FOMC Statement: Skeptical This Will Work

Below you will see my summary of the FOMC Statement and how it changed. Before I give you that, let me summarize what I think the changes are, the market impact, and whether I think it will work.

The Changes

• The Fed will expand its balance sheet massively, buying another $750 billion of agency mortgage-backed securities, $300 billion of long Treasuries, another $100 billion of Agencies, and expand eligible collateral for the TALF to include who knows what.
• The crisis involves the real economy in a big way now, not just the financial economy.
• The crisis is definitely global.
• They have ceased to forecast when it will end.
• They are pursuing recovery, not growth now.

The Market Impact

• The Dollar fell roughly 2-3%. Gold rallied 4%+.
• The ten-year sector of the nominal Treasury curve fell the most in yield terms, around 50 basis points. Biggest rally since 1962. The long end fell 30 basis points. Agencies outperformed Treasuries. Mortgages lagged.
• TIPS outperformed nominal bonds with the long end falling 40 basis points, and the 10-year 55 basis points, leading inflation expectations to rise.

Will this work?

I’m skeptical. This is just a bigger shift of financial obligations from the balance sheet of financials to the Fed, at prices unfavorable to the Fed, because their own statements will make them buy dearly. When they unwind these trades, they will take significant losses, eliminating seniorage income to the US Treasury.

Lowering Treasury, Agency and conforming mortgage rates, assuming that it can be done in the long run (not likely), will not help consumers or corporations. Forcing a small spectrum of interest rates down does little for collateral values. People are inverted on their debts, and this does not solve that. You might get a few refinances out of that, but that’s all. Credit card, auto, and other debts are unaffected, and the TALF is still pie-in-the-sky. Can it work? Corporate bonds, bank debt, Commercial real estate loans, etc. – there is no effect. It only makes life better for the US Government, Fannie, Freddie, the FHLB, and those seeking conforming mortgage loans.

There is no real debt reduction here, and debt levels are the cause of this crisis, not interest rates on the debt. I don’t think this will work, but this is another case where “the beatings will continue until morale improves.” Ben Bernanke is too certain of what is the correct move, given his Ph.D. studies. It would be better and simpler to follow an inflationary course that hits at the root causes of debt by giving every adult a $5,000 voucher good to pay off a debt to any regulated financial institution. Consumers win, banks win, and foreign creditors lose.

Current Recommendation

I don’t think this rally will hold, so when upward momentum fails, sell long duration fixed income positions.

Fed Statements Compared

I reordered the January Statement to make them compare better. Click to enlarge:

Comments

[Steven Hansen:]

dave, nice summary and comparison between the last meetings.

Mar 19 06:05 AM

[Larry MacDo...:]

OK, lowering the price of money may not have much of an impact but what about raising the quantity of money?

Mar 19 06:43 AM

[aarc:]

Good enough!

This is a lot better than more talk and no action. The longer this financial crisis lasts, the deeper the economic malaise goes into.

At least we have a good chance with inflation forcing some if not all of those trillions of hoarded cash to be re-invested into the economy and re-start a new round of hiring or even just to forestall a market meltdown.

I don't know which is worse, risking Fed balance sheet or risking an economic meltdown. If the Fed cannot prevent an economic meltdown, they might as well not exist at all.

More than half a million job losses a month for several months with no end in sight does'nt sound like we are only quagmired in a normal or garden-variety economic crisis. This spiraling joblessness can easily spark social crisis or civil unrests that can undermine capitalism, the government and democracy itself.

Wait and wait (as per Obama and Geithner stance) .... or act like Bernanke just did. As long as Bernanke keeps on avoiding Paulson's mistakes; at least we have an active "national" leader instead of an IFFY president.

Effective or not IS not the issue. We have investor confidence or lack thereoff issue. Now, we are starting to see the initial signs of leadership credibility issue.

Political will in solving the deepening joblessness and economic crises is sorely lacking from the government that is now trying to gain political points with social issues such as Madoff, AIG and the minor issues such as the Uptick Rule and Mark to Market. What else can be expected from the government? If they enter the economic arena with no prior knowledge nor experience - most probably they will look more like fools than heroes.

They have to show leadership to make up for their lack of knowledge. There are not enough time for them to "learn the ropes" of this once in a century economic crisis before things get from bad to worse or worst - at an unprecedented speed and gaining momentum "un-noticed" while the politicians discuss matters with no special benefit to the resolution of the crisis.

Gladly, the Fed did not step to the sidelines as this political maneuvering by economically ignorant leaders takes it's course.

Mar 19 07:31 AM

[Fabien Hug:]

aarc, I agree. At least some actions and shorts on the wrong side.
It's certainly not THE solution and not the final move, but at least they did something and they hit pretty hard.

Mar 19 08:59 AM

[prudentinve...:]

If it stokes inflation it will further batter the consumer with price increases in basics, like food and energy.

The fed's move will delay the necessary adjustments, and not contribute to correcting them. The economy is too heavily biased towards the favored financial industry, and manufacturing has been decimated. The high salaries and profits of the financial industry have inflated the cost of living across the economy and priced out manufacturing, which was then outsourced. Until manufacturing comes back, and the financial industry is reduced to its pre-bubble size as percentage of GDP, there cannot be any sustainable recovery.

Mar 19 11:02 AM

[Lilguy:]

I agree wholeheartedly with Mr. Merkel's assessment of yesterday's FOMC actions.

Yet, I don't think we've yet considered the consumer demand side of the equation adequately. While yesterday's move was inflationary, I think the growing number of layoffs and threats thereof nationwide does--at some level--offset the inflationary concern. People simply can't buy stuff and, if prices go up, they can buy even less. And that doesn't consider actual cuts in wages/salaries as companies face an increasingly hostile market place.

Longer term, I don't see the employment-wage picture recovering significantly until well after--as in years after--the US economy hits bottom (maybe next year, possibly 2011).

We need to look more closely at this aspect of demand.

Mar 19 11:40 AM

[JohnL:]

"If the Fed cannot prevent an economic meltdown, they might as well not exist at all."

Ahh! Now you're getting somewhere!

They caused this problem with easy credit and now they can't cure it with....err...easy credit.........Wait..I'm confused...

Mar 19 11:47 AM

[Sober Realist:]

"Government buys its own debt and stock markets rally. Just wait until Bloomberg runs the headline "Dog Eats Own Vomit". That should spin off one humdinger of a rally!"

Mar 19 12:20 PM

[James Quinn:]

It will work. It will work in bringing down our financial system.

theburningplatform.com...

Mar 19 12:38 PM

[G23ROCKS:]

Best overview I've read so far. Nice job!

Mar 19 02:30 PM

[Jason Rines...:]

Exactly. Worst of all scenerios for the consumer has occured is occuring and will continue to occur. The consumer will respond by voter revolution in 2010 and 2012. When the last of the inept and corrupt are removed from the House of Representatives in 2012, the U.S. will begin a real recovery. But it will be a tepid Bull compared to the 80's and 90's as the U.S. pays down it's public debts over a decade. If we are really fortunate, we will avoid global war.


On Mar 19 11:02 AM prudentinvestor wrote:

> If it stokes inflation it will further batter the consumer with price
> increases in basics, like food and energy.
>
> The fed's move will delay the necessary adjustments, and not contribute
> to correcting them. The economy is too heavily biased towards the
> favored financial industry, and manufacturing has been decimated.
> The high salaries and profits of the financial industry have inflated
> the cost of living across the economy and priced out manufacturing,
> which was then outsourced. Until manufacturing comes back, and the
> financial industry is reduced to its pre-bubble size as percentage
> of GDP, there cannot be any sustainable recovery.

Mar 19 04:25 PM

[samwise:]

buy high sell low. those who can, do--those who can't--run the fed?

Mar 19 04:40 PM

[Lilguy:]

To follow up on my mild criticism of Mr. Merkel's article that it doesn't look at the demand side of the equation, let me refer you to the following major article by Jamie Galbraith:

www.washingtonmonthly....

His view is that not only is the financial system broken and virtually insolvent, but the massive destruction of personal wealth means massive federal stimulation of the economy (much larger than at present) are needed to stabilize the system and return it to prosperity (in 20 years!)

The following is the central conclusion of his assessment:

"A brief reflection on this (Great Depression & WWII) history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around. "

A great piece! I recommend you all read it.

Mar 20 02:28 PM