Wednesday, March 10, 2010

FED Speaketh With Forked Tongue

While declaring its allegiance to transparency, no other institution in modern history has ever said so many things to so many people so many times - yet said absolutely NOTHING!

The famous practioner of "FED-Double-Speak" was none other than the "Maestro" Alan Greenspan.  The man had the ability to deliberate on a "yes" or "no" question in 30 minutes without every even giving an answer.  Mr. Greenspan was so well-versed at non-answers, that during routine Q and A sessions in the House and Senate, congress-people routinely nodded off.

Lately, various FED spokespeople have begun the process of telegraphing future interest rate policy, which until recently, they have been hesitant to do.  But on Monday, one of their chief lieutenants, the man charged with implementing FED policy, offered a pretty clear take on the likely timing of a move up in interest rates. The official, New York FED Markets Group chief Brian Sack, who has no formal role in setting monetary policy, suggested in a speech some sort of rate tightening will occur by late year.

“The current configuration of yields and asset prices incorporates expectations that short-term interest rates will begin to rise around the end of this year,” Sack told a group of economists in Virginia. “The markets seem prepared for the risks toward tighter policy,” he said, adding a “decent-sized term premium” on longer-dated yields suggests low chances of a “sizable upward shift in yields" when that tightening comes.

Sack’s speech also provided a road map for the monetary stimulus unwind.  He envisions the FED removing reserves on a temporary basis, then raising rates, while allowing the $1.7 trillion in mortgage and Treasury assets it will have purchased by March to mature.  Any active sales will come much later.  Importantly, he said the actions will be taken by mid-year, lending additional support to the idea the FED can start easing rates up off 0% by year end.

Some Fed officials, like St. Louis FED President James Bullard, have implied that a rate increase may not come this year or next.  On the other hand, New York FED President William Dudley, San Francisco FED President Janet Yellen and Dallas FED President Richard Fisher, have affirmed the need for low rates to be maintained for an extended period.

With so many voices saying different things, what conclusions can we draw?

First of all, any hint that interest rates may rise is premised on the notion that an economic recovery of substance is underway and gathering momentum.  It isn't!  In fact, the FED's ability to predict economic cycles is laughable at best.  As the second-dip of the Double-Dip Depression takes hold, it will absolutely constrain any desire to raise rates.

Second, even IF the FED were to gradually raise interest rates, inflation will accelerate thereby keeping the FED "behind the curve".   Undoubtedly, any increase in interest rates is likely to be substantially less than 1%, while it is virtually certain that the rate of inflation will increase MORE than 1% and probably MUCH more!  As a result, the "real" interest rate will continue to become more negative and any increase in rates will be completely illusory.

Ultimately, the MARKET and not the FED will set interest rates.  At the prevailing absurdly low interest rate structure, the only buyers of substance, such as Japan and China, have curtailed purchases. 

The FED's utter mismanagement of monetary policy, coupled with its propensity to create asset bubble upon asset bubble, has put it and the U.S. Economy in a most unfortunate situation.

Marko's Take

For more background on the FED, how it works and what its mission is, click here (

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