9 Aug 2011

Fed Expected To Try To Sooth Markets Without QE3


A stressful weekend for the world’s bankers and politicians, followed by a sleepless Monday, and all with a single question rattling around in their heads: How can we fool them again?
For decades now the financial/public sector complex has been able to clean up its recurring messes — from Long Term Capital Management to the Asian Contagion to the tech crash to the housing bust — with credit. Just lower interest rates, shovel capital into the banks, and watch the hedge funds and CNBC eat it up. This has worked so well for so long that most of the people now running things seem to believe that it’s right, that easy money actually improves lives and greases the wheels of capitalism.
History will show, of course, that an unfettered printing press is actually economic heroin, inducing happy dreams at first but requiring ever higher doses until it finally kills its victim. Over the past three decades, the doses of debt have grown to near-fatal levels, leaving only the question of timing: when do we realize that not only have we been conned but that the con is over, and abandon, perhaps violently, the existing system?
Today could easily be that day. Interest rates are as low as they can go, debt is surreally high, and life is still getting worse. Government and the big banks seem to fallen back on platitudes and finger pointing. Just today the president proclaimed that “The United States of America is now and always will be a triple-A credit!”
On the other hand, they’ve fooled us so many times, and so brazenly, that the possibility of one more for the road can’t be discounted. Here’s how the strategy is evolving:

Federal Reserve policy-makers are likely to try for language assuaging financial markets Tuesday, but probably are not ready to embark upon a third round of quantitative easing, economists and market analysts say.
This is because fears of possible deflation are smaller than when the Fed last embarked upon quantitative easing, plus 10-year Treasury yields are already low.
The Federal Reserve has already embarked upon two rounds of quantitative easing, which is buying of long-term Treasury securities in an effort to push down market-set interest rates. “I don’t think the Fed is going to do anything dramatic, i.e., QE3,” said Greg Michalowski, chief currency analyst with FXDD.
“We’ve already had QE1 and QE2, and here we are today,” he said in reference to continued economic problems. “Participants who are looking for an actual QE3 announcement could be disappointed because the Fed has stated on a number of occasions now that it’s a really high bar in terms of implementing a QE3 program.”
Still, economists and analysts look for the Fed to acknowledge economic headwinds and craft some kind of communiqué that lets markets know the Fed is ready to help as necessary.
“There might be some type of change in the language that drives home the point they are committed to keeping interest rates very low for a significant period of time,” O’Hare said.
“One thing they might do is be a little more explicit in what they mean by extended period,” said Mike Moran, chief economist with Daiwa Capital Markets America. “For example, instead of just saying we intend to remain accommodative for an extended period, they might say we will remain accommodative until well into 2012, or something along those lines.”
Likewise, it’s possible the Fed may provide a more definite timeline on how long it will keep its balance sheet at elevated levels, said Robert Lynch, currency strategist with HSBC. “They are reinvesting interest in maturing debt, but they haven’t said how long they are going to continue to do that.”
Still another possibility, Moran said, is the Fed might opt to increase the length of the securities in its portfolio.
“They would not enlarge it by doing additional quantitative easing, but to try to lengthen its maturities, so that as securities mature, they would roll them into something longer term than what they had originally held and gradually increase the average maturity,” Moran said.
This might put some upward pressure on short-term yields, Moran said. “But long-term rates probably have more of an effect on the economy, therefore it would be a mild form of support for economic activity.”
The above is mostly speculation, of course, but it does seem reasonable that among the things we’ll be offered at Tuesday’s Fed meeting will be a promise of low interest rates pretty much forever, increased buying of long-term bonds to lower interest rates even further, and a statement of willingness to flood the banks with cash again if the bonus pool shrinks, er, if the economy keeps slowing.
None of these, of course, will make the junkie stop shaking. So the next dose — a towering QE3 — will come soon. But will it “work” again, buying the banks another year to drain the last few drops of wealth from the system? Or will the markets finally see through the monetary illusion and pour every last bit of free capital into hard assets and out of the US?
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