Is the Federal Reserve asleep at the wheel? If it is seriously considering ending quantitative easing now, I would have to say it is. Furthermore, Chairman Bernanke's crew would be blind at the wheel if it were considering raising interest rates this year. Fortunately, I do not believe the Fed is contemplating a near-term action, but unfortunately, it failed to communicate that clearly enough this week.
The testimony of Chairman Bernanke to the Joint Economic Committee and the FOMC Meeting Minutes release that followed set stocks in motion downward, and raised a specter of doubt in Fed wisdom. The SPDR S&P 500 (SPY), SPDR Dow Jones Industrial Average (DIA) and the PowerShares QQQ (QQQ) closed the period lower by 1.0%, 0.2% and 1.2%, respectively, but the week was much more tumultuous than the end result makes it to appear.
The market may end up being justified in its concern. It would not at all surprise me if the Fed were asleep at the wheel, given our recent revelation that the Fed's math does not even add up regarding its GDP growth forecast. If the Fed were contemplating a monetary policy change in the near term, it would seem to me to be misplaced given the economic reality we are seeing globally, with Europe falling deeper into recession and China seemingly slowing. I have regularly detailed economic shortfall over the last few months within the flow of my articles on the economy. As such, I believe the Federal Reserve should not be seeing anything but the need for providing continued monetary and fiscal support to our economy.
Bernanke's Part in It
This past Wednesday, the Federal Reserve shook up securities markets when Chairman Bernanke wavered between dovish and hawkish commentary. Of specific concern to investors was Bernanke's answer to the question regarding the Fed's exit strategy, which you can review via this video. What I found most concerning was that the Chairman is hinging the end of asset purchases to improvement in the labor market. In this regard, I wonder if the Fed is only looking at the reported unemployment rate, or if it is at all considering the real unemployment rate, which we estimate is much higher. Not considering the unaccounted for unemployed, who have fallen off the radar after running out of unemployment benefits, or who are working, but toiling for only enough hours to not collect unemployment benefits while also not being able to pay their bills, is an example of blindness.
Bernanke wisely noted that any initial Fed action would not signify the beginning of an automatic series of actions set to curb excess economic expansion. I'm not sure anyone noticed the statement, or if those who noticed it believed it. Then he followed with another statement that perturbed me, saying that the Fed may or may not sell assets. In other words, curbing the asset purchase program does not mean the Fed will reduce its balance sheet. I'm just not sure I want the Fed invested in anything for too long, given the importance I see in it bearing as little of its own risk as possible. Still, there is wisdom in not contributing to excess interest rate rise by selling assets into the natural market, for however natural a derivative market can be.
Probably the most important question asked was when Joint Economic Committee Chairman Brady asked Bernanke specifically whether he thought these prematurely conceived and market terrifying Fed actions would begin before Labor Day. Bernanke's response was, "I don't know. It's going to depend on the data." That shocked a market that saw a quarter away as abruptly too soon. I do not believe Chairman Bernanke intended to imply that before Labor Day was possible, but he raised the specter of doubt nonetheless.
Then, Brady said something I found myself nodding in agreement with. He said, paraphrasing, that it seems that at this point the economy should be in much better shape than it is, but that it seems to remain vulnerable. He added that he feared that the Fed did not have the medicine for what ails our economy, and that it is targeting employment, where fiscal policy plays a greater role. However, he misses the point that what the Fed does, in fact, offers support to the broader economy and makes fertile land for the economy to grow upon. Jobs will sprout from that soil as long as the issue is not structural or partly structural, which is something I see. But the Fed Chief seemed to read my mind, noting that the Fed could only impact those jobs lost to the cyclical downturn which could return, and not those jobs lost for other reasons, though perhaps opportunistically pushed forward by the crisis.
Chairman Bernanke smartly noted that indeed fiscal policy has been a headwind of late, along with other headwinds like Europe and the scars of the real estate and financial sector collapses. I agree with Bernanke that without the Fed's efforts, this economy would be in even worse shape. However, I also believe that he should be more instrumental in advising the President and Congress as to exactly what to do, and probably get paid an awful lot more for it. He clearly is the smartest guy in the room, but unfortunately also perhaps too reserved and a role player where a leader of his caliber is needed in Washington. Did I really just say that?
FOMC Drinks Too Much Coffee
Because the Federal Open Market Committee has very little else to talk about, the discussion at its regular meetings has gotten monotonous over the last few years. The question must ring true meeting after meeting, what more can we do to stimulate economic expansion? This reality leads the pawn of inflation hawks, Jeffrey Lacker, to play devil's advocate and dissent and discuss the risk of future inflation, which never seems to develop (not that it won't). I happen to agree that it will, but it's a few more moves ahead yet and will require a catalyst, which I'll speculate about in future articles.
So, as a result of all the monotony and the reality of a growing economy, however unnaturally and weakly it grows, the topic of ending quantitative easing and raising interest rates must come up in passing. The problem is that with all this uproar about the need for transparency around The Creature from Jekyll Island, what should be a private discussion since it does not dictate current policy becomes what moves markets.
The release of the FOMC Meeting Minutes from the April 30 - May 1 meeting added fuel to the fire that the Federal Reserve Chief and the Joint Economic Committee began earlier in the day.
What the Market Noticed
What the Market Missed
A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome. One participant preferred to begin decreasing the rate of purchases immediately... Regarding the composition of purchases, one participant expressed the view that, in light of the substantial improvement in the housing market and to avoid further credit allocation across sectors of the economy, the Committee should start to shift any asset purchases away from MBS and toward Treasury securities.
Participants also touched on the conditions under which it might be appropriate to change the pace of asset purchases. Most observed that the outlook for the labor market had shown progress since the program was started in September, but many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate.
So, I ask you, is the Fed asleep at the wheel? Sometimes, yes, I believe it is. For instance, in its forecasting of the economy I believe it has been notoriously poor, and I believe its most recent math has been flawed. Of course, the statement by the Fed Chief that the real estate crisis would be contained was notoriously in error as well. Still, for the most part, I think Chairman Bernanke and the rest of the group work hard to maintain economic stability. Without his guidance through the crisis, I cannot say how deeply we would have sunk, but I'm sure it would have been much deeper.
The Fed's monetary policy actions are the result of a process, which probably should be transparent. However, maybe we need to see the FOMC Meeting Minutes and other Fed publications after the market close rather than intraday. That way we could carefully inspect and dissect the economic discussion without the pressures of miscalculating weighing so heavily upon us with every passing tick. Speaking of ticks, if you enjoyed this latest bite, I welcome you to follow my intrusive and disruptive column.