FOMC Policy Bias 2012 & 2013

This chart is useful for guessing the policy bias of members on the FOMC. It includes not only the members in 2012. It also includes the four new members that will rotate onto the Committee in January 2013. The Chairman (Bernanke) does not get to select who the new members are in each annual rotation because they are predetermined. His primary variable for strategy is the timing of the monetary policy matter he wants to present for vote. Obviously, the policy hawks are outnumbered and therefore not able to impact a vote in either 2012 or 2013 as well as they can impact a discussion.
The following graphic is from the Financial Times Alphaville blog.

Robert Wenzel's speech at the NY Fed, April 2012

From the Economic Policy Journal;

   Thank you very much for inviting me to speak here at the New York Federal Reserve Bank.

Intellectual discourse is, of course, extraordinarily valuable in reaching truth. In this sense, I welcome the opportunity to discuss my views on the economy and monetary policy and how they may differ with those of you here at the Fed.

That said, I suspect my views are so different from those of you here today that my comments will be a complete failure in convincing you to do what I believe should be done, which is to close down the entire Federal Reserve System

My views, I suspect, differ from beginning to end. From the proper methodology to be used in the science of economics, to the manner in which the macro-economy functions, to the role of the Federal Reserve, and to the accomplishments of the Federal Reserve, I stand here confused as to how you see the world so differently than I do.

I simply do not understand most of the thinking that goes on here at the Fed and I do not understand how this thinking can go on when in my view it smacks up against reality.

Economic Condition Review

Here at the end of the 3Q2011 all eyes are focused on the European Union (EU), the European Central Bank (ECB), the International Monetary Fund (IMF), the Federal Reserve Bank (FRB), and now laser like focus on the 17 European Monetary Union (EMU) parliaments who are individually considering their agreement to further assistance for Greece. The process is complicated by the complexity of the euro currency experiment. It is also complicated by the number of politicians in positions of influence. I hope cynicism is reaching high tide. The danger is extreme if there is not a plan developed to corral the ripple effects from what is expected to be substantial losses to major banks who are Greece's sovereign debt owners. One danger is that there is a known lack of adequate reserve capital at several European banks due to their investment in the sovereign debt of Greece and other over indebted countries. Compounding the problem is the lack of detailed information about credit default swaps intended to hedge risk on Greek debt. Lack of information deepens the fear.

The probability of Greece's default is high as reflected in the yields for their debt. Greek 2 year bonds yield 65.24% and their 10 year debt costs them 22.67% as of 9/29/2011. For reference, 10 year bond yields in other EMU countries are Germany at 2.01%, Italy at 5.58% and Portugal at 11.16%. The US Treasury 10 year is at 2.00%. The problem is how to contain the eventual wreck.

Economic Condition Review: June 2011

The last economic review I did for the blog was in January 2011. At that time conditions for the US economy felt hopeful with corporations getting ready to announce good to great business results and guardedly optimistic business outlook messages. Food and energy inflation were an established factor in the US and the rest of the world. QE2 was adding fuel to inflation and to the prices for most commodities, especially the money hedges, gold and silver. The US$ was weakening, reaching a recent low near 73 (see graph below). A review of the weekly market data for January 14 is linked here. Company share prices elevated for much of the early part of earnings season before hitting a ceiling in mid February and suffering a March pullback in sympathy with Japan's enormous tragedy trio, earthquake, tsunami and nuclear power plant catastrophe's. The US markets recovered to the year-to-date high at the end of May.

Now in June, the world is captivated with concern about the bank and sovereign debt crisis in Greece. The concern is over the terms by which it will be resolved and when. The political forces are at work, the ECB, the IMF, and the US Fed are all applying pressure. The Financial Times describes the situation as "A Defining Moment for Greek Debt". A play on words since the article is about the definitions given to what everyone perceives to be a 'credit event' in Greek sovereign debt, involving credit default swaps. Eurozone forces feel the resolution is to deepen the austerity of the Greeks putting the problem on the back of labor as well as insisting that the government sell prime assets, such as state owned transportation and valuable land assets. Bloomberg describes the situation here. The proposals are being met with resistance from Greek labor unions. It remains to be seen how the government decides what to vote. Will they shun the political force representing the banking/eurozone interests or will they adopt an Iceland type reform to protect their assets from fire sale and force losses on the financial system. If they choose the latter, the potential exists for wide ranging credit related losses for European banks and possibly other money center banks around the world too.

The US Fed has announced they do plan to end QE2 as planned at the end of June. Until then, they are still in the markets supporting asset prices. A widely held view, that I share, is that there will be some form of market manipulation choreographed by the Fed until they get enough political support for the next QE. It will take a good financial scare to move the political will, so this is the time to be patient, waiting to take on risk. John Hussman writes that more QE will be politically aggressive in the face of a discouraged populace and critical global community. In addition, the lack of evidence that QE has been successful would support its abandonment. But the final decision likely revolves around the determination of Fed Chairman Bernanke to maintain the practice.

FOMC Statement Summary

From Econoday:
There were no surprises in today's FOMC statement. The Fed retained its "extended period" language for keeping the target rate extremely low. The vote for the policy decision was unanimous.

Regarding the economy, the statement said that "the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually."

While noting that some prices have risen significantly, the FOMC participants overall see inflation expectations as stable and underlying inflation as subdued.

"Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March. Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued."

The Fed does appear to be giving expectations greater consideration as it is now given as one of the reasons allowing for the continued and exceptionally low policy rate. Also allowing this are low rates of resource utilization (primarily unemployment) and subdued inflation trends (meaning for core rates).

Despite some District bank presidents questioning in earlier speeches the need for the second round of quantitative easing, the FOMC voted to complete the $600 billion in expansion of the Fed's balance sheet in QE2.

"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter."

There was no discussion of what should happen with the balance sheet level after June. That is, we do not know if the Fed will let the balance sheet unwind with pay down on mortgage-backed securities and agency debt and maturation of Treasuries. Or the Fed could continue to reinvest pay down. This decision will need to be made at the next FOMC meeting.

Scanner: For a simple point of reference, here is a chart showing the level of Excess Bank Reserves held at the Fed. These excess reserves have been suspected of having the ability of being in more than one place at the same time! As the balance grows, so does the benefactor of the hidden use (the stock market). Observe the increased balance since the implementation of QE1 in November 2008 and of QE2 in November 2010.

When the Fed is utilizing its quantatative easing program, the new cash is called monetary base. Here is a chart of the Monetary Base for the past ten years. When the Fed is creating monetary base it is also, and obviously, creating excess reserves at banks. The banks are free to use it as they wish. It's the Fed that has little wiggle room. The Fed is essentially following orders to create more money or take it away in a partnership that does not fit conventional understanding.

Economic Condition Review 1Q2011

Looking back on the end of 1Q2011, the world is still reeling from the tsunami and earthquake damage in northern Japan, and traces of radiation turning up in unwanted places like certain food and drinking water sources and in ocean water along the plants. In northern Africa, the civil revolt in Egypt has resulted in the departure of the 4 decades long dictatorship of Hosni Mubarek leaving a power vacuum which will be resolved later, hopefully with a democratically run election. Next door to Egypt, the dictator of Libya is fighting his own countrymen who want him, Muammar Gadhafi, to give up his dictatorship. Other uprisings are beginning to build in several other oil producing countries in the region, including the Arabian peninsula. The threat of crude oil shipments being interrupted is a big concern for all countries importing from this region and is the reason for the multi-lateral military action intensifying now, particularly targeting Libya.

In Europe, the government of Portugal has collapsed. The government voted to not accept more austerity measures which was recommended by the former prime minister and his finance minister. This development is expected to lead to a bailout of the country's sovereign external debt by the European Central Bank and/or the IMF. The financial conditions attached to bailouts have been painful so far for Greece and Ireland. Both of those governments are debating how to incorporate the painful bailout conditions or to default on them. Default is immediately easier and politically popular in the countries. China is concerned with internal high and climbing food and shelter inflation threatening the massive lower classes, potentially destabilizing the power of the ruling party. Published reports claim that interest rate increases are on the calendar in China now to slow lending and personal discretionary consumption.

In the US, the Treasury market is finding some strength on a risk-off move recently. The US$ is weak, currently near the 76 mark. New and existing house sales numbers were reported recently by the Commerce Department and are lower than projections. Nationally, median house prices are now at December 2003 levels. Banks, the primary source of credit for economic expansion, both consumer and commercial borrowers, are lending only to prime customers, letting growth of credit remain below trend. Bank closings totalled 11 in January, 12 in February and 3 through March 25, according to the FDIC. Most businesses do not have pricing power, so prices are holding the line so far despite rising commodity prices. Exceptions are businesses with pricing power such as universities, health care services, food and energy producers. Inflation (see Q4 CPI) for gasoline in 2010 came in at 13.8%, the overall energy component at 7.7%, and in the major grocery store food groups, the index for meats, poultry, fish and eggs posted the largest increase at 5.5 percent.

The Federal Reserve is pulling the strings to guide global perception about the strength of the US$. The Fed has no choice but to continue it's zero interest rate policy and money printing practice. They will attempt to support the Treasury market when the primary dealers and global participants back away more than they have now. How the Fed uses it's power may look different and they will call it by another name to put watchers off the scent. But we are talking about a global economy here. Not just the US. Other major economies are directly impacted by the Fed's actions. So they become partners in the deed and will cooperate to the greatest possible extent. This will buy time. The possible time frames are wide ranging from many months to years. Unforeseen events, natural and physical, with financial consequences are wild cards that can, of course, shorten the time frame by changing the delicate balance in place now.

One Eye on The Fed: 'Dual Mandate' is Camouflage

Today New York Fed President William Dudley spoke about the condition of the US economy. His record reflects that of a supporter of current Fed policy. Here is a brief statement from his speech that illustrates his overall sentiment about the economy and the need for the Fed to continue its money printing and intervention in certain asset markets.

"On the activity side, a wide range of indicators show a broadening and strengthening of demand by households and production by firms. For example, on the demand side, after an unusually deep retrenchment during the recession, consumer spending has begun to recover, and that recovery strengthened considerably in the final months of 2010. Not surprisingly, businesses' orders and production are following suit.
These factors led to a 3.1 percent growth rate in our most comprehensive measure of national output (real, or inflation-adjusted, gross domestic product or GDP) in the fourth quarter of 2010. Growth for the first quarter looks likely to be similar, near 3 percent. In my view, the revival in demand and production—while not as strong as desired—suggests that we may be much closer to establishing a virtuous circle that will support stronger growth. What I have in mind is a cycle in which rising household and business demand generate more rapid income and employment growth, which in turn bolsters confidence and leads to further increases in spending. This is why we upgraded our assessment of the economy at last month's FOMC meeting, noting the economy is now on a "firmer footing". The major missing piece of the puzzle has been the absence of strong payroll job growth. We will need to see sustained strong employment growth in order to be certain that this virtuous circle has become firmly established.
With respect to the labor market, we have seen some conflicting signals. On one hand, the unemployment rate has fallen sharply over the past four months, dropping to 8.8 percent from 9.8 percent in November. On the other hand, payroll employment gains have been relatively modest."

Dudley's message is that there is still work to be done by the Fed before he can feel assured of an economy that will sustain itself in terms of employment growth and consumer spending growth (maybe GDP above 3.0). This is camouflage to the real purpose of QE.

Quantitative Easing Explained

Economic Condition Review 4Q 2010

As 2010 ended, the wait began for Q4 corporate earnings reporting season. Expected are confirmation of the health of the US consumer and corporate guidance leading to confirmation of an economic recovery that is sustainable. Commercial balance sheets are doing everything possible to restore financial health, including cutting expenses by laying off workers and paying off debt. Banks, the primary source of credit for econimci expansion, both consumer and commercial borrowers, are lending only to prime customers, letting growth of credit remain below trend. Most businesses do not have pricing power, so prices are holding the line so far despite rising commodity prices. Exceptions are businesses with pricing power such as health care, food and energy. Inflation (see Q4 CPI) for gasoline in 2010 came in at 13.8%, the overall energy component at 7.7%, and in the major grocery store food groups, the index for meats, poultry, fish and eggs posted the largest increase at 5.5 percent.

During Q4 2010 the Fed implemented the follow-on to quantitative easing we call QE2. This liquidity program is ultimately responsible for accomplishing one of what has become three objectives (maintain price stability, maintain full employment, and now support reflation of US stock market indexes). Obviously the one objective the Fed is succeeding at is reflation of the stock markets. So far, the Fed is not being successful at their two primary objectives. Now a big question is how can US stocks maintain their advance without the rest of the world's participation. Hello Ben. An answer please.

Federal Reserve Open Market Committee (FOMC) for 2011

Each January there is turnover of at least four of the eleven seats on the Federal Reserve Open Market Committee (FOMC). The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Here is a link to a previous post with some additional background on the FOMC and the nine 2010 members.

The new members for 2011 will be presidents from four of the 12 Regional Bank Branches. The four Branches are in Chicago, Philadelphia, Dallas and Minneapolis. In addition, Janet Yellen, President of the San Francisco Branch, and Sarah Bloom Raskin, formerly the Commissioner of Financial Regulation for the State of Maryland, (the state ranks #12 as of 12/31/2010 on the unofficial problem bank list) were each appointed Governor's on The Fed Board last October, making them long-term members. In Yellen's appointment her vote is retained past 2010 because her Branch moves to the non-voting alternate member list for the 2011 term. Non-voting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options.

Below is a look at representative quotes from speeches made recently by each ot the new members. Bloom Raskin has given only one speech as a board member. These might provide helpful background when the time comes to speculate about whether the program of quantittative easing gets extended. The current program is scheduled to stop by the end of June 2011.

The speech by Kocherlakota is given to an audience of college students and so he talked in terms that more people can understand. Many of the other speeches are weighted with econo jargon. Never-the-less, a quick browse will be enlightening for understanding more about the Fed's practices and plans for managing through the policy challenges that the economies of the world are faced with.

One Eye on the Fed: QE 2 Affirmed

This from Econoday/Bloomberg today in summary of the FOMC Meeting and their message to the public.

"Basically, the Fed still sees the need to continue with its plans for balance sheet expansion. In turn, the Fed maintained its position regarding continuing with $600 billion in QE2.

"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month."

Kansas City Fed President Thomas Hoenig continued to dissent.

"Mr. Hoenig was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy." The vote for the statement was 10 to 1.

The bottom line is that QE2 continues much as expected. This will continue to support economic recovery, eventual lower unemployment, and a more acceptable rate of inflation. On the news, markets were little changed as the statement largely met expectations in terms of rates and commentary."

The statement affirms the Committee's commitment to doing everything they can to reflate assets and reduce unemployment levels. Call this what you want, it is still bullish for assets in the short term.

Economic Condition Review, 3Q 2010

So far, the consumer is missing-in-action in the US economy, placing all the pressure on both commercial and government balance sheets. Commercial balance sheets are doing everything possible to restore financial health, including cutting expenses, mainly by laying off workers and paying off debt. Banks, the primary source of credit for consumers and commercial borrowers, are lending only to prime customers, letting growth of credit remain below trend. Most businesses do not have pricing power, so prices are holding the line. Exceptions are businesses with pricing power such as health care, food and energy. Interesting to include that food inflation is widely recognized in China too. Online newspaper Caixin reports that: A rise in food prices, driven by too much bank credit, quantitative easing measures in the United States, speculation in commodities and natural disasters, was mainly responsible for the worse-than-expected inflation, according to the National Bureau of Statistics.

The government is using it's balance sheet (Federal Reserve as proxy) with the QE2 strategy, with the goals of increasing inflation in assets and stimulating job recovery, by creating new money with serial quantitative easing. John Hussman describes, in his Nov 15, 2010 letter, the financial recovery seen in 2010 as "an "economic recovery" that requires a tripling in the Fed's balance sheet, continues to average 450,000 new unemployment claims weekly, and relies on fiscal stimulus to counter utterly stagnant personal income, is ipso facto (by the fact itself) not a "standard" economic recovery. We have swept an enormous volume of bad debt under rugs, behind dams, and in back of curtains (not to mention in off-balance sheet vehicles such as Maiden Lane that were created by the Federal Reserve). But it is all effectively still there, festering. Meanwhile, our policy makers are trying to reignite financial bubbles in order to create an illusory "wealth effect" to propagate spending patterns that were inappropriate in the first place." These are conditions that are almost identical to a year ago, not overlooking isolated and significant price inflation over the year.

Fundamentally Speaking, Now is a Confusing Time

Quantitative easing (QE 2) has begun and the markets are pretty confused, based on volatility of commodity prices and daily currency exchange swings, and the VIX. It's a terrible time to try forecasting a market's direction amidst all the financial situations around the world (Ireland banks, China inflation, Yen direction, euro direction, US$ direction) as well as the economic influence of QE 2 operations. There is also speculation about the process the Fed has chosen for it's QE 2 plan and whether it will be successful soon, if ever. An interesting observation of the plan is described in "They Just Don't Get It", written by Paul Kasriel.

Kasriel observes that the Fed is targeting the middle-term sections of the maturity spectrum, avoiding the bill's, or short-term issues. He contends that the Fed may have to deliver more easing until they can move the needle of credit outstanding up. He writes "The Federal Reserve has the unique ability to be able to create credit figuratively "out of thin air." So does the commercial banking system, if the Fed provides the "seed money." The ability to create credit out of thin air implies that the recipients of that credit can increase their current spending without any other entity in the economy having to cut back on its current spending. 

Quantitative Easing: Pushing on a String?

John Hussman has published another in his series of weekly articles that is a must read. In the article titled "Bernanke Leaps into a Liquidity Trap" he describes his opinion of what should be expected from more expansion of the 'monetary base' or quantitative easing. One of his points is...

Certain economic equations and regularities make it tempting to assume that there are simple cause-effect relationships that would allow a policy maker to directly manipulate prices and output. While the Fed can control the monetary base, the behavior of prices and output is based on a whole range of factors outside of the Fed's control. Except at the shortest maturities, interest rates are also a function of factors well beyond monetary policy.