In reading through the FOMC minutes I ponder the headlines that screamed about the hawkish tone in the minds of the FOMC members. You have to be looking for “negative waves” to find an overly cautious FED. The most striking effort of ending the LSAP (large-scale asset purchase) program is the work of Governor Jeremy Stein who delivered a powerful speech last week about the mal-effects that the FED‘s QE program was having on other financial markets (especially the corporate debt markets where the search for yield was causing the possible removal of risk pricing into the high yield corporate bonds.) The minutes noted: “Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability.” Again, no surprise here as it was detailed out in Jeremy Stein’s speech.
The FOMC did note what I reported earlier in the week, which was a concern of St. Louis President James Bullard:
- The Fed’s continued asset purchases could expose the Fed to significant capital losses with a very large portfolio of long-duration assets
- More purchases could have a detrimental impact on the effective pricing of risk on all financial markets
- Others worried about the FED ending its program prematurely and a FEW participants noted examples of past instances in which policymakers had “prematurely removed accommodation with adverse effects on economic growth and price stability.”
The most bothersome mood in the MINUTES was the complacency because the markets have maintained their composure, bond rates remained subdued and volatility low. The FED‘s LSAP was not seen as a problem … yet. The overall mood was set by the staff’s report, which stated: “On net, global equity prices rose and euro-area spreads narrowed. As global risk sentiment improved, the DOLLAR depreciated against the euro and most emerging market currencies.”
This is really troubling for it seems that the most significant participant in the global growth game is watching the same variables as the market participants and judging the success of its actions by what the traders and investors do–the true response to the PORTFOLIO BALANCE CHANNEL. Bernanke and company are satisfied with the success of the market reaction function. Wow, economic policy made through market tautology. The Fed giveth and the market reacteth in the desired fashion and it just keeps repeating itself.
***My friend JA raised an issue that all traders will certainly understand and needs to be placed before all market participants. As traders, we have to wonder what happens when the FED‘s trading desk makes it first call for prices to exit the market.
NY FED: Hello, JPMORGAN, this is SOMA (security open market account) from the Federal Reserve. Can we please have a bid for $25 Billion MBS.
JPM: Can you hold for just a moment? Looking for a market price for you.
(The trader mutes the phone and yells to all traders on the desk: “SELL EVERYTHING!”)
Experienced traders know what happens one a large position begins to exit the market. Remember back to the time when Alan Greenspan was worried about the outcome of the liquidation of Long Term Capital Management. The NY BANKING community basically had to be sequestered in a room and told not to race ahead of the liquidation of LTCM‘s positions causing even larger disruption to the markets. Foreign currency are very well aware of the power of just the rumor of a central bank intervening in the markets. I know the FED‘s rocket scientists are all aware of the theoretical value of its enormous portfolio, but theoretical pricing models are rendered useless in the reality of actual market practice. Yes, members of the FOMC will shout–it hasn’t happened YET–but a BOND market that has suffered under the harsh financial repression of the FED‘s PORTFOLIO BALANCE CHANNEL will seek its revenge. So premature extraculation may result in some unsatisfied theoreticians.