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To our inbox this morning came a note from RBC arguing that the FOMC statement last week acted as a kind of “Anti-Stimulus”.
Here’s the explanation:
But perhaps the bigger problem is not that what the Fed has done "won't work" but rather the potential perception that the Fed's latest action could actually prove to be an anti-stimulus. The reaction in global equity markets following the Fed's announcement was telling and indicative of an investor community that has come to grips with the notion that there is little the FOMC can do at this point to kick-start growth. We say anti-stimulus because the ramifications for the consumer balance sheet from the equity market correction are significant.
Following the sharp pullback in US equities over recent days, we are now trading down nearly -15% quarter-to-date. This precipitous decline is consistent with no less than a -$2.6 trillion loss in household net worth for the quarter. This is apotential risk not only for the latter part of 3Q activity, but also in terms of providing an extremely weak hand-off for 4Q. One cannot understate the significance of a decline in net worth that is consistent with a downright contraction in real personal consumption. Right now our base case is for Real PCE to clock in barely north of 1% for the balance of this year.
The equity market swoon and commensurate wealth destruction suggests the risk to this call is tilted to the downside.
Maybe, but RBC don’t really get into their reasoning here, instead just alluding to the equity market selloff as evidence that Twist was anti-stimulative.
This has a circular quality to it — Why did equity markets sell off? Because Twist was anti-stimulative. How do we know that Twist was anti-stimulative? Because equity markets sold off.
But the equity decline in the latter half of last week (and the decline in expected inflation) wasn’t necessarily the result of the policy being anti-stimulative; it could have been because of disappointment that it wasn’t more stimulative — or, even more likely, a reaction to the Fed’s gloomy economic outlook in the statement.
It also seems a bit odd to attribute all of the selloff to the statement itself — we heard there were a few problems in Europe as well. And China. And pretty much everywhere. (The potential scale of the selloff’s impact on consumer spending — call it a reverse wealth effect — was interesting to note, but it’s also a fickle point.)
A more persuasive argument that Twist is anti-stimulative was in the FT this morning. Written by our colleagues Mike Mackenzie and Dan McCrum, it argued that Twist amounted to an implicit recognition by the Fed that its previous weak-dollar reflationary approach — QE2 — didn’t work. Thus was Twist greeted with another rise in the dollar against developed-country currencies and the corresponding fall in inflation expectations. (We previewed this argument last week in our post expressing bewilderment about the gold selloff.)
From the piece:
The move is seen by analysts and traders as a renewed attempt to help homeowners via lower mortgage rates, and a break with policies that pumped up global financial asset prices via a weaker dollar.
Alan Ruskin, strategist at Deutsche Bank, said: "The market has delivered its initial verdict "“ without an expansion of the Fed's balance sheet the US dollar is a natural beneficiary."
A sensible argument from Ruskin, though again it seems more a case of underperforming expectations than an actively damaging policy. Our own guess chimes with the conventional narrative that Twist might have some beneficial impact on the margins, but that the fall in mortgage rates is unlikely to lead to a big refi wave. In other words, inadequate but probably harmless. As ever, we could be wrong.
And in addition to the above-mentioned issue of, erm, global economic turmoil, there’s also exceedingly low liquidity in some markets as trading in certain asset classes gets more expensive, margin requirements climb, etc…
Nor are we so sure that Twist implicitly signaled the end of large scale asset purchases — only that that they’re not on the menu for now. If the big fall in inflation expectations is followed by actual disinflation, as the Fed’s James Bullard thinks it might be, then you can expect the argument over QE3 to intensify anew. The Fed can be justifiably accused of poorly communicating its thinking in recent years, but one theme it has never departed from is that it will act with urgency and force if deflation threatens.
Related links: Strange days for goldbuggers – FT Alphaville Operation Twist has investors moving – FT
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