaps as Bullard has indicated) is when does it go all in on supporting growth? 


To be fair in the first graph Hilsenrath calls the policy change “modest but symbolically important” – that has to be out of the mouth of a senior Fed official…Board member…maybe Bernanke himself. 


If the US economy is bordering on a deflationary slide where monetary and fiscal policy come up short on recharging the growth engine, why pussy foot around with symbolism?  If this is an expectations management game and the prognosis is radical surgery and PT or a permanent vegetable state, who needs the nurse bringing fresh flowers?  


I wonder if the Fed ever thinks about downside risk from policy pussy footing.  Figure out what your best guess is on the future and do something…if you think deflation beckons a la Japan, then act big, act now and file away symbolism.  If you are not sure say so and keep the powder dry. 


All this makes me a little nervous as we head into US midterm Congressional elections and the Democrats are unusually concerned they face another Gingrich revolution…loss of one or both houses of government.  Obama can’t buy much if any public support for his handling of the economy.  Indeed Geithner may be done if November is a disaster for the Democrats as some polls suggest.  I can’t help but think that the White House and Democratic leadership would welcome an all-in Fed…and not soon enough.  This tells me that the Fed can’t afford to delay an all-in move much more or it may not be able to exercise it without prompting charges of politicization of monetary policy. 


This story is likely to develop fast and markets now have some red meat to eat…they may get more on Friday with a weak jobs report (I don’t believe in forecasting monthly time series when the error term is often as big as the change itself).


In any case I have to bury my EURUSD top and powder my face to hide the red of embarrassment over being so unwilling to believe in the weak USD narrative that started in June.


David Gilmore


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