Friday, December 10, 2010

Clueless WSJ on Fed Activity

WSJ writes this morning:

The Federal Reserve's decision to spur the economy with a $600 billion round of bond buying was among the most controversial in its history.

Fed officials quarreled over whether to proceed. At worst, some members argued, such a move risked whipping inflation to dangerous levels.

 Six weeks later, the bond program looks more like a water pistol than a cannon—and the reasons explain the immense and strange challenges of steering monetary policy in the aftermath of a financial crisis when short-term interest rates are already near zero.

The purchases of government bonds are meant to drive down long-term interest rates, which did happen in the lead-up to the Nov. 3 move. But since then, long-term rates are up sharply.
This is a perfect example of the simplistic thinking you get from most of the financial media, who look at one step, i.e., one cause and effect relationship, and think they have solved some grand equation of how the economy works.

This is precisely the problem with WSJ's view that the Fed's bond purchases were going to drive down rates. Back on October 18, before the start of QE2, I wrote in the EPJ Daily Alert:

 It's always tough to call a bottom in a market (or top), but my view is that Bernanke's money printing will back fire and that rates will head higher.

Quite simply, the inflationary fears of QE2 are pushing rates up. Further, the dramatic demand to hold cash that we saw during the middle of the crisis is starting to unthaw. With the demand to hold cash falling, the willingness to borrow increases. So while, the Fed action, ceteris paribus, is an action that pushes rates lower, other factors are not remaining the same. The inflationary fears and the greater willingness to borrow are factors pushing rates higher and are clearly overwhelming Fed bond market operations.

The WSJ will start writing about these additional factors down the road when they are much more obvious, but it is a sad commentary on the state of economic knowledge amongst the financial media, when they can't figure these things out in advance.

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