Wednesday, August 29, 2012

The Fed

Let’s discuss the Fed again. I know: We are all fed up with the Fed. However, it’s a light week for other news with the exception of the hurricane-abbreviated Republican convention. Besides, Fed Chairman Ben Bernanke will present his widely anticipated annual speech at Jackson Hole on Friday. I’m sure it won’t be as good as the one Ann Romney delivered last night at the convention. The one Bernanke presented on August 27, 2010, was especially important since it set the stage for QE2, which was implemented right after the mid-term elections on November 3. Investors may be expecting that Friday's will do the same for QE3.

More likely is that he will repeat the ready-willing-and-able language of his August 22 letter to US Rep. Darrell Issa (R., Calif.). The letter was in response to a series of 22 questions posed by the US Congressman to the Fed Chairman, who assured Rep. Issa that "[t]here is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.”

It’s worthwhile reading Bernanke’s letter to see how to provide more or less the same answer to 22 questions. He did warn that “monetary policy is not a panacea,” but proceeded to defend his view that the Fed can still do more. He defended the use of “nontraditional policy tools, such as balance sheet actions…” In his opinion, they’ve promoted a stronger economic recovery by lowering bond yields. He didn’t explain why the FOMC seems inclined to do more given that yields are at record lows. He dismissed the suggestion that the Fed is redistributing income and wealth by stating that the Fed’s top priority is to boost economic growth for the good of us all.

Another worthwhile read is an article titled “Interest on Excess Reserves and Cash ‘Parked’ at the Fed,” which was posted on the FRBNY’s blog on Monday, August 27. It explains that all that cash that banks have does not in any way reflect their unwillingness to lend: “In the aggregate, therefore, these balances do not represent ‘idle’ funds that the banking system is unwilling to lend. In fact, the total quantity of reserve balances held by banks conveys no information about their lending activities--it simply reflects the Federal Reserve’s decisions on how many assets to acquire.”

During the week of August 22, deposits at the Fed held by depository institutions totaled $1.51 trillion, near the record high of $1.68 trillion during the week of July 13, 2011. Yet commercial and industrial loans have increased by $268.1 billion since late 2010.

The real zinger in the article is that cutting the interest rate the Fed pays on those deposits from 0.25% to zero is a bad idea: “Lowering this rate may also lead to disruptions in markets that weren’t designed to operate at very low interest rates.” Paying a negative interest rate would be a really bad idea since “banks may choose to store currency rather than hold deposits at the Fed, and households may prefer holding cash if banks impose significant fees on deposits.” In other words, the Fed really is running out of policy tools, though there still is open-ended QE3. Then, as Bugs Bunny often said: “That’s all Folks!”

Today's Morning Briefing: Divergences. (1) Same old, same old. (2) Dow Theory warning. (3) So why are Railroads in record high territory? (4) Fundamental Stock Market Indicator still bearish. (5) Consumer confidence still as fragile as labor market. (6) Home prices rising. (7) Ben’s speech won’t be as good as Ann’s was last night. (8) FRBNY says excess reserves have nothing to do with bank lending. (9) Lowering the rate on bank reserves is a very bad idea. (More for subscribers.)

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