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THURSDAY NOVEMBER 12, 2009Political "Tools"The market seems to be demanding that the Federal Reserve provide clearer signs of an exit strategy from its easy money policies. And the market is voting with its feet, or more specifically, with its money! The dollar continues to slide despite all of the “strong” dollar rhetoric from Washington. Gold is over $1100, oil is near $80, and commodities prices across the board are on the rise. Chairmen Bernanke and many other Fed “spokesmen” are a constant presence in the media. They talk of the “tools" the Fed will use to reverse its quantitative easing and low interest rate policies. The articles and TV appearances are filled with discussions of reverse repos, reserve requirements, asset sales and the Fed’s readiness to raise rates whenever its “extended period of time” is over. Many of these “tools” are arcane concepts that only an economist can appreciate. But the market is already aware of these complex tools. The issue is not which tool or tools the Fed will use. Few people question the Fed’s technical ability to use these tools. It is when the Fed will use them! The Fed seems to be saying “trust us,” we will pull the plug on easy money just in the nick of time to avoid inflation. Ignore man behind the curtain, that is, the worrisome signs of inflation such as the weak dollar and rising commodity prices. But this takes a leap of faith. After all, there are plenty of times the Fed got it badly wrong, like the Great Depression (too tight) and the entire decade of the 1970’s (too easy). In an effort to stabilize the housing market, the Federal Reserve has been purchasing billions of mortgage-backed securities (MBS). This is viewed as a "quantitative easing." This “tool” pumps money into the housing sector which in turn keeps mortgage rates low, thus supporting the housing market in a time of great weakness. So far, so good. But at some point, the housing market will need to stand on its own. The Fed is telling the market that when that point arrives (in their judgment), it will simply reverse policy and start selling the MBS back into the market. No problem. Selling securities back into the market is really is one of the simplest tools of the Fed. But the market’s skepticism comes not from the Fed’s ability to use this tool, but its willingness to use it. Why? Can anyone imagine the response of a certain outspoken Member of Congress when the Fed starts increasing mortgage rates at a time when unemployment is above 10% and house prices are still underwater? All of the arcane discussions about the Fed’s tools miss the point. The Fed has many tools at its disposal and few doubt its technical ability to use them. The question is whether it has the political will to use them. Given the modest economic recovery, the market is looking to the Fed to provide some adult supervision for Washington’s free spending ways and at least articulate an exit strategy. It is not a which, but a when discussion. So far, the market has been disappointed. Until the Fed stops talking about its tools and actually begins to use them, the market will remain cranky. Look for further dollar weakness and higher commodity prices.
POSTED AT 1899-12-30 09:46:00.0 |
KEN ENTENMANN, CFA
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