Wednesday, July 21, 2010

Fear Not: Bernanke Will Talk The Markets Back to Health

Fear not, Helicopter Ben's soothing prose will act as a policy tool.  Courtesy of Clusterstock comes Ben Bernanke explaining that he is not in fact "out of bullets" in terms of monetary policy:

“We have not fully done that review and we need to think about possibilities. But broadly speaking, there are a number of things we could consider and look at; one would be further changes or modifications of our language or our framework describing how we intend to change interest rates over time — giving more information about that, that’s certainly one approach. We could lower the interest rate we pay on reserves, which is currently one-fourth of 1%. The third class of things has to do with changes in our balance sheet and that would involve either not letting securities run off — as they are currently running off — or even making additional purchases."

So let's review this real quick:  the first method Bernanke describes is changing the wording of the FOMC's policy statements in such a way that, well, I have no friggin' clue what Bernanke is thinking.  He's going to make it even MORE clear that rates are not going up soon? As a reminder, the current statement about the interest rate outlook is this:

"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

How exactly will Bernanke alter that statement?  Will he say that the FOMC has no plans to raise interest rates any time before hell freezes over?  Does he really think that the market isn't getting the message: "things suck, and there is no chance that we're raising rates any time soon, but I can't say that things suck because my job is political and people in my position just don't say that."  Not even Josh Wilker could rewrite the FOMC statement in a way that would make me feel any better about the prospects for sustained low interest rates.

The second method BB describes is lowering the interest paid on reserves.  As a former colleague of mine put it in a research note yesterday, 

"Interest on reserves was really a tool to help the Fed get overnight Fed Funds back to the top end of their range because GSEs had been taking their excess reserves and putting it to the street driving down Fed Funds. Currently 10day Fed Funds effective rates (FEDL01 index) are 18bps down from Apr/May avg of 20bps, LIBOR isn’t up, there isn’t any stress, so this excess cash will do little."

The important point here is that there is no stress indicated in the LIBOR markets - we aren't seeing the problem we saw when Lehman blew up: that banks don't want to lend to each other and are parking money at the Fed out of desperation. 

Of course, there's always method 3:  when all else fails, print money and use it to support asset prices.  Eventually, things magically get better.  (sarcasm!)



Hammer Player a.k.a Hoyazo said...

Well said, KD. Those comments from Bernanke are ridiculous and should be recognized as such. And I think the market reacted today to what was really not a well-thought out testimony at all.

We all knew a couple of years ago that the Fed was basically loading all of its bullets into the gun when they cut rates effectively to zero. Talking about changing the wording of their policy is about the dumbest thing I could imagine for him to say in this spot.

Steve Wynn for Fed Chariman anyone???

getyourselfconnected said...

Minyanville always said the last bullet the FED has will be loaded and aimed at itself; as in option #3!

But What do I Know? said...

Spot on, KD. The really scary thing is that BB probably believes his own BS and thinks changing the Fed statement is meaningful (But, but, I told them I wasn't going to raise rates FOREVER--why won't they bid up risk assets again?????)

Right now, all BB can do is exchange no-interest, no-maturity government debt for maturing, interest-bearing government debt (that includes the GSE's). Wake me up if he ever gets around to exchanging his FRN's for other assets.