UBS floor guy Art Cashin has a great preview of today’s Fed announcement.
Here are the key points:
- The conventional wisdom is that the Fed will only extend Operation Twist (selling short end bonds, buying more long end, and keeping the balance sheet the same size.
- The market will sell off on the news.
- At 2:00 PM, the Fed will significantly lower its economic outlook.
- At his 2:30 press conference, Bernanke will be very explicit about his willlingness to do more in the imminent future.
Below is Cashin’s full comment, and you can see here for a full preview of what Wall Street expects >
May I Have The Envelope, Please – This afternoon the FOMC will announce its decision on policy. At 2:30, Chairman Bernanke will hold a press conference to expand on that and take questions from reporters. The conventional wisdom is that the Fed will extend Operation Twist.
If that were so, we think the market would be disappointed. We also think that Mr. Bernanke knows that. Mr. Bernanke, throughout his tenure has scrupulously tried not to surprise the market. He has tried to make the Fed more transparent in order to avoid the risk of surprise.
Yet, Mr. Bernanke also knows that every Fed initiative is not greeted universally with open arms. The QE initiatives and even Twist have been criticised by some for producing spikes in commodities and even food prices. Within the FOMC itself, there are said to be critics who feel the recent efforts have run into the law of diminishing returns.
So, Mr. Bernanke is in a bit of a quandary. The economy may need some easing. The markets want more easing. Prior efforts, however, have not achieved the desired effect and may even have produced some unintended negative consequences.
That quandary was very much like the one that Bernanke was addressing in that speech back in 2002. So, once again we went to the file to go over the checklist. On page 5 of the speech, after introducing the concept of ultimately addressing deflation by the process of printing more dollars, Mr. B went back to monetary policy:
Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behaviour).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system–for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.
Mr. Bernanke then details other means to lower rates further out in the yield curve (Operation Twist) and suggests buying mortgage paper along the curve.
If those measures fail, the bank could circuitously get money to private companies. The means would be to lend money to banks, interest free for 90 days or 180 days, taking as collateral private paper of the same duration. He then returns to the concept of devaluing the dollar and cites success of that effort in the early 1930’s.
And, finally, in a separate speech back then, Mr. Bernanke suggested that the Fed might announce a wider tolerance for inflation. That might spur some of the money to mobilize as folks bought “stuff” fearing the price might rise.
So where will we go today?
Look for the Fed to lower its forecasts, perhaps significantly, at 2:00. Then at the 2:30 press conference (or maybe even in the statement) look for the Fed to dangle a big carrot – some semi-specific course of action that would be put in place if the labour markets continue to worsen.
Net/net, he needs to keep the door wide open and maybe outline certain milestone “triggers” that will allow the Fed to act later in an election year without being accused of being overtly political.
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