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

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Fed Raises Rates... Or Did They?

In a move that had already been well telegraphed, the Federal Reserve (FED) raised the discount rate from .50% to .75%.  Is this the beginning of a new tightening cycle?  NO!  What readers of "Marko's Take" already know is that any major upward move in rates is not in the cards for 2010. 

Reason 1 is the size of the National Debt, which had its ceiling recently raised by Congress to in excess of $14 Trillion!  A 1% increase in rates translates into an additonal $140 billion per year increase in our budget deficit!   Reason 2 is that the economy is NOT in a recovery, but slipping into the second dip of this "Double Dip Hyper-Inflationary Depression".  Any material increase in rates is just not going to happen.

Furthermore, for any "tightening" to occur, the FED must raise rates FASTER than the increase in inflation.  The "real" interest rate is defined as the prevailing interest rate MINUS the ongoing inflation rate.  Historically, real rates have been slightly positive - about 2%.  However, at the present, real rates are NEGATIVE and given the latest release in the Producer Price Index (PPI), a meager .25% increase in rates still keeps the FED way behind the curve.

Negative real rates were a FED policy blunder in the 1970's.  The result was Stagflation and a mania in Gold.   Fast forward to the 2010's and HISTORY WILL REPEAT!

The FED's move may also have been a token measure to appease China, which has been vocal in its displeasure with U.S. monetary policy and the debasement of the dollar.

Foreign owners of US government debt reduced their holdings by the largest monthly amount ever in December, with China offloading so many Treasury securities that it is no longer the largest foreign holder! Total foreign holdings of treasury securities plunged by $53 billion in December.  China led the sell-off, reducing its holdings by $34 billion, while Japan increased its holdings by $11 billion to become the new largest foreign holder of Treasuries.

China has increased their holdings of U.S. Treasuries eight-fold over the past decade, so this latest dumping is relatively small in the grand scheme of things.  It is newsworthy only in the fact that China is no longer the largest holder of Treasuries and this could be the beginning of a much larger trend to divest of U.S. debt.

The discount-rate move didn't affect the FED's main policy tool, the federal-funds rate, a FED-influenced rate that banks charge each other on overnight loans.  That benchmark rate  filters through to other market rates.  The FED on Thursday reiterated the fed funds rate will remain near zero for an "extended period," which means at least a few more months.

So, while the FED has taken this rather minor move, the big picture remains unchanged.   The FED is far more concerned about NOT derailing the incipient "recovery" it maintains is taking place.   What recovery?

Love the FED?  Hate the FED?  TAKE ME ON!

Marko's Take

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