Monday, October 4, 2010

Here Comes Federal Reserve Balance Sheet Targeting

A very important analysis is out by EPJ's very own Bob English.

English breaks down today's speech by Brian Sack, manager of the Fed's System Open Market Account. Got that? Manager of the Fed's System Open Market Account. This is the guy in charge of all the buying and selling the Fed does through the Fed Bank of New York. They usually don't let these guys out of the trading room, ever. This is the equivalent of Iran allowing its top nuclear scientist to appear on Oprah.

English's conclusion: QE 2.0 is virtually guaranteed to be announced at the FOMC's Nov 3 meeting and assuming the FOMC adopts some or all of Sack's suggestions, we can expect balance sheet targeting language to be a regular, rather than a punctuating, feature of future FOMC announcements.

English is spot on in his analysis.

This does, however, open up more questions. Balance sheet targeting, when all is said and done, is another step by Fed chairman Ben Bernanke away from the basics of Fed money control used by past Fed chairmen, i.e. the discount rate, the reserve requirement and open market operations to control the Fed funds rate.

You'll recall, there are over a trillion dollars in excess reserves just sitting at the Fed, thanks to various new "tools" designed by the Fed.It is not completely clear what adding additional reserves will do. Will the funds enter the system or will they find their way into excess reserves?

We have over recent weeks seen mild money supply (M2) growth as a result of the Fed choosing to reinvest cash flow from the mortgage backed securities it holds. Although many expected the cash flow buying to be neutral, we here at EPJ expected just such a blip up in money growth.

How balance sheet targeting plays out will be a bit more complex to call, since it will depend to some degree on what assets the Fed adds and from where they buy them. That said, my bet, though not adamant prediction, is that the funds will end up in the system rather than as excess reserves. If this does occur,it will boost money growth significantly and quite possibly push annualized money growth over the annualized rate of 10%, which I have identified as the Fed money manipulation level that will push the economy out of recession and into a manipulated boom with serious inflationary consequences. If you think gold is strong now, wait until you see what happens when money growth is at double digit rates.

Read Bob English's important analysis, here.

1 comment:

  1. It is looking increasingly more likely that without the mortgagee’s help in providing documentation, their note will be wiped out, along with the corresponding collateralized debt obligation security that the note is supporting.
    What impact is there to the money supply if the Fed buys these impaired CDOs from pension funds?