The much-awaited piece from Jon Hilsenrath about FED “tapering” appeared in the weekend WSJ, and, as promised by the abundant tweets, it delivered very little in providing any new insights into Fed halting of security purchases. The headline, “Fed Maps Exit From Stimulus,” wasn’t a map of any kind and merely seemed to provide the philosopher’s answer to question of what to do when confronted with the fork in the road … TAKE IT. The FED is caught on the horns of a dilemma for it wants to provide some clarity as to how it will end the large-scale asset purchases (LSAP) without sending the market into a downside tailspin. The massive increase in the FED‘s balance sheet has provided the rocket fuel to boost the demand for all types of risky assets but how do they know the economy has enough strength to sustain the rally on its own. It seems that the most important voice now will be Fed Governor Jeremy Stein–more important than Jon Hilsenrath–for he seemed to unnerve Chairman Bernanke with his April 19 speech in which he warned about the distorting impact the Fed was having on risk assets. It seems the Chairman has awoken to the idea that the FED has blown an asset bubble, especially now that the Japanese have added to global liquidity.
The Europeans are most in need of an economic boost but have been the most reticent in providing the necessary actions. The ECB has actually removed some of its QE programs by having some banks repay the LTRO money early, and again, remember that the outright monetary transactions (OMT) have never been called into action. Europe has room to move but on liquidity adds but the Germans provide a barrier to the type of FED-influenced QE efforts. It’s not a coincidence that ECB President Draghi has put forward the idea of an ECB program of purchasing asset-backed securities (ABS).
This would enable European banks to bundle bad loans into a bond that could be placed in the pool of ECB assets, basically creating a bad bank. By removing the poor quality loans the ECB is hoping that banks will again begin lending to small and medium enterprises (SME) and thus get money flowing to the backbone of many EU economies. European banks are fearful of lending to the SMEs because of the large increase in non-performing loans. Push the loans onto the ECB and banks will be freed to begin lending again and the velocity of money will help energize the economy.
The G-7 meeting provided little and no communique was provided, but my take on the purpose of the meeting was to get EUROPE TO GET BEHIND DRAGHI’S ABS PURCHASE PROGRAM AND AS A QUID PRO QUO THE U.S. WOULD BEGIN TO REDUCE ITS BOND PURCHASES. The Japanese have provided a boost and the U.S. would like Europe to do the same, but to placate the Germans and others the U.S. WOULD REDUCE ITS EFFORTS SO AS TO NOT BLOW THE GLOBAL ASSET BUBBLE TO EVER GREATER HEIGHTS. The U.S. is muddling through and is the best of the G-7 but Europe is needed to help the global economy. The meeting failed though as the German finance minister is opposed to the ECB buying ABS. In a Spiegel article, Schaeuble maintains that ABS purchases by the ECB “would be ‘covert state financing’ and would violate present rules.” Schaeuble also noted that he was worried about the danger of “relatively high levels of liquidity” flowing around the global economy.
Finally, in staying with the importance of curtailing FED bond purchases, I quote from a Rick Santelli interview with Dallas Fed President Fisher:
“No central bank anywhere on the planet–has the experience of successfully navigating a return home from the place in which we now find ourselves.”
This is a quote that prompted me to think: The present FED modelers think of themselves as scientists with their math-based projections. In this regard, the issue President Fisher begs the question: If the FED is seen as getting the economy to the moon through massive LSAP would anybody deem NASA a success if they failed to bring the Apollo mission back to the Earth? Ending the present program means returning the economy to health without crashing it again. This has let to be determined and thus the success of the Bernanke program has not been completed. Will FED withdrawal be a mission accomplished with a soft splashdown in a sea of liquidity? FED withdrawal will depend upon European compliance for liquidity creation.