Notes From Underground: Bill Dudley refills the PUNCHBOWL (or why New York bankers shouldn’t Head the NY FED)

All was right with the markets as the unemployment data was released and for one of the few times in recent memory, the Wall Street analysts, ADP and others were right on target. Private sector job growth continued to improve, and the state and local governments were continuing layoffs to try to balance its budgets. The softest part of the employment data was the average hourly earnings, which were FLAT. This implies that employers are under no stress to lift wages with the unemployment rate at 8.8 percent. The markets took the data in stride as the DOLLAR was rallying on the positive data. With the previous day’s comments from various FED presidents, there appeared some need to lift some of the SHORT DOLLAR positions. The short-end of the yield curve was under pressure, aiding the DOLLAR RALLY and the selloff in the precious METALS. The equities seemed to be basking in the perfect storm for no WAGE GAINS, a mere threat of 1 percent FED FUNDS with an improving JOBS PICTURE doesn’t get any better for the EQUITIES.

The the markets received the words of the GOLDMAN-turned NY FED PRESIDENT BILL DUDLEY. The METALS and CURRENCIES reversed as DUDLEY‘s words were deemed by the market to be Bernanke’s and thus carry more weight than those of Plosser, Fisher and Kocherlakota. The FED president’s from west of the HUDSON, with the exception of San Francisco and Chicago, appear to be far more concerned about the FED‘s CREDIBILITY than those FED members that are too close to Wall Street. It seems that the guardians of the money-centered banks and the believers in the impact of the PORTFOLIO BALANCE CHANNEL do not want to raise rates to upset the positive impact of the “WEALTH EFFECT” as reflected in DUDLEY‘s speech on Friday (hat tip: SPARTY):

“The coast is not completely clear–the healing process in the aftermath of the crisis takes time and there are several areas of vulnerability and weakness. In particular, housing activity remains unusually weak and home prices have begun to soften again in many parts of the country. State and local government finances remain under stress, and this is likely to lead to further spending cuts, tax increases, or job losses in this sector that will offset at least a part of the federal fiscal stimulus.”

This appears to be where the battle lines are being drawn between the HAWKS and DOVES. It is FED credibility that is on the front burner for HOENIG et al, while the DOVES are waiting for all variables to provide an all-clear signal. It is the FED‘s credibility that will prove most important, even though CREDIBILITY is not one of its mandates. If the FED pushes the QE game and zero-interest policy too far it will have a major problem unloading all the securities on its balance sheet. This is in fact what Pimco’s Gross and others seem to be warning about. If you measure the FED‘s credibility after the first round of QE, it seemed to be unaffected as the yield curve was FLATTENING and the DOLLAR was holding up as the EURO DEBT PROBLEM was considered a bigger issue.

Post-Jackson Hole and QE2 the DOLLAR has weakened, metals have rallied and the 2/10 curve has steepened. The EURO CURRENCY has rallied even as issues surrounding the SOVEREIGN DEBT ISSUES PLAGUING ITS BANKS and the SOLVENCY OF THE PERIPHERALS continue. THE DOLLAR also has failed to rally with all the turmoil in the MIDEAST, allowing the markets to assess that the U.S. DOLLAR HAS LOST ITS HAVEN STATUS, which must mean that the FED HAS DIMINISHED CREDIBILITY. If this proves to be the case, then BERNANKE is going to be astonished at the FED‘s inability to clear its BALANCE SHEET of long-term MBS and TREASURY SECURITIES.

The Chinese have awoken to this and have sold off some of its MBS holdings and are also not buying as many TREASURIES. I had often heard that when Paul Volcker was FED CHAIRMAN, he considered the GOLD PRICE his enemy, thus waging war against inflation. It was Mr. Volcker who restored FED credibility. Let’s hope that Chairman Bernanke does not destroy the gift that he was given. Dudley’s desire to rush to refill the PUNCHBOWL that was being drained by Kocherlakota leaves more questions than answers.

When the world’s LARGEST DEBTOR loses its credibility, all the models will fail to explain the price that will be needed to be paid. The DOLLAR STANDARD is based on the credibility of the FEDERAL RESERVE. PLEASE BEN DO NOT SURRENDER IT. Amazing how the DOLLAR reacted to just a hint of a rate rise to 1 percent. Again, if this economy cannot tolerate a return to 1 or 2 percent overnight rates, what shape are we really in anyways?

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15 Responses to “Notes From Underground: Bill Dudley refills the PUNCHBOWL (or why New York bankers shouldn’t Head the NY FED)”

  1. menkenman Says:

    A cynic is a man who, when he smells flowers, looks around for a coffin.

    H. L. Mencken

  2. yra Says:

    menkenman–you believe I am a cynic oh well I think I would disagree for I know the value of many things but the price of very little.

  3. Kevin Waspi Says:

    You’ve got to love a Fed that constantly reminds everyone about their “dual mandate”, without acknowledging their own self-anointed third mandate; re-flating market bubbles. So much for their credibility.

  4. Rob Syp Says:

    Yra, You are so awesome in your writing’s. I was just telling someone to sign up to your blog.

    It’s a pleasure to be acquainted with you. Keep up the good work and here’s to springtime in Chicago.

    My Best…

    It’s Masters week & the Kentucky Derby on the horizon.

  5. usikpa Says:

    What will Mr. Duddly say when inflation gauge exceeds Fed’s targets while employment still lags (which is certain)?

  6. yra Says:

    USIKPA–I believe that the FED will deem that a positive that increased inflation will help alleviate the DEBT that still plagues the balance sheets of many actors in the economy.Increased inflation will send investors out to purchase foreclosurers as they look for hars assets to replace holding depreciating cash–once housing starts to turn we will stop hearing about dual mandates.It appears that the FED believes that Volcker taught them the assymetry of interest rates—it is easier to stop inflation thru raising rates then it is to stop deflation by lowering rates–Schumpeter’s concept of pushing on a string

  7. Joe Says:

    The Fed acolytes are wearing out their copies of the classic The Wizard Of Oz.” I don’t believe the Fed really knows, anything. What and whose definition of inflation or deflation are we using? The Fed serves one master and that is the US Treasury. As someone alluded to a third mandate, and that is to keep the government’s borrowing costs as low as possible. So far, it has been the fact that the US is still the safest place on the planet to keep an asset that has kept yields low and has allowed us to export some of that “inflation” that the Bernanke says is the “other” banks problem. When the market starts believing we’re no different than any other self-serving “democracy”,” we’ll have used up all of our collective credibility. Lead on, “Dr.” Bernanke!

  8. Arthur Says:

    I share Yra´s view about the Fed-Inflation. Anyway, I´m probably wrong but I´m bullish on the US dollar… dollar smile theory?

  9. yra Says:

    what is the dollar smile theory????

  10. Arthur Says:

    A theory originally advanced by Stephen Jen, then an economist with Morgan Stanley, now a hedge fund manager (London) and one of the world’s best-known foreign exchange strategists, according FT or Citywire

  11. Craig Shaw Says:


    In response to H. L. Mencken observation of your work

    The power of accurate observation is commonly called cynicism by those who have not got it – George Bernard Shaw (No relation)

  12. Arthur Says:

    Craig Shaw, very good quotation! Thanks

  13. yra Says:

    Thanks Craig–very good .Again the high level of responses is what is the true joy of this–the discussion has really been kept to a high level over these 16 months.

  14. Kevin Waspi Says:

    To Arthur,
    I like the “dollar smile” hypothesis. It has good intuitive basis. That said, I do feel a little uneasy with the “history repeating” part of the dollar recovering in the upswing of an interest rate cycle. The implicit assumption in the hypothesis is that the U.S. dollar retains its status as a respected, trusted fiat currency in a quickly changing world of global economic and militaristic dominance. If this element were not active, Greece would still be using the Drachma, and it would be the strongest currency in the world with some of the highest interest rates available, despite their inability to afford them!

  15. Arthur Says:

    To Kevin Waspi,

    Thanks for your comment, very interesting. Yes, the assumption (probably wrong) is that the US dollar will retain its status, so the dollar´s weakness is not a trend.

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