Notes From Underground: Will Big Ben Turn Back The Hands Of Time?

The FOMC will release the results of two days of policy deliberations at 11:30 a.m. CST Wednesday and the market is convinced that the Bernanke FED will vote to end Operation Twist but increase FED Treasury purchases. It may not be the full $45 billion but something above $25 billion, which would be in addition to the already promised purchases of $40 billion of mortgage-backed securities (MBS). It will be difficult to continue Operation Twist because the FED‘s System Open Market Account (SOMA) is nearly void of debt of less than three-year duration. Any new FED purchases will have to be with cash resulting in an increase in bank reserves. The result be not be a Maturity Extension Program but a new round of Quantitative Easing. It is doubtful that the FOMC statement will allude to fiscal policy but will just remain true to discussion of the dual mandate.

The potential fireworks will be at the Bernanke press conference, which begins at 1:15 p.m. CST. The Fed Chairman will undoubtedly be asked about the potential economic impact from the fiscal cliff. It was Chairman Ben Bernanke who gave power to the “fiscal cliff” at the post-FOMC meeting press conference of April 26. Mr. Bernanke called direct attention to expiration of tax cuts and spending sequestration by “the size of the fiscal cliff is such that there’s, I think, absolutely no chance that the Federal Reserve could or would have the ability whatsoever to offset that effect on the economy.”

This is Chairman Bernanke casting doubt about the FED‘s ability to prevent economic damage from a fiscal tightening. This does not meld with Bernanke’s often-published views on the failure of the Fed and the Treasury in 1937. The Roosevelt Government gave in to fiscal conservatives in 1937 and contracted the federal budget by almost 10 percent while the FED moved to raise rates. We know for certain that the FED will not be raising rates but the expiring tax cuts and spending sequestrations could mirror the actions of 1937, thus reenact the toppling a fragile economic recovery. It is in this situation that Chairman Bernanke will have to lay out some type of action to minimize the fallout from enforced austerity.

The April 26 quote will not stand against an economy struggling to take off. Congress has certainly failed to do its work and it seems that Senator Schumer has been proven correct: “Mr. Chairman, you are the only game in town.” Now what will the game entail? If the Federal government dramatically cuts spending and raises taxes, the multiplier effect at the zero interest rate will be dramatic. Larry Summers has raised the issue that the impact of the fiscal multiplier when the central bank is encumbered at the zero-bound is far greater. The IMF has also acknowledged that its long-held view of a one percent cut in the budget would lead to a 0.5% cut in GDP. It now believes that the cut to GDP may be anywhere from 0.9% to 1.4%.

If Chairman Bernanke speaks to this issue and the 1937 redo at tomorrow’s press conference, the headline driven algos will be certain to creat great volatility.The FOMC statement will be a mere tease  and we know that the Statement ‘s release always causes some headline driven movement.

***In a Financial Times piece for tomorrow, it was revealed that Mexican President Enrique Nieto is seeking to open up the Mexican energy sector to private investment. Readers of NFU have been aware that I have argued for three years of the need for Mexico to reform the 1938 Constitution and allow for foreign investment in the energy sector. The previous government of Felipe Calderon attempted to open the national energy monopoly to foreign investment but failed to attain the legislative support. The Mexican national budget is very dependent on the revenues from Pemex but as the oil resources are depleted the pressure on the Mexican Treasury will intensify.

Pemex needs the financial support and technical expertise of the world’s energy giants and it seems that President Nieto is going to try to reach a compromise by not privatizing PEMEX but just trying to move for some private investment–probably on a royalty licensing basis–as it appears he wants to craft some PUBLIC-PRIVATE partnership. If this comes to fruition this will enhance the bullish story for the MEXICAN peso and economy.

***In a Bloomberg story today, Dimla Rousseff Tells Hollande that Rich Nations Practice Protectionism, the Brazilian president castigated the French president regarding the use of monetary policy as a form of protectionism. By keeping monetary policy ultra easy, the developed world is weakening their currencies and trying to support exports in direct competition with the low-cost labor of the developing world.P resident Rousseff’s comments followed yesterday’s warning from BOE Governor Mervyn king. The fact that King warned of political friction in the coming year because of global foreign exchange policies and competitive devaluations certainly showed itself for the Brazilian President delivered the incendiary speech at an event in Paris with President Hollande in attendance. The colonial world model is dead–except at the IMF and World Bank–but change is in the air.





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2 Responses to “Notes From Underground: Will Big Ben Turn Back The Hands Of Time?”

  1. MD Says:

    Yra called it again….The yields on 10 yr Treasury are yielding much less than MBS and they are beginning to find a middle ground through heavy manipulation…Are we going to see MBS and 10 yr yields correlate?

  2. yra harris Says:

    MD–thanks for the acknowledgment.As far as the covergence between MBS and Treasury it depends whether we are talking the primary or secondary market.Even Chairman Bernanke acknowledeged the difference between what the FED pays for MBS and what the all in cost is for retail borrowers from the mortgage lenders–so it is difficult to give a straight forward answer

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