Notes From Underground: One More Issue Resolved … Chancellor Merkel Prevails

The German election results were pretty much as polls predicted, although the CDU/CSU party of Angela Merkel ran stronger than polls suggested and the FDP, Merkel’s present coalition partner ran similar to last week’s Bavarian State votes, and is forced out of government as it failed to reach the necessary 5% threshold. The FDP failed to receive as many votes as the UPSTART Alternative for Germany (AfD), which just missed the 5% criterion and thus will have no votes in the Parliament. Chancellor Merkel has not yet formed a governing coalition as she still needs five votes to secure a parliamentary majority. The EURO performed in a very stable fashion as the news reflected the status quo. The market is still busy digesting the news from the FED‘s non-tapering announcement, which has put more turmoil than stability into the financial markets. The U.S. equity markets, using the S&Ps as my measure, closed below the low made on September 17 before the FOMC surprise statement. (NOTE: I am using a continuation chart for this picture). The FED‘s “Wednesday Surprise” has left the market wondering what the FED sees that kept it from beginning a tapering of its LARGE SCALE ASSET PURCHASES, or QE by another name. It may well be that the FED doesn’t see any problems but just being cautious in response to recent weaker data.

In the September 17 Financial Times, former FDIC Chairman Sheila Bair had an op-ed piece, “Tapering Threatens A Stormy Outlook For America”. Presciently, Ms. Bair warned that while reducing FED asset purchases will result in increased volatility in markets (aiding large investment banks and increased rates on commercial loans) there will be a hit to other participants in the global and domestic financial system. Overall, she maintained that the end of cheap money will result in financial instability in a still-too-fragile market. Along with Sheila Bair, Fed Governor Daniel Tarullo delivered a strong speech on Friday, dealing with “macroprudential regulation.” As the Fed’s point man on regulatory issues, Governor Tarullo’s words carry added significance. He made the case for the FED to be leading the global push for enhanced capital requirements, leverage ratios and other methods of “leaning against the wind.” The tighter regulation of bank leverage will prevent excess speculation and thus be a drag on economic growth as the FED prepares to cut back on its asset purchases.

The issue is not tapering per se but rather the huge balance sheet that the FED continues to inflate, which is why curtailing bank lending will hopefully prevent money’s velocity from exploding. The Fed is juggling multiple balls that lack a strong economic foundation, which may have added to the central bank’s reticence in tapering LSAP. Today we heard again that the vote wait to taper was close. Who cares if it was close? The FED brought a stain on its credibility to its potential customers. I WILL SAY IT AGAIN: IN A FIAT CURRENCY SYSTEM A CENTRAL BANK’S CREDIBILITY IS PARAMOUNT. The Fed’s credibility is much more important than what has been referred to as “INTELLECTUAL INFALLIBILITY.”

Today, the New York Fed (NYFRB) began testing its recently discussed full-allotment, fixed-rate overnight reverse repo facility. Every day through January 29, the facility will test the ability of the New York Federal Reserve to influence short-term interest rates. While this is a very technical segment of the Fed’s operation, it reflects the central bank’s desire to begin some type of controlled unwind of its massive balance sheet. (And another reason why the FED may have held off tapering.) Ultimately, releasing GOOD COLLATERAL into the banking system while removing reserves will certainly test the FED‘s ability to begin the unwind of its multi-year QE program. Waiting for this operation to begin and measuring its effectiveness may well have prevented Chairman Bernanke’s tapering. Whatever the rationale, the FED has stretched the limits of its credibility.

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6 Responses to “Notes From Underground: One More Issue Resolved … Chancellor Merkel Prevails”

  1. Joe Says:


    Hard to quantify and qualify when squandered.

    I see, from this morning’s WSJ, Janet Yellen has a new press agent.

  2. ronald ferrill Says:

    Aha! The NY Fed action might just be the canary. Not being a wizard of the debt markets, I freely admit to ignorance of understanding beyond the simplicity of being both a lender and borrower (doomed in Biblical terms), and sometimes bond buyer/seller.

    So, does the canary presage an orderly exit from the mine, a disorderly stampede, or just duck and cover and hope to be rescued?

    No matter which, there is likely a way for us to protect ourselves and possibly to profit.

    I’m not sure I like the way I sound here….

  3. yra Says:

    Ronald—you sound like a finely tuned canary.But the yield curves and FED machinations over the next year are going to be indicators of central bank actions and intentions and not just barometers of economic activity or lack there of—thought it was interesting how the biggest canary,PIMCO,has been telling the public how beautiful its plummage is

  4. arthur Says:

    Martin Wolf “Germany’s strange parallel universe”

  5. Alex F Says:

    “The committee has some concern that the rapid tightening of financial conditions in recent months could have the effect of slowing growth, as I note earlier, a concern that would be exacerbated if conditions tightened further.”

    OK, that is a reasonable concern but if that is the case, why not share that with the market, Ben? Most of the tightening of financial conditions had already occurred by the time the FOMC met at the end of July.

  6. yra Says:

    Alex and Arthur–good points and the martin wolf piece is a joke in the fact that he held it to after the german elections—it was amazing how many negative news items about Europe have suddenly appeared

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