Notes From Underground: The Bernanke testimony was no surprise … so why did the market respond so negatively??

Yes, we know that Bernanke was right out of central casting with the FOMC minutes being the mainstay of the prepared text. The market was supposedly surprised by the chairman’s words about the FED preparing ways to remove all the previous stimulus. We don’t know why Bernanke paid homage to that as it was in direct contradiction to the everything else he said. (He believes that the FED will have to leave interest rates at these low levels for an “extended period.”) Again, we stress that there was nothing new in the testimony, but as always we respect the market’s wisdom and its ability to inflict pain. We have long thought that as the long end of the DEBT markets rallied, the FED ought to be selling some of the MBS debt that it has bought as they would need to relieve their balance sheet to make room for future possible purchases. As long rates have fallen due to demand for BONDS and other debt instruments, we wonder who is buying all that paper now that the FED has stopped? If it is pension funds, shouldn’t the FED be selling it them so as to insure that they don’t bid the market to ridiculous levels?

Thus, the FED would be doing the market and pension funds a favor while potentially helping themselves. We want to raise a serious question at this point and it stems from what the BOJ under Hayami proposed about seven years ago. The BOJ was worried that they had bought so many JGB’s and if its anti-deflationary tact was successful then they would be left holding the bag as inflation soared and they owned all the bonds (the BOJ is a privately held institution–yes there are stockholders). Hayami said the BOJ would hence forth buy equities to pump liquidity into the system, and, at the time, it put the low in the Nikkei, which was around 7200 at the time. Our question: wouldn’t the FED get more bang by buying stocks and pushing up equity prices to ease the terrible situation of the pension funds, as well as pumping liquidity into the system? Just food for thought and certainly a question we would ask Chairman Bernanke.

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16 Responses to “Notes From Underground: The Bernanke testimony was no surprise … so why did the market respond so negatively??”

  1. Arthur Global Practice Says:

    “The Fed probably believes that unconventional policy does not have much traction as market functioning gets better”, said Vincent Reinhart, a resident fellow at the American Enterprise Institute and a former Fed official.

    Investors may be looking to Asia for inspiration? Japan has run huge deficits for 20 years and still has ten-year bond yields of under 1.5%. If investors think the American economy is in for a similar period of stagnation, then Treasury-bond yields of almost 4% look attractive?

  2. Arthur Global Practice Says:

    Bernanke. Responding to questions on fiscal policy in which senators tried to get him to endorse their preferred policies, he argued that the long-term budge deficit is unsustainable and that any effort to boost the economy in the short run should be paired with longer-term deficit reduction. So what exactly means?

    Yra, don´t forget “geopolitics”. How is affecting the FED?

    My best

  3. Hubert Says:

    Since the Fed is not audited, how do we know it does not already own a bunch of S&P futures (via Goldman or JPM) ?

  4. yra Says:

    Arthur–the Japanese situation is not similar to the u.s. in that japan debt is owned 97% by domestic investors who also carry very little personal debt.As Naomi Fink,one of the better analysts on Japan has pointed out–it is net debt that is the primary indicator;public and private debt.I think many err in comparing Japan to U.S. for that reason.The short term stimulus and longer term debt reduction is most probably the impact of what we wrote last week about Greenspan’s pay/go rule—but as Nixon so ominously said–we are all Keynesians now!

  5. yra Says:

    Hubert–thanks for getting the ball rolling on this issue.No we don’t know but I am certain that if the FED was using “investment” banks in that capacity some drunken ass from one of these firms would be blabbing about it and the rumor mill would be abuzz—and yes I am aware of the PPT

  6. Matt Burns Says:

    Besides persistent rumors of the PPT, is there any precedent to the Fed buying SPS? And is it within their limits to do such?

  7. yra Says:

    Matt great question –I was just reading fed reserve article 13.3–not a lawyer so i am not certain if the fed has the legal right to do so—but hopefully we will find out more

  8. Arthur Global Practice Says:

    Yra, I buy your argument about Japan. I´m not sure about “we are all Keynesians now” (Nixo/M. Friedman)… I don´t see massive investment in infrastructure and job creation in the US or Europe.

    Joseph E. Gagnon (Peterson Insitute for International Economics) argues that “pushing down yields on short- to medium-term Treasury securities is precisely the strategy for fighting deflation recommended by Ben Bernanke in 2002.”

    I recommend: Deflation: Making Sure “It” Doesn’t Happen Here

  9. yra Says:

    know the Bernanke piece well–it is in my briefcase all highlighted from nov.2002—-the nixon quote was the tricky dick learned how to finance a sure fire election—turn the spigots on and coerce artie burns into a soft money stance and george mc govern didn’t have a chance

  10. Arthur Global Practice Says:

    So, we have Bernanke’s solution or policies to deflation>

    1. Increasing the number of U.S. dollars in circulation.
    2. Holding the overnight rate at zero for some specified period.
    3. Begin announcing explicit ceilings for yields on longer/maturity Treasury debt, say next two years.
    4. To operate in the markets for agency debt or to lend to the private sector indirectly via banks, through the discount window.
    5. To offer fixed/term loans to banks at low or zero interest.
    6. To buy foreign government debt.

    Yes, US is not Japan. However, as Bernanke has pointed out “political constraints, rather than a lack of policy instruments, explain why its deflation (Japan) has persisted for as long as it has”. What about political constraints in the US?

  11. yra Says:

    the tea party is brewing as a force of political constraint—but the republicans ala Nixon are certainlt fiscal profligates as we saw under Bush—and somebody wrote about the deficit chicken hawks–good line–but I don’t see the political constraints in the U.S.

  12. Hubert Says:

    to continue the discussion:
    Fed could just sell a very big put-option to one market maker when markets are breaking down. In 9 out of 10 cases the puts will not be exercised because the markets turn when they see big delta buying. The PUts could even be forgotten. The “Big Put” does not even need to be a transaction – it could be a promise by Bernanke or the respective president of the NY Fed (or both) “to be there” if needed. This would be a very profitable promise to receive because you could go all hog in.

  13. Arthur Global Practice Says:

    PIMCO says: the markets’ belief that the Fed will keep rates low longer is doing what the Fed wants: propping up prices of financial assets.

  14. yra Says:

    hubert–very nice thought .I appreciate that as it is not my expertise but it makes perfect sense

  15. Arthur Global Practice Says:

    Neil Irwin (Washington Post Staff Writer) makes a good point about what Beltway is thinking (i don´t if right): Although the current large budge deficit is caused mainly by the weak economy and a short-term economic stimulus that will soon expire, in the longer run the government faces a vast unfunded burden, particularly tied to Medicare and Medicaid.

  16. yra Says:

    arthur those fears are too far removed from the next election cycle so the mass media can’t report it and there are no pictures of the looming crisis to show on the mind numbing box.If I can’t visualize it ,it doesn’t exist for as we are wont to say–the revolution will not be televised

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