‘THE FED’S ROLL OVER—NOT MUCH OF A TRICK,’ by Randall Forsyth in Barron’s.

In Uncategorized on August 12, 2010 at 17:22

The Fed’s roll over — not much of a trick


Randall Forsyth

Reinvesting maturing securities only prevents accidental tightening. More to come?

The Federal Reserve took a first, small step toward supporting flagging economic growth. It is a necessary step, but far from sufficient.

In a move telegraphed in the press, the Federal Open Market Committee announced Tuesday it will reinvest maturing agency and agency mortgage-backed securities into “long-term” Treasury securities. And, of course, the panel maintained its intent to keep the its key federal-funds target at rock-bottom levels for “an extended period.”

The FOMC’s announcement had an immediate effect on the markets; stocks pared their losses, the dollar tanked and Treasuries rallied. What it also did was to let loose a torrent of uninformed commentary.

What the Fed isn’t doing is changing policy or monetizing the federal deficit.

What it is doing is to prevent an inadvertent tightening of monetary policy that would have taken place had the central bank not taken steps to reinvest maturing securities.

Nor was it printing money to paper over the federal budget deficit. While the Fed will shift towards Treasuries from agencies and agency MBS, that will return its assets to their traditional holdings, which had historically consisted primarily of full faith and credit obligations of the U.S. government.

Only during this unprecedented credit crisis did the Fed engage in allocation of credit in the U.S. economy, purchasing $1.25 trillion of agency MBS to support the housing market. It also took on assets of failed institutions through its “Maiden Lane” facility, named after the street in lower Manhattan where the literal back door of the New York Fed opens.

So, the moves announced by the FOMC maintain the status quo in. They do not mark a new, radical phase of debt monetization. It is actually conservative and those who would assert otherwise do not understand the workings of monetary policy.

A radical move would have been to expand the Fed’s balance sheet to stave off deflationary forces, as St. Louis Fed President James Bullard suggested in a recent widely discussed paper that the central bank consider true quantitative easing in the form of further purchases of Treasuries.

That may still lie ahead. As significant as the FOMC’s change in tack (if not in course) was its downgrade of the business outlook. “The pace of economic recovery is likely to be more modest in the near term than had been anticipated” as recently as last June 23, when the panel thought the “pace of economic recovery is likely to be moderate for a time.” In the intervening time, Fed Chairman Ben Bernanke told Congress last month the outlook was “unusually uncertain.”

Truer words were rarely spoken. The FOMC pointed out what was readily apparent, that housing remains depressed while employers remain reluctant to hire and nonresidential construction continues to flag.

The one bright spot has been business capital spending on equipment and software, the FOMC noted. But a J.P. Morgan analyst wrote in a note Tuesday that personal computer orders “are falling off a cliff” in Taiwan, which implies PC makers will be pushing out orders for components. Chips stocks were crushed, with Intel (INTC) down 4% and rival AMD (AMD) off 8%.

While wheat and other grain prices have rallied lately, electronic components are the commodities of the information age. The latter’s prices speak to the deflationary signs that are spreading, even as the commodity prices that were significant to a past agrarian era rise. As if monetary policy can do anything about the weather anyway.

While the FOMC essentially maintained the status quo, the panel pledged it will “employ its policy tools as necessary to promote economic recovery and price stability.” In other words, whatever it takes.

Almost exactly three years ago, the FOMC also held policy steady with expectations the next move would be to raise rates. Within days, the U.S. central bank was scrambling to ease funding difficulties among European banks in one of the first episodes of the credit crisis that only a few months earlier was declared by various officials to be “contained” to the subprime sectors.

Now, the economy and employment are weaker than expected while tech, the previous stalwart, is faltering. Even so, the economy cannot live on iPads and iPhones alone. Meanwhile, it’s hardly gone unnoticed in Washington that there are some elections in November.

All of which suggests Tuesday’s Fed action to reinvest maturing securities in Treasuries is more a prelude than an end to the story.


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