A More Forceful Fed... Wow!

by: John M. Mason

On the front page of the New York Times business section, we read the headline: "A More Forceful Fed Stands By the Stimulus."

In the Wall Street Journal, we read: "Fed Moves on Bond Buys as Inflation Slows." It starts, "The Federal Reserve said it would press forward with an $85 billion-a-month bond buying program and hinted it might even dial it up if the job market or inflation figures fail to meet the Fed's expectations."

In the Financial Times, the headline reads: "ECB "Ready" for More Action After Rate Cut." The European Central Bank acted: "Facing diminished prospects for an economic recovery in the recession-bound bloc, the ECB cut its main refinancing rate by a quarter percentage point to 0.50 per cent and Mario Draghi, ECB president, said the bank remained 'ready to act if needed.'"

For one, the economies of the United States and the eurozone are not growing anywhere near the rate that people would like. Furthermore, the unemployment rates in both areas are too high.

Perhaps the most important additional piece of information, however, is that the rate of inflation in both the United States and in Europe is substantially below the target range of the two central banks. In the United States, the year-over-year rate of increase in the consumer price index in March is just one percent, while in the eurozone, the rate of price inflation in April was 1.2 percent, year-over-year. The European figure is the lowest rate of consumer price inflation in more than three years.

The Federal Reserve is on its third round of quantitative easing and the statement it released on Wednesday indicated, according to the Wall Street Journal article, "no sign it is leaning toward pulling back."

How aggressive has the Fed been in purchasing securities in the first quarter? In the New York Times article we read, "The volume of the Fed's first quarter purchases already roughly equaled the volume of new mortgage bond issuance and about 72 percent of the volume of new issuance of long-term federal debt." That is, the Federal Reserve bought up the vast majority of all new mortgage bonds and new long-term Treasury bonds issued in the first quarter of 2013.

That's pretty aggressive! And the statement indicated that the Fed might do even more "if the job market or inflation figures fail to meet the Fed's expectations."

It seems as if Mr. Draghi and the European Central Bank is willing to do the same thing.

The central banks can "talk tough" if the numbers for price inflation stay down.

The Fed's actions over the past year have resulted in the total reserves in the banking system increasing by almost 19.0 percent. This is a very high number by historical standards.

Looking at the latest figures on the Fed's balance sheet, we see that the actual dollar value of securities in the Fed's portfolio rose by almost $432 billion, net, over the past 52 weeks. A net amount of about $291 billion was added in the past 13-week period and a net of just about $93 billion of securities were added in the past 4-week period.

As a consequence of this purchase activity, reserve balances at Federal Reserve Banks rose by almost $333 billion over the past year. Of this increase, $169 billion were added in the past 13-week period.

This is the basic action that has taken place on the Federal Reserve's balance sheet. Pretty dull relative to what happened over the past five years.

Even with all this activity, there seems to be very little pressure, one way or another, on the effective Federal Funds rate. This rate, on a daily basis, has seemed to vary between 13 basis points and 17 basis points. That is, the Federal Reserve actions are not driving the Fed Funds rate to zero, what one might think would be the case given all the reserves the Federal Reserve is injecting into the banking system.

In term of the money stock, the growth rate of the M1 measure has slowed considerably. Year-over-year in April, the M1 money stock grew by 11.4 percent. This is down from the 15 percent to 18 percent rates of growth that were achieved in the past couple of years. The currency growth rate has slowed considerably, dropping to about a 7.0 percent, year-over-year rate of growth, but demand deposit growth remains very rapid at over 22.0 percent, year-over-year.

The growth of time and savings deposits continues to remain quite slow. Well, very little interest is paid on these accounts. Year-over-year, the non-M1 growth of the M2 measure rose by almost 6.0 percent.

The movement out of retail money market funds still continues. Retail money market funds dropped almost 1.0 percent, year-over-year.

Institutional money funds rose by a little over 1.0 percent, year-over-year.

No magic here. The Federal Reserve is doing what it is saying it is doing. Almost dull, isn't it?

So the only drama that exists with respect to monetary policy is what the officials at the Federal Reserve are saying, and that is not very interesting or insightful these days. Even the press is having a difficulty making something interesting out of what the Fed is doing.

Likewise for the actions of the European Central Bank.

But the officials of these central banks are being more forceful about it.

The consequences, for the time being, are that economic growth will continue to be tepid, price inflation will remain low, credit inflation will be excessive, and those that can will take advantage of the huge amount of funds floating around the financial markets and earn returns that most other people can only dream about receiving.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.