Yesterday, the FOMC meeting was held. There was a lot of interest among financial observers on how they would use the carefully designed language in the press release from the group, and most importantly use the Fed's balance sheet to turn the slowing economy from a course that they acknowledge could be deflationary for assets and GDP. Today is a good time to reflect on my expectation and the reality.
In my post, Sustainable Rally or a Bear Trap?, I wrote about St Louis Fed Pres. James Bullard's recent public statements. His analysis of the economy concludes that deflation in the US is possible, even though
he describes himself as an inflation hawk. His solution is for the Fed
to initiate a new QE program that is a huge, targeted and managed release of
money. This is a big departure from what I would expect from him as an inflationist. It increases my curiousity about his motive.
I concluded that he is paving the way for the Committee to make a bold and unpopular decision by floating trial balloons, looking for reaction from the investment community. He acknowledged that "policymakers have to commit to the new policy and the private sector has
to believe the policymaker. Unfortunately, in actual policy
discussions, nothing of this sort seems to be happening." If Bullard is floating a trial balloon as a beginning to creating a huge expansion of the Fed balance sheet, the FOMC does not feel the urgency that I do. Otherwise, they would have been more bold. This story is not over with, it will continue, and the catalyst for the FOMC to be more bold may surface soon. I don't know what it will be, but one likely message would be a stock market in a steep decline having no encouragement left in the tank.
Here is the key paragraph from the press release yesterday. "To help support the economic recovery in a context of price stability,
the Committee will keep constant the Federal Reserve's holdings of
securities at their current level by reinvesting principal payments from
agency debt and agency mortgage-backed securities in longer-term
Treasury securities. The Committee will continue to roll over the
Federal Reserve's holdings of Treasury securities as they mature."
What they tell me in the statement is that the balance sheet will not be reduced as debts are repaid. Instead, they will use the cash flow to purchase Treasuries. That represents just a continuation of the current policy, with a bias towards being expansionary. I was expecting more. It might take another scary market to convince the Fed of the urgency needed to use their balance sheet in a manner like what James Bullard described. Of course, that inflates the other problem we already have, which is how to reduce the balance sheet without sending the economy into another recession. There are no good options at this point. I bought bonds on the news.