But one day she said
Sweetheart the party's over.
Turn out the lights..."
- Willie Nelson
After the March meeting of the FOMC, what was driving monetary policy until nest November became clear. It's an election year. The Fed is aware of the fundamental wisdom parroted by then Presidential candidate Bill Clinton: "It's the economy, stupid!" And the FOMC is dominated by members who want the economy to look as strong as possible in November.
There is a lovely bedtime story the public hears from time to time, about an independent, collegial group of men and women at the Federal Reserve, that form monetary policy according to their Congressional mandate. They meet from time to time to consider how best to control inflation, unemployment, and interest rates. The FOMC, as the story goes, uses the instruments it controls, a list that has grown as a result of the Financial Crisis, to achieve this goal.
But whether by intent, or as a result of the uncertain course of events during the last decade, it has gotten increasingly difficult to look at a specific number, like the fed funds rate (how I miss the good old days!) to read the Fed's intent. Now, we also have the rate banks are paid on excess reserves, forward guidance, and the dot plot, too. And don't ever forget - monetary policy is data driven!
Then there are the speeches of twelve Fed District Bank Presidents and seven members of the Federal Reserve Board. Last week there were bearish speeches by District Reserve Bank Presidents. Speculation focused on dissent within the Fed.
Baloney. Twelve people vote when the FOMC votes on policy. Five of them are members of the Board of Governors, with offices in Washington DC. The Governors are all appointed by the President. The five Board members serving now were all appointed by President Obama.
The one permanent voting Federal Reserve Bank President, the President of the New York Fed, is the only permanent voter that doesn't have his office in Washington, D.C, and was not appointed by the President. The New York Fed's President has the traditional role of the Fed's ambassador to Wall Street. Who does Wall Street want in the Oval Office, I wonder?
This leads to the conclusion that the President's will is a factor. And the President has made his will concerning the election very clear. He wants a Democrat to be elected.
The reality is that the very limited effect the Fed can have on the economy between now and November is mostly through stock prices. That is why the Fed's intention is to ease policy, through an unchanged policy rate, until the stock market strengthens. The market is a buy until November [for example SPYDR S&P 500 (NYSEARCA:SPY)].
Chairman Yellen, in yesterday's speech, reiterated the essentially irrational motive provided by the FOMC for the March policy reversal: weakness in the economies of other countries. But weakness in other economies is no part of the FOMC responsibility. Nor is it the forecast consensus that this weakness will significantly impact the unemployment rate, inflation rate, or interest rate in the United States, beyond the effects that the Fed was aware of in December, when the Fed announced their original policy intent - 100 basis points increase in the policy rate within a year. The Fed has backed off, and the reason is an excuse.
So what else do we need to know? Two things. The Fed knows what it's doing. And there is very little the Fed can do that is helpful to the Democratic candidate between now and November. They can only affect the values of common shares.
The Fed knows what it's doing. The leadership of the FOMC is quite capable in policy matters. They are not the President's stooges, but skilled professionals.
This means that silly things, like negative interest rates, are not in the cards. On the subject of negative interest rates, I heartily recommend former Chairman Ben Bernanke's article discussing the Fed's policy options, here. The former Chairman is the master of damnation through faint praise. For him, negative interest rates are the third of three options. (On the general topic of Bernanke damnation through faint praise, also see his article congratulating China on being included in the IMF's Special Drawing Rights. The title, " China s Gold Star," says it all.)
So many choices. What to do?
So what, in Bernanke's opinion, can the Fed do to ease now? In the following article on policy options, here, he blesses targeting long term interest rates. I buy this as both a viable choice and a powerful way to stimulate very short run growth. The kind that could matter between now and November.
How would the Fed do that? Bernanke points out two keys to successfully pegging interest rates: consistency and credibility.
- Consistency: The Fed's actions and behavior would need to be consistent with the lower targeted longer term rate. That would mean changes. No more dot plots. The puerile exercise of forecasting short term interest rates that are, in fact, primarily the result of the Fed' own decisions, wouldn't be missed. And if the forecasts were inconsistent with the targeted long term rate, they would be counterproductive. Similarly, there would be no need for forward guidance. The long term rate targeted is the forward guidance.
Perhaps most important, the opposing positions, delivered in speeches, of various minor lights of the Fed pantheon would self-extinguish. The speeches would be revealed, in advance, as complaints - not prophesies. Not a good look for the speaker.
- Credibility: This is perhaps the horse that has already left the barn before the door is closed. There is a question of credibility that has been introduced in the Fed's recent policy reversals.
The Fed's credibility would be important to the exercise of pegging long term interest rates, because the method by which the rate would be fixed is through Fed commitment to buy the maturities they are fixing. And if the government securities dealers think the Fed will allow the pegged rate to rise, they will sell the entirety of the pegged issue to the Fed, and short the issue as well, which would "blow out" the Fed's balance sheet. On the other hand, if the dealers believe the peg is final, the dealers have no motive to sell at all.
The bottom line is that the Fed no longer has the credibility to do something as aggressive as peg long term interest rates. What they can do is leave the policy rate unchanged. And that's what they will do.
Disclosure: I/we 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.