Or: Why Stimulus Won’t Stimulate….(Bloomberg)
The biggest price swings in Treasury bonds this year are undermining Federal Reserve Chairman Ben S. Bernanke’s efforts to cap consumer borrowing rates and pull the economy out of the worst recession in five decades.
The yield on the benchmark 10-year Treasury note rose to 3.90 percent last week as volatility in government bonds hit a six-month high, according to Merrill Lynch & Co.’s MOVE Index of options prices. Thirty-year fixed-rate mortgages jumped to 5.45 percent from as low as 4.85 percent in April….Costs for homebuyers are now higher than in December…..
“The Fed is stuck in a very difficult place,” said Mark MacQueen, a partner at…Sage Advisory Services Ltd…“You can’t have it both ways. You can’t say I’m going to stimulate my way out of this problem with trillions of dollars in borrowing and keep rates low by buying through the other. I don’t think that is perceived by anyone as sound policy”…..
“To the extent yields are going up because the economic outlook is brighter, the answer would be, don’t do anything,” Federal Reserve Bank of New York President William Dudley said in a transcript of an interview with the Economist last week.
Surely Dudley and the other Fedsters know that rising mortgage rates are the neutron bomb that will obliterate their monetary-induced “recovery.” If the “brighter” economic outlook to which he’s referring brings with it median-reverting mortgage rates it will lead to a renewed deflationary spiral. And yet, even as Treasury yields and mortgage rates climbed last week, the Fed didn’t step up asset purchases. Holdings of Treasury Securities rose only $9 billion last week, and MBS holdings fell $3 billion; agency debt holdings were flat. And the prior week the Fed was only marginally more aggressive: $17 billion increase in Treasurys, $5 billion increase in agency debt, flat MBS.
The Fed still has hundreds of billions left to spend under their previously announced $1.75 billion asset purchase plan. Why are they waiting?
Perhaps it’s because they know that nothing, not even the printing press, is strong enough to fight off bond vigilantes who see $3.25 trillion of Treasurys set to be dropped on the market. Remember when Hank Paulson spoke of the Federal Government “bazooka” that was going to protect Fannie Mae (FNM) and Freddie Mac (FRE)? With explicit government backing, he argued, there wouldn’t be a run on Fan and Fred debt. The Chinese weren’t impressed, sold their F/F debt, forcing Paulson to take the two into conservatorship.
What’s the moral of the story? As big a balance sheet as he has, Uncle Sam doesn’t have the resources to corner the bond market.
As powerful a tool as the printing press is, the Fed doesn’t have enough electronic ink to corner the bond market either. Not when Congress needs to borrow trillions to meet its fiscal commitments.
Is it possible Bernanke is playing chicken with Washington pols? Last week he made headlines by calling for deficit reduction. He knows runaway deficit spending will neuter his monetary-induced “recovery.” He needs Congress to get serious about deficit reduction. Now:
Clearly, the Congress and the Administration face formidable near-term challenges that must be addressed. But those near-term challenges must not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances. Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.
Somehow I doubt that Bernanke is comforted by the administration’s promise to cut the deficit “in half” by 2013. Letting rates rise may just scare Obama into cutting it down to size much sooner…
