Friday, January 4, 2013

Dissension over QE at the Fed

Everybody's friends at the Federal Reserve released the minutes of their December 11th and 12th, 2012 Federal Open Market Committee meeting recently.  Here is a look at some of the key points from the meeting which was attended by the following, focussing on the discussion and the dissension regarding the continued asset purchases of QE3.

Here is a snippet taken from an interesting paragraph in the otherwise mind-numbingly boring minutes:

"Participants discussed the effectiveness of purchasing different types of assets and the potential for the effects on yields from purchases in the market for one class of securities to spill over to other markets. If these spillovers are significant, then purchases of longer-term Treasury securities might be preferred, in light of the depth and liquidity of that market. However, if markets are more segmented, purchases of MBS (mortgage-backed securities) might be preferred because they would provide more support to real activity through the housing sector. One participant commented that the best approach would be to continue purchases in both the Treasury and MBS markets, given the uncertainty about the precise channels through which asset purchases operated. Others emphasized the advantages of MBS purchases, including by noting the apparent effectiveness of recent MBS purchases on the housing market, while another participant objected and thought that Federal Reserve purchases should not direct credit to a specific sector. With regard to the possible costs and risks of purchases, a number of participants expressed the concern that additional purchases could complicate the Committee’s efforts to eventually withdraw monetary policy accommodation, for example, by potentially causing inflation expectations to rise or by impairing the future implementation of monetary policy. Participants also discussed the implications of continued asset purchases for the size of the Federal Reserve’s balance sheet. Depending on the path for the balance sheet and interest rates, the Federal Reserve’s net income and its remittances to the Treasury could be significantly affected during the period of policy normalization. Participants noted that the Committee would need to continue to assess whether large purchases were having adverse effects on market functioning and financial stability. They expressed a range of views on the appropriate pace of purchases, both now and as the outlook evolved. It was agreed that both the efficacy and the costs would need to be carefully monitored and taken into account in determining the size, pace, and composition of asset purchases." (my bold)

It seems that the issue of further asset purchases by the Fed is quite divisive with some members becoming increasingly concerned that the rising size of the Federal Reserve's balance sheet is ultimately going to "bite it and the economy on the ass".

Here is a graph showing the size and composition of the Fed's balance sheet and how rapidly it grew after the near economic meltdown in 2008 - 2009:

Here is a graph showing the size of the Fed's holdings of Treasuries:

As of October 31, 2012, the Fed owned $1.645 trillion worth of Treasuries.  According to SIFMA, on that same date, there was a total of $10.88 trillion worth of Treasury Bills, Notes, Bonds and TIPS outstanding meaning that the Fed now holds just over 15 percent of outstanding non-intragovernmental debt.  On top of that, the Fed owns $852 billion in mortgage-backed securities and has net commitments to purchase another $105 billion worth.

As it stands now, the Fed has announced that the federal funds rate will not be raised until mid-2015.    Right now, this rate sits at an all-time low as shown on this chart:

Meeting participants suggested that this specific date guidance should be replaced with specific quantitative thresholds of 6.5 percent unemployment and 2.5 percent projected inflation.  The minutes state that: 

"...Among the benefits of quantitative thresholds that were cited was that they could help the public more readily understand how the likely timing of an eventual increase in the federal funds rate would shift in response to unanticipated changes in economic conditions and the outlook...."

Some participants were concerned that setting employment and inflation targets could be interpreted by the public as set-in-stone, that is, when the targets are reached, the fed funds rate would automatically rise.  That, quite clearly, is NOT the Fed's intention.

Even though the participants at the December FOMC meeting felt that the economic recovery would pick up steam in 2014 and 2015, there is obviously an undercurrent of concern.  The Committee agreed that the Fed would continue to purchase $40 billion worth of mortgage-backed securities and $45 billion worth of longer-term Treasuries every month and that it will resume rolling over maturing Treasuries at auction.  By buying MBS, Mr. Bernanke and his buddies are hoping to kick-start the housing market by putting downward pressure on mortgage rates.  He hopes that this will create more demand for housing by creating more demand for mortgage debt.  Isn't that what got us into this mess in the first place?

In closing, here is a key paragraph:

"While almost all members thought that the asset purchase program begun in September had been effective and supportive of growth, they also generally saw that the benefits of ongoing purchases were uncertain and that the potential costs could rise as the size of the balance sheet increased....In considering the outlook for the labor market and the broader economy, a few members expressed the view that ongoing asset purchases would likely be warranted until about the end of 2013, while a few others emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases. Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet. One member viewed any additional purchases as unwarranted." (my bold)

The dissenter was Jeffrey M. Lacker, President of the Federal Reserve Bank of Richmond.  He felt that additional asset purchases will do nothing to increase economic growth without increasing the risk of inflation down the road.

Obviously, some of America's central bankers have noticed that there is a nearly $3 trillion elephant in the room and that its presence is becoming increasingly worrisome.  Maybe, just maybe, there are risks involved with the ballooning Federal Reserve balance sheet that will prove to be problematic in the long run.  After all, the Fed is in uncharted territory and is just about out of ammunition.

1 comment:

  1. I think it's clear that these guys have no idea what their monetary policy will create, or HAS created. That December meeting sounds like they were sitting around a petrie dish debating whether mold would grow. NOBODY had any clear idea what the outcome would be - it was all pure speculation. They're the consummate elite academics holding a scholarly discussion while literally the fate of the world hangs in the balance. Now they've unleashed this monster on the world and all they can do is debate possible outcomes based on the different scenarios. It might have been nice if they had gamed out these eventualities beforehand. Now, instead, we have a Fed that has for all intents and purposes destroyed price discovery in all the world's capital markets by it's profligate monetization policies (policies that have in one form or another been aped by nearly all the world's other equally clueless central banks), and it's clear NOBODY has a clue what will happen next. Brilliant. Simply brilliant.