Mr. Bernanke Goes to Washington

Federal Reserve Chairman Ben Bernanke made his semi-annual report to the U.S. House and U.S. Senate this week. Questions were many.

Wall Street and world equity markets reacted with a collective yawn.

Last month, when Bernanke spoke, the Dow lost 600 points in two days.  Then, last week after the FOMC minutes from last month were released, the markets soared to all-time highs.

Sadly amusing is that the message from the Fed all three times was exactly the same!

More important, though, details revealed in Q&A speak of an ominous shift.

The Bernanke Message

Beginning later this year, Treasury bond purchases will be tapered down to nothing by mid-year 2014. Unless economic conditions dictate otherwise, QE will end. And the Federal funds rate will remain where it is at, at least until unemployment reaches 6.5% in 2015.

Federal funds rates are the interest charged to member institutions of the Federal Reserve for overnight and liquidity loans.

The Fed has taken zero action in the last several months.
Bernanke talks about current expectations; actions the Fed MIGHT take, not WILL take.

Nothing is etched in stone. There are no triggers. The Fed will modify monetary policy based on what the economy does going forward.

Repeat after me:
Price stability! Maximum Employment!… Price stability! Maximum Employment!
Price stability! Maximum Employment!… Price stability! Maximum Employment!

That is the Fed’s dual mandate, its purpose for existing. Bernanke mentions them literally every time he speaks. Pay attention. Everything the Fed does revolves around those two things.

Since 2008, the Fed has been blazing new trails to meet its mandates: unconventional policy!

Unconventional Monetary Policy

According to this week’s testimony, the Fed takes a two-pronged approach:

  1. Expanding the Federal Reserve’s portfolio (QE/bond purchases)
  2. Forward guidance

Concrete actions; expanding the Fed’s portfolio, the size of its balance sheet and QE is all that Wall Street cares about.

The “forward guidance” portion is undervalued and misunderstood. The Fed, however, values both equally. Implementing Fed transparency will define Ben Bernanke’s legacy.

Forward guidance educates business and ordinary citizens on how the Fed works and tells them what to expect in the future. That has never been done. The Fed was a black box before.

Bernanke views communication tools equally as important as actual actions taken. It gives everyone sufficient information and time to prepare for future changes in monetary policy.

Q&A Sessions

After reading prepared remarks, Chairman Bernanke always has a question and answer session with Congressmen. They brought out two important details.

First, during the U.S. House Q&A session, when asked about the impact of ending QE on rising U.S. Treasury yields, Bernanke said “we need to monitor, particularly the housing market, to see if there has an impact on higher mortgage rates.”

Bernanke recognizes that ending QE is counter-intuitively raising Treasury yields which, in turn, raises mortgage interest rates; but then, once again, expressed his belief that keeping the federal funds rate unchanged near zero through 2015 is sufficient to keep interest rates low enough to stimulate economic growth. It isn’t.

Second, during the U.S. Senate Q&A session, Bernanke stated that adjusting the federal funds rate is a far more effective monetary policy tool than is Fed portfolio expansion through bond and QE purchases.

The federal funds rate is the most powerful weapon in the Fed’s arsenal for meeting its dual mandate. That rate has been pinned to the floor since late 2008. It ain’t gonna budge. At rock bottom now, it cannot lower interest rates any more than it already has over the last 4 years.

Should Treasury yields keep rising, as they’ve started to do, there is no monetary tool left to keep them in check. The Fed could keep making more or even increase bond purchases, but that itself will drive up yields should investors turn away from treasuries.

Treasury yields are a sleeping giant held artificially low by a depressed global economy.

Conclusions

During testimony this week, Chairman Bernanke did not say anything different than he said last month after the FOMC meeting. But Q&A brought out important details.

Since the Fed came along, there have been vast periodic investment shifts. Traditionally, investors buy stocks in good times because returns on investment are high. During bad times investors flock to bonds to “chase the yield”. Shifting from one basic type of investment strategy to the other is called a great rotation.

We are at a crossroads. Investors are heavily vested into safe bonds because of the Great Recession. Using unconventional policies, the Fed has purchased Treasury bonds to prop up the economy. Wall Street got addicted to bonds just like they got addicted to mortgage backed securities before 2008.

Last month, Bernanke just may have inadvertently triggered a great rotation away from Treasury bonds back full into stocks when announcing an end to QE.

The Fed helped create a treasuries bubble. A sleeping giant is awakening.

Rising yields will cost taxpayers and the Fed dearly and strangle future economy growth.

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About azleader

Learning to see life more clearly... one image at a time!

Posted on Jul 19, 2013, in Business, Debt, economics, Economy, Government, Jobs, news, Opinion, Politics, The Fed. Bookmark the permalink. 2 Comments.

  1. If you’re right about a Treasury bod bubble, This country is in for one hell of bumpy ride, AZ.

    • It is my fear. I think the Fed underestimates its ability to control yields…
      A lot of folks have talked about a great rotation over the last year…
      I think the prospect of an end of QE has inadvertently triggered it.

      It will take several years to evolve, but once it gets momentum federal debt service will force serious government cutbacks and mortgage and auto loans will cost a lot more.

      At least it will force Congress to finally address entitlement reform. 😉

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