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BUY THE RUMOR, SELL THE news is the old Wall Street credo. It's hardly news that the Federal Reserve is able and willing to step up its purchases of Treasury securities, but not just ready.
So, it's no surprise that the release of minutes from Sept. 21 of the Federal Open Market Committee were less than earth-shattering for the markets. Stocks erased earlier losses while the Treasury yield curve steepened as the policy-setting panel laid out its thinking about the next round of quantitative easing.
As has come out in various bits and pieces of Fed-speak since the late summer, the economic recovery is unsatisfactory and unemployment remains way too high; indeed, inflation is too low to meet the central bank's twin objectives of growth and price stability; and interest rates are so low that the policy-makers have literally run out of basis points to cut.
But the FOMC minutes revealed some further evolution in the Committee's thinking. Previously, the Fed has bought securities by the truckload, some $1.7 trillion of Treasuries, agencies and agency mortgage-backed securities beginning in March 2009. Last summer, as the economy began to stall, the Fed said it would replace maturing MBS with Treasuries to keep its balance sheet from shrinking.
Since then, Fed Chairman Ben Bernanke and other Fed officials have discussed the efficacy and need (or in the case of some dissenters, the lack thereof) for a new round of Treasury purchases. Expectations were that after the "shock and awe" of the massive buying campaign of last year, more measured purchases would take place, dependent upon incoming data on the economy.
The idea of the Treasury purchases, of course, has been to bring down the yields on those securities, which would exert a gravitational effect on other interest rates, such as corporate bonds and mortgages. In that, the Fed has been successful; high-grade corporate yields and mortgage rates are at record lows.
But the benefit to the economy has been limited. It doesn't matter how low mortgage rates are if you don't qualify for the loan because your house price has fallen and your job prospects are dicey. Companies that issue bonds in order to fund dividends or stock repurchases merely reap an unintended windfall from the economy's weakness, which produced the depressed borrowing costs, which lowers savers' and investors' incomes.
What the FOMC engaged in last month is what JP Morgan Chase economist Michael Feroli described as a lengthy discussion of the "fairly radical steps to support inflation expectations."
"Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal [gross domestic product,] according to the FOMC's minutes.
"We would be surprised to see price-level targeting (or nominal GDP targeting) implemented in any foreseeable horizon, but the mere fact that the committee is willing to consider such a step sends a strong message about the degree to which the Fed is prepared to support a return to full employment," Feroli writes in a research note. "Effectively, the FOMC seems ready to do whatever it takes to prevent following what are perceived to be the policy mistakes committed by the [Bank of Japan.]"
Or for that matter, the errors of the Fed back in 1937, which led to the second contractionary phase of the Great Depression. Back then, critics called on the Fed to drain the excess reserves that were sloshing around the banking system, similar to the approximately $1 trillion in excess reserves that exist currently.
Whether adding to that surfeit will do much is another question. So far, it has helped push Treasury note yields to record lows and helped make for the best September for the stock market in over six decades.
The downside is that expectations of further Fed ease is pushing the dollar steadily lower, exacerbating the tensions in the currency markets as every nation seeks to maintain a competitive exchange rate. And in the process, the flight from paper currencies has gold perched near a record, topping $1360 an ounce last week.
That may be a bit esoteric to the average person, but commodities are up across the board, from the grains to crude oil. I noticed gasoline jumped 15 cents a gallon between my fill-ups. Rising costs for these necessities reduce consumers' discretionary-spending power and could backfire if they crimp the economy, as they did in 2008 well before the failure of Lehman Brothers.
What Bernanke & Co. seem to want to provide for the economy is some chicken soup, which, as the expression goes, couldn't hurt. That is, unless it makes the price of chickens go up.
E-mail: randall.forsyth@barrons.com
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