Fed Decision – A Minority Report

The analogy sort of fits; and what put me in mind of it was the news this week that the FBI has commenced a project to create a hi-tech facial recognition database.

We of course, are concerned about a different set of ‘Feds’ right now.

The Federal Reserve’s interest rate decision will come at 1630 GMT, and will be followed by Chairman Ben Bernanke’s press briefing.

Watch it here. [That’s the Fed’s official www.ustream.tv/ channel.]

I don’t know what Ben Bernanke will say. I know what I think it would be logical and prudent for him to say.

I’m not alone either.

Whilst we know that a majority of professional economists polled by Bloomberg [paragraph 5] and Reuters [paragraph 3], expect a third round of quantitative easing, a minority disagrees.

I’m with that minority.

The logic of those who disagree goes, a-little-something, like, this:

  • In theory, quantitative easing is meant to impact the real economy through a two major channels.
  • Via the interest rate channel, QE is meant to lower borrowing costs and consequently increase borrowing activity and then real investment in property, plant and equipment.
  • However it’s clear that QE’s most important channel is not a formal one. Rather it can be argued that sentiment is at least as powerful a channel as interest rates.
  • We know that the QE has lifted 5Y US Treasury yields ~35bp from the first mention in Bernanke’s Jackson Hole speech in late August 2010 through to its formal end on June 30, 2011).
  • Over that same period S&P 500 rallied 27% and DXY fell by about 15%.
  • Right now SPX is around 14% higher on the year, 10-year yields are well off the highs of earlier in the year and 5-year yields much lower than in 2010.
  • The ‘real’ trade-weighted dollar is ~3% lower than before QE2.
  • You know where I’m going don’t you? The question of whether the financial markets really need a QE3 arises.
  • I’m afraid I am going to have to skirt the question of whether the real economy needs [another] one – maybe our experience of the extent of the efficacy of the last two is implicit enough of an answer.
  • There would clearly be an element of protection in any decision in going full-on QE tonight.
  • However, given the Fed’s robotic drumbeat of readiness to act if needed over the last year, it seems a stretch to think that any market upset resulting from a failure to announce QE today would be akin to semi-catastrophic meltdown.
  • The market reaction might certainly be cheaper than the QE option.


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