Fed Watch: Only the Timing is in Doubt

Tim Duy:

Only the Timing is in Doubt, by Tim Duy: Yesterday I opined on the Fed’s hesitation to cut rates when such a call should be a slam dunk. Why not step forward with the intermeeting cut? Could possibly the Fed have given up hope on rate cuts, and instead intend to focus on other policy measures? Fed Chairman Ben Bernanke today made clear that given the deterioration in the real economy, a rate cut was on the table:

Overall, the combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased. At the same time, the outlook for inflation has improved somewhat, though it remains uncertain. In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate.

Moreover, the minutes from the last FOMC meeting indicated that there was already some thought to a rate cut “way back” in September:

Some members emphasized that if intensifying financial strains led to a significant worsening of the growth outlook, a policy response could be required; however, such a response was not called for at this meeting.

Wall Street, however, was unimpressed by confirmation of an imminent rate cut. There appears to be no shock value in such news. Indeed, equity markets plunged even as expectations grew that a global coordinated rate cut is likely as early as Thursday, and if not then, this weekend. The Fed can only disappoint, it appears. Or perhaps market participants simply feel that lacking a functioning credit channel, rate cuts are now simply a sideshow to the financial crisis.

I would not disagree. The Fed can provide infinite amounts of liquidity, but if it does not get into the hands of someone who will spend it, then it is just worthless paper.

One argument against a rate cut is that it risks upsetting a very nice little equilibrium the Dollar has shifted into as global deleveraging in the financial sector looks to be forcing a rapid unwind of Dollar based carry trades. The more stable Dollar, and the subsequent downward pressure on commodity prices (with the exception of gold), eases the US inflation outlook, which in turn gives the Fed room to cut rates. The pressure to ease, coupled with pressure to sustain the Dollar, thus argues for a coordinated cut, as 50bp across the board would leave interest rate differentials unchanged. In theory, this would allow the Dollar to hold it ground while delivering the easing that everyone expects and expects to be meaningless (although it provides grist for bond traders).

Of course, 50bp is all the Bank of Japan has to give, so it takes something of a leap of faith to see them go along with such a plan.

Current Dollar supportive dynamics notwithstanding, the path of monetary policy is placing the Dollar in an increasingly perilous position – if credit channels refuse to loosen, the Fed will be driven inexorably toward policies that attempt to place cash directly in the hands of those that will spend – such as today’s leap into the world of commercial paper. And as the Fed draws more and more risk onto its balance sheet (as well as the US government, via TARP), its credible commitment to price stability will be increasingly in doubt. Will outright monetization soon be the only remaining option if the Fed is under pressure to restore spending power to the US economy?

Is outright monetization really off the table at this point? Consider that Bernanke is widely thought to be determined not to make the same mistakes of the Fed of the 1930’s. Consequently, he has pulled out all the stops, cutting rates quickly and lending freely on a wide range of collateral. But the credit crunch continues unabated, as this is not simply a panic, but a massive deleveraging brought about by fundamental insolvency. Recession is now unavoidable, and the length of the downturn grows longer with each day the credit markets are constricted. Short term interest rates are headed toward zero, suggesting a liquidity trap. What options are left? Bernanke must have at the back of his mind the incident that many believe ended the Great Depression – the 1933 devaluation of the Dollar as the US left the gold standard. Certainly outright monetization would bring such an end; and going back to the Great Depression has been a good way to look for Bernanke’s next move.

Maybe this is getting ahead of ourselves; maybe not. I think it is important to remember that as we head into next year with a profoundly weakened consumer, the calls to “do something” will be increasingly louder. Actions to date have centered on fixing the financial system; the billions in debt soon to be issued for TARP are not likely to flow into the hands of ultimate demanders. And if credit channels remain broken even after these efforts, near-term options to support growth are limited. Monetization of deficit spending is one such option.

Bottom Line: The stage is set for a rate cut; only the timing is at issue. If a rate cut does not come via coordinated fashion by next Monday, it is safe to assume that the Fed intends to move rate policy back to its regularly scheduled meetings. The Fed’s apparent hesitation to cut in the midst of a significant equity sell-off (13% on the Dow in five days) and credit collapse is puzzling given their past behavior.

Comments

[Disgusted]

The Fed is hesitating to cut rates because they have few bullets left in the magazine, and it has finally dawned on them that they cannot afford to squander the last of their ammo on something as trivial as a 13% decline in the indices. A trillion dollar intervention just doesn't buy as much as it used to. Oh well. At least they squeezed some short-sellers out of the market.

[esb]

Well lookie here, we have what can appropriately be termed a "crash" in Asia as I am writing this.

If there is not a banking nationalization statement possessing some measure of credibility by Monday, then look for a series of lock limit down days in US equity markets.

The facilities tapdance is at an end and interest rates are essentially meaningless.

The fractional reserve lending function must be moved inside the public sector in some manner. Right now.

What the hell are these buffoons waiting for?

[a]

The bottom line is the Fed is now a joke. Every week, a new program, thought up on the fly. The Fed thinks of this as a financial crisis - and that moving paper around will help solve it. The problem is with the real economy - too much consumption for too long, not enough invested.

[Ken Houghton]

I'm not about to turn down a drop in my HELOC rate, but it doesn't really get things going again if the loans aren't happening.

Nationalise first; deal with rate-cutting after.

[Bruce Wilder]

The rate looks pretty meaningless, at this moment.

[esb]

Hong Kong just took rates down 1% and Mr. Market just said "crash."

Question ... who does Henry Paulson report to on an "ongoing" basis?

My suspicion is that he is not reporting to anyone but is operating the US ecomony in the manner of a loose canon on deck. Perhaps every few days GWB calls over with a, "dude, 's up?"

(At least in the other G-7 states all of the people in the room are able to join intelligently in the discussions.) And no executive of government during a crisis should state publicly that "this sucker's goin' down."

[Oupoot]

Just nationalise some of the private debt. The US govt is not overstretched in terms of public debt. This means, giving US consumers tax rebates specifcally for them to repay some fo their private debt. Thus, for average Joe, his individual financial position is suddenly much improved and their expenditure/consumption adjustment is not so severe on the econmy as it would have been if they still had to pay exhorbitant amounts in interest on debt.

[Oupoot]

Basically, sidestep the financial sector totally and give directly to the man in the street and Main Street. Let "trickle down" economics work in the opposite way - Finance Sector being "bailed out" by businesses & hhlds reducing their debt from the tax rebates. Obviously it will be repaid in future through higher taxes (hopefully for the rich).

[dd]

Fed, ECB, Central Banks Cut Rates in Coordinated Move
Oct. 8 (Bloomberg) -- The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an emergency coordinated bid to ease the economic effects of the financial crisis.

The Fed, ECB, Bank of England, Bank of Canada and Sweden's Riksbank each cut their benchmark rates by half a percentage point. The Bank of Japan, which didn't participate in the move, said it supported the action. Switzerland also took part. Separately, China's central bank lowered its key one-year lending rate by 0.27 percentage point.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aM4emVQ1.5iE&refer=home

[ddt]

on a lighter note:

Paul Krugman: "A Morning Thought"

"The only thing we have to fear is fear itself. Fear and negative equity … The two things we have to fear are fear itself and negative equity, and the depleted capital of financial institutions … Amongst the things we have to fear are fear itself, negative equity, and the depleted capital of financial institutions."

http://krugman.blogs.nytimes.com/2008/10/08/a-morning-thought/

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[Anti-Bubble]

"Consider that Bernanke is widely thought to be determined not to make the same mistakes of the Fed of the 1930’s..."

He has already repeated the mistakes of the 1920s that led to the disaster in the 1930s. Monetization would repeat the mistakes of the 1970s, or even worse the mistakes of Weimar. The futures are down on the news of the rate cut. We are now in the anti-bubble, where many people are selling solely because prices are going down. Nothing being done is inspiring any confidence in people.

Change course already. Fix the core problem.

[Mark]

From CNN: "The Federal Reserve, working with central banks worldwide, today enacted an emergency interest rate cut, CNNMoney reports. The Fed lowered its key funds rate by half of a percentage point to 1.5 percent. The Bank of England and banks in Canada, Sweden, Switzerland and China also cut key interest rates. "

[hari]

Recall I suggested Mon 6/10 50bb rate cut 10 Oct coordinated by Fed/ECB and CBs....

The coordinated rate cut decision today is not a suprise. It further cements the argument we're gearing for a winter of discontent and more of depressing news to come from across the global financial markets. The fundamentals are getting worse and there is no way to know where and when it will all end - just now.

2009 is going to be year of policy reckoning. Already German *three wisemen* (economists) are foretelling GDP will decline to 1.7% and maybe 1% in 2009. No recession!

France is in recession and German exports will hit the fork on the road, for sure. Bulk of its exports are inter-EU trade. So expect more adjustment process ahead; unemployment doesn't seem to be an issue for now in Germany. Rest of EU-27 will not find it easy to adjust to the downturn given their (potential) exposure to US subprime and rest.

However Euro rate is declining against dollar - a good sign for exports.

Bottomline on rate cuts today suggests that from monetary policy perspective things are worsening faster than expected
and further depressing economic news are anticipated.

[lonesome moderate]

Krugman again: The coordinated rate cut was the right thing to do. But I don’t expect much from it — because the relationship between Fed funds rates and the rates most businesses actually pay is very weak right now, thanks to the messed-up state of the financial system.
A quick illustration: in early July 2007, before the crisis, the target Fed funds rate was 5.25% and the rate on 30-day A2/P2 commercial paper — that is, CP issued by less-than-sterling borrowers — was 5.4%. On Monday of this week, the target Fed funds rate was 2%, down 325 basis points from pre-crisis levels, but the CP rate was 5.61% — up from pre-crisis levels.
So will this latest rate cut make any difference to borrowers? Maybe — but only to a few of them. We’re way past the point at which conventional monetary policy has much traction.

says...

Bernanke is using his knife in a gunfight.

[dd]

Every move made to bolster the regulated markets reels the unregulated OTC derivatives markets and vice versa. It is a positive feedback loop and the "hedge" is now a hammer.

[hari]

Look this is now a confidence game for Fed/ECB and CBs around the world. Monetary policy has no further traction in this grim scenario...recession is inevitable, and with it a lot more misery for the unemployed.

[dd]

hari, even CBs have no confidence in banking:
Bullion lending by central banks all but dries up
"Central banks have all but stopped lending gold to commercial and investment banks and other participants in the precious metals market, in a move that on Tuesday sent the cost of borrowing bullion for one-month to more than twenty times its usual level."
snip
John Reade, a commodities strategist at UBS, added that there had been a lot of talk about some central banks being unwilling to lend their gold because of a redoubled focus on the risk of borrowers not returning it.
"There is very little appetite for unsecured lending at the moment," he said.
Central banks usually do not ask borrowers to post any guarantee – or collateral – to secure bullion loans. "The key word now is safety," an official from a Europe-based central bank said.
In normal circumstances, central banks lend gold into the market – providing key liquidity – to earn a small return on what otherwise is a non-yielding asset. "
via FT
but posted here:
http://money.ninemsn.com.au/article.aspx?id=643285

[esb]

Well, the markets are voting.

A down close in the USA would be the worse tell imaginable.

It would signal the arrival of an situation without precedent, complete loss of control by authorities.

[esb]

Shorts are not in the game yet.

One more day to wait.

Bernanke seems like an heroic figure who covers a nuclear bomb with his body as a shield against the blast. He simply cannot believe the extent of the event that is running,

and it seems that Paulson will not nationalize without the prodding of a true crash in the equity markets in the USA.

I suppose that is inevitable now.

[emergency]

Governments need to accomplish 3 things in the financial system immediately

1. Reduce counterparty risk
2. Reduce counterparty risk
3. Reduce counterparty risk

Recession is happening. Complete credit freeze would be worse than recession. Stop credit freeze.

[dd]

How can it be reduced if it is unknown? Shadow banking and unregulated derivatives make it impossible to determine current and future liabilities. Hedge funds were among the major "insurers" taking the "premiums" but without reserves to pay the "claims." All the hype about "cash settlement" on Freddie and Fannie was just that unless someone has the cash to pay the claims. Next up the Lehman "settlements."

The current unwinding is hedge funds, faced with redemptions and derivatives settlement liquidating in the only liquid markets left.

[outsider]

outsider says...

The Fed doesn't like to fool with interest rates close to an election lest they be accused of being political.

[yamada]

"Will outright monetization soon be the only remaining option if the Fed is under pressure to restore spending power to the US economy?"

Here is the alternative:

Why not make use of FRB’s profit when they print dollars? In this model, it won’t cause inflation, because it come back to FRB at last. In this model, the printed dollars won’t be withdrawn, because each economic unit(including bank) legally forced to write-off next economic unit that they hold credit.

Bubble is caused by peoples’ expectation that the price of asset(real estate) will soar in future, with pouring high-powered money to the asset side of economic units’ balance-sheet. So, to solve this problem, such asset bubble on economic units’ balance-sheet must get ridden of, by the new system as below. Though it may be seen contradictory, high-powered money enables to work this new system. Please remember, no one has ever invented the solution in history.

1. Every economic unit’s(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe auditor), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic units.
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, according to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all.
4. Other economic unit that gets profit from the written off by the bank should next enforced to, by using the profit from the written off as original fund, write off it’s loan(or trade claim) to its each debtor, according to the amount of insolvency of each debtor. If the economic unit is unable to use all profit it earned, the remainder is taxed all. These processes are to be repeated operationally.
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. The tax claims is finally assigned to FRB. It’s up to FRB how they dispose of their above claims, considering the situation of economy, of each bank and of each economic unit. Talking about the latter two, as a option the FRB should examine the possibility of the bank’s and economic units’ turnaround, together with the other creditors, remaining desirable debt to the bank’s and economic unit(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA, of the economic unit), writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and tracable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic unit, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic unit that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic units, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. In case inflation expectation exists, the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic units.
10. FRB should carefully watch the rate of the number of insolvent economic units to the number of all economic units in the US, when deciding the amount of the loans(trade claim) written off on 2.
11. FRB print greenbacks(bring about profit) correspond to the write-offs, which return to FRB as tax claim, so these greenbacks could be stored to the safe in FRB forever.

For further details, please see the blog as below:

http://reversewealtheffect.blogspot.com/

[Winslow R.]

a wrote: "The bottom line is the Fed is now a joke"

bruce wilder wrote : "The rate looks pretty meaningless, at this moment."

I too would add this rate cut is for 'appearances'. The sad thing is many economists still think it will have some impact. It seems very difficult for those that have invested their lives (our host included) into the monetary policy tool, to admit failure. Hopefully this admission is just a timing issue.

[cent21]

I suspect it may be best for the politicians and central banks to try to inject some calm rather than more panic.

Right now every action is seen as further evidence that things are really bad. We're in October. It will soon be November, and the traditional witching season will give way to thanksgiving and solstice. Between now and then, the existing shock therapy will have some opportunity to show signs of how it is working, and what the side effects are. Maybe the FED can figure out exactly where the helicopters should be doing airdrops of cash by then, if the markets continue to empty the cesspool of illusory evaporating equity and the credit markets continue not to lend the paper that they've been offered.

Right now, the volatility trade is immense. Someone should be tracking it closely, as there are huge opportunities to manipulate the downside of the market for gain.

The one way that Greenspan was a maestro, as was Clinton, was in setting up positive expectations without needing to do a whole lot. We need some of that prescription now - not more panic.

[esb]

I wonder if the words "state of national emergency" will issue from the mouth of George Walker Bush within a few days,

followed, perhaps, by "please remain in your homes." On second thought, it would most likely be "please drive to the mall."

There are Chinese goods awaiting purchase.

[Patrick]

The question I see is this: what are the banks so afraid of that they won't even lend to each other? It's not MBS exposure because everyone has known about that problem for a year or more. I think it's the $60 trillion CDS time bomb.

The SEC needs to get off its behind and get disclosure so Congress can nullify the 'naked' CDS contracts immediately. To heck with the hedge funds who will take it on the chin. Better that than wrecking the world economy. CDSs need to be regulated like insurance to ensure the capital is there to meet potential obligations and to prohibit parties with no stake in the underlying assets from using derivative to speculate and spread systemic risk.

[emergency]

dd said, How can counterparty risk be reduced if it is unknown?

Liquidate all insolvent financial institutions, including hedge funds, now. Its an emergency. Kill them now. Dont wait for the great unwind, margin call, slow motion, agonizing death. Execute them now. Its an emergency. Recapitalize the remaining solvent counterparties.

If lack of trust between counterparties really is at the core of the immediate and dangerous credit freeze, then kill all insolvent, suspicious counterparties now, fast.

[esb]

Rumor now running is that GM has decided to go in with a prepackaged filing and just get rid of all of the remaining legacy retiree costs.

The crisis gives them cover.

If GM goes in, so will F.

Then the suppliers will go too.

Cascading bankruptcies.

Frankly, they should have done this months, even years, ago.

[esb]

A foreign central bank just did a t-paper dump accross the 5-7 yr maturity range.

[Patrick]

esb - t-paper ... you mean treasuries?

[dd]

Think it was Treasury's surprise auction. Across the Curve explains it:
http://acrossthecurve.com/?p=1821#comments

emergency, liquidating hedge funds just offloads the impact of cascading defaults to the hedge fund counterparties and their regulated bankers/brokers; the ones "insured" by FDIC and SIPC.
Although this seems to be the Paulson Plan per Fuld's email of 4/12/08, item 4:
"they want to kill the bad HFunds + heavily regulate the rest."
http://www.usnews.com/blogs/the-home-front/2008/10/6/richard-fuld-my-dinner-with-henry-paulson.html

[esb]

Yes, and the range was wider, 5-12 yr maturities.

Perhaps someone knows which holder sold.

[Pliny]

If you want to put a permanent end to prosperity in America and turn us into a third world nation just keep it up. Nationalize everything; enjoy living in huts.

Or we could go back to free market capitalism and prosperity. Now is the time for deciding.