Notes From Underground: St.Louis Federal Reserve President gave the market the Blues

St. Louis Fed President James Bullard  warned that the U.S. was closer to mimicing the Japanese situation now than at any other time in recent history. Bullard, who has been a noted hawk, surprised the market with the vibrancy of his rhetoric about a possible renewed downturn. He said if there is a negative shock to the economy the FED should expand the quantitative easing program or cut the interest rates of reserves that the FED pays. Bullard’s statement initially sent the S&Ps and Dow lower as the market s became very concerned that a noted inflation hawk had lost his talons.

“The most likely possibility from where we sit today is that the recovery will continue through the fall, inflation will start to move up and this issue will all go away … Suppose we get another negative shock ,another surprise. We have to be prepared in that event to have a plan in place to do something.”

Again, we note that Bullard has been an inflation hawk and the market was initially scared by his sudden shift to raising the issue of more quantitative easing. The equities eventually bounced back to unchanged after the initial drop, but the GOLD did get a late rally after being steady most of the morning.

Bullard did not say how he would go about another round of quantitative ease and for us at NOTES that is the question. Will the FED announce a huge buy of Treasuries in order to shift the entire curve lower? Will they start selling U.S. Dollars in the market ? Can they possibly purchase stocks or stock indices? We do know that a huge buy of Treasuries would shift the entire curve lower which would force uncommitted investment capital to seek higher ,more risky returns. Would you rather own a 10-year note that yields less than 3 percent or maybe even David Rosenberg’s 2 percent call, or would investors then be forced to purchase equities with sizeable dividend yields?

These Bullard comments are important for the fact that they come from the base of the very conservative St.Louis Fed. Mr.Bullard will be on CNBC’s Squawk Box for an hour as a special guest on Friday. We advise all traders to be attuned to further discussion on this very important issue of potential deflation caused by any type of new economic shock. If the FED is getting nervous, we wonder what the White House and Congress are feeling. Friday’s GDP number just may bring some more insight into the politics of the current economic malaise.Maybe the CARDINAL will play out in St.Louis.

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2 Responses to “Notes From Underground: St.Louis Federal Reserve President gave the market the Blues”

  1. Danny Says:

    Yra,

    It seems easy enough to follow the argument behind QE in the context of purchasing mortgages and other interest rate products in order to manhandle the cost of debt lower – in an effort to increase investing activity (capital or residential). However, what would be the economic merit behind purchasing stocks or stock indices outright?

    Such an action could potentionally dampen volatility (from what would likely be a very excacerbated place even in the context of recent volatility). But I have seen you quoted as saying, “the markets are like water…they will flow to the weakest point that they can push through, and they always do.”

    Applying that same logic implies that purchasing stocks would be an egregiously risky move (especially considering the fact that the Fed will take these actions in the event of a major negative economic shock which implies risky assets are far more risky at that exact time) that would likely yield very limited benefit to the real economy aside from padding the rocky decent – as markets are going to go where markets are going to go?

    In your view, what would be the pros or cons behind QE in the more risky securities realm? I just wonder if direct SBA lending via the Fed or some Fed induced bank tax on excess reserves to try and force lending higher would be more effective in staving off the fallout from another shock.

    Thanks for your time and your thoughts.

    Danny

  2. yra Says:

    Danny good point–but the FEd will look at other Central banks that have intervened thru the equity markets.Hong Kong comes to mind,but I will not dwell on this as it may be illegal and only is hypothetical.The FED must acknowledge the pension shortfall that is a huge drag on state budgets and wouldn’t a mega boost to the equity markets remove the stress caused by these pension shortfalls–and the fed could go to zero rates on reserves but as this is a new tool in the box not sure of the impact anyway—remember that the FED pushed for the right to pay interest on reserves for they wanted it as a tool to remove the excess liquidity from the system.

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