Sunday, August 8, 2010

Fed Blinks; Will Resume Money Printing

The Federal Reserve tight money policy may just about be over.

As we have been reporting, a Federal Reserve tight money policy has been driving the economy into a second leg of the Great Recession. The Federal Reserve has apparently (finally) caught on that this is the case.

FT reports:
The Federal Reserve is set to downgrade its assessment of US economic prospects when it meets on Tuesday to discuss ways to reboot the flagging recovery.

Faced with weak economic data and rising fears of a double-dip recession, the Federal Open Market Committee is likely to ensure its policy is not constraining growth and to use its statement to signal greater concern about the economy. It is, however, unlikely to agree big new steps to boost growth.

Smaller measures to help the economy could initially take the form of a decision to reinvest proceeds from maturing mortgage-backed securities held by the US central bank, thereby preventing the Fed’s balance sheet from shrinking naturally.
Take this as though you were overhearing FT/Bernanke pillow talk. It is well known that the Fed uses FT as an early warning alert system to changes in Fed policy (most likely it is Bernanke leaking.)

What does this mean?

It is not entirely clear, since it is dependent on the maturities of MBS instruments the Fed holds. If sizable amounts come due in the short-term, the additions to the monetary system could be dramatic. (There is no published data as to the maturities of the MBS instruments the Fed holds). Although nothing is published, it is likely that the maturities are quite widely spread, which means that on a short-term basis, this change in Fed policy is not very powerful. It is likely to be just one notch above simple jawboning. What it does mean is there is serious fear in Bernanke's eyes and that at some point Bernanke may go nuclear and lower the interest rate it pays on excess reserves. At such point, inflation is likely to kick in at a much more rapid pace than anyone expects. Once all those who are now holding large cash balances, decide cash is not the place to be, because of an inflation threat (and I am not talking those just holding physical currency but anything in M2), then all hell breaks loose on the inflation front. We aren't there yet, but I can hear the cannons rolling into place.


  1. Ah, but there is:

    Avg weighted coupon is 4.65% as of Aug 4, which suggests annual cash flows of $52,024,098,398.

    Not far from the number I used the other day:

    It's probably just a token signal that there will be a more substantial amount of QE to come in the future.

  2. Okay, but still you can't get inflation into the eCONomy while people's wages are still low to falling further. I suppose that the banks could bid up the commodities market, $150 bbl oil again?

  3. No, certainly not across the board inflation. Maybe a mini-bubble in one asset class at most. Maybe nothing until Ben goes nuclear.

  4. @BobEnglish

    It's true that the amount of money the Fed will pump in via this method is likely not terribly sizable, but the actual amount is unknowable. It depends on how many of those 30 year and 15 year mortgages experience pre-pays. Plus, although they are identified as 30 year and 15 year product that would be the maturity at issue, not currently.

    It is likely they mostly contain mortgages between 2000 and, say, 2007, so there is probaly some time (but not 15 or 30 years) before big waves hit, but given the current low level in rates, you would think any good paper is being refinanced, if terms allow that to be done.

  5. Wouldn't sound money eliminate all this horsing around? Patch one problem, then another pops up to patch. All the while the producers take the hit.

  6. My response is here: