Two Days Until the Fog Lifts, by Tim Duy: Some additional stories to consider as await the outcome of this week's Fed meeting. First, tonight's Jon Hilsenrath WSJ article detailing the Fed's concern about the credit divide:
The housing bust left behind millions of people with credit records damaged by plunging home prices, lost jobs, past overspending or bad luck. Many are now walled off from the low interest rates engineered by the Federal Reserve to spur the economy and remedy the aftereffects of the borrowing boom...
...Shrunken access among credit have-nots is triggering more than personal plight. It has weakened the influence of the Fed—one of the best hopes for spurring stronger economic growth—and raised doubts within the central bank about whether it is doing much to reduce unemployment...
That underwriting conditions have tightened dramatically is not exactly a new story - as Hilsenrath writes, the Fed released a report urging Congress to take action to ease credit conditions in mortgage markets. What is interesting is the timing, coming just two days ahead of what is likely to be a somewhat contentious FOMC meeting. The underlying context of the story is that if credit market channels are clogged, additional action on the part of the Federal Reserve will have little impact. Consider this in terms of the risk/reward trade off that Fed official like to cite when discussing options for additional easing. They may be hesitant of taking the risk that all they get from additional easing is criticism from lawmakers - and no shortage of it during an election year - in return for very little benefit.
The article also highlights the Fed's fetish with low interest rates. They should forget about trying to keep interest rates low, and instead enact policies that support enough growth such that interest rates begin to rise. This is of course how policy is supposed to operate - long-term rates rise as market participants believe the Fed will need to raise short term rates in response to real inflationary pressures, not just the phantom ones in the minds of a subset of monetary policymakers.
With that in mind, Zero Hedge posts Goldman Sachs' FOMC preview Q&A. Goldman is expecting a new round of QE, largely on the expectation that the Fed will significantly mark down its economic forecast as well as feel a need to respond to the European crisis (in effect, doing the job the ECB has abdicated). This is a greater policy response than the more generally expected extension of Operation Twist, but also a completely reasonable expectation given the some of the Fedspeak we have heard. Goldman, however, suggests the Fed might go one step further:
If it is specified as a "stock" of purchases, we would expect a similar size as in past programs, i.e. $400bn-$600bn over 6-9 months. However, it is also possible that the program would be specified as a "flow" of purchases of perhaps $50bn-$75bn per month.
I believe the emphasis was added by Zero Hedge. Given that the Fed has repeatedly emphasized that it is the stock of holdings, not the flow, that is important, this would represent a major policy shift. The Fed would be finally utilizing the expectations channel, effectively promising to hold policy steady rather than promising a discrete end date.
While I would greatly welcome open-ended QE, it seems like a pretty big leap for a central bank that just a few weeks ago was expected to hold policy constant. Moreover, I am hard-pressed to say that economic or financial conditions have deteriorated such that the Fed would shift gears so quickly. This doesn't feel like 2008. I am not even sure it feels like last fall when the Fed embarked on Operation Twist. That said, the Fed might suspect, or know, that Europe is going down the tubes on the back of some let's just say some questionable economic policy making. Better to get ahead of that curve. Well ahead.
Bottom Line: More grist to chew on as the Fed's two-day meeting begins, with one take away that the Fed might opt to do less than expected, and another much more.