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Federal Reserve Fires Last Bullet - Historic Day for Monetary Policy

Posted on | December 17, 2008 Time: 1:43 am |

We’ve had more than a fair helping of Fed letdowns lately, so today’s announcement was just all the more impressive and historic. Even PIMCO’s Mohamed El-Erian could only say “wow” at the language and posturing made inside today’s FOMC statement.

Feelin' Lucky Mr. Market?

In an unprecedented move, the benchmark fed funds rate was set to a “range” of 0% to .25%, reflecting what the market has already priced in. But just think about it for a second…0% borrowing rates. That’s it - there’s no more bullets in the tried & true pistol that is monetary policy. Want money? Here - just take it.

In a nominal sense, there’s no reason to think that banks will want to lend any more tomorrow than they do today. But the cut in discount rates was not what made today epic…it was just the getting out of the way of the semantics.

No Fed-Speak Today - Simple Words for Difficult Times

The historic part was in the language, where “all possible tools” were pledged to come out of the garage in order to keep the economy from deteriorating further. The specific tools mentioned today were the direct purchase of mortgage-backed securities and agency bonds. Even the Ole’ Yeller of fixed income - the 30-year Treasury - could see bids being hit by the Federal Reserve in the coming weeks. The Fed has a theoretically limitless ability to borrow, so no amount of purchases is too big for consideration. It’s all hands on deck…after all, why shouldn’t the Fed borrow like crazy when 10 yr bonds are yielding 2.27%?

In other words, we can expect pure liquefaction of the Fed’s balance sheet, and an overt attempt to reconcile what is should be mispriced mortgage debt in relation to demand. Treasury markets immediately rallied on the statement, as did Fannie & Freddie debt, while the USD dollar weakened. While stock markets cheered the news, real questions began to surface about the wheres, whens, and hows of future inflation.

Are we creating an inflation monster?

Are we creating an inflation monster?

Today’s news was the culmination of the largest re-inflation attempt in history. We think it will work, but we really don’t know. Right now none of the money is “sticking” to new loans, lower corporate borrowing costs, and consumer credit. But when it does begin to stick, re could inflate god-awful quickly. Will we be able to put on the brakes in time? It’s uncharted territory, but history tells us we’re much more adept at inflating currencies than deflating them. In the meantime, I continue to overweight select commodity-based names (POT, AA, FCX, PBR, BTU) that have not only secular growth trends but future inflation winds at their back.

Goldman Spoiled a Linchpin Bear Argument

Goldman Sachs shares made an impressive stand today against a headline loss that was more than consensus estimates, but less than the most fearful whisper numbers. Goldman reported a loss of $2.12 billion, or $4.97 per share, on the back of write-downs totaling a) $3.6 billion on principle investments, and b) $1.7 billion on commercial loans & mortgages. These figures are right in-line with what I anticipated back in November, and Goldman shares promptly rose hard on high volume, closing up 14% on the day.

The inability of GS to “sell on the news” reflects the company’s overriding status as a barometer for systemic risks in the financial sector. I’ll wait until Goldman gets above book value (currently $98.68/share) before calling the barometer no longer relevant.

Disclosure: Author does not hold positions in the companies mentioned

More on this topic (What's this?)
Auerback: Bernanke Fesses Up: America Has No ‘Insolvency’ Issue (naked capitalism, 2/26/10)
FORMER ATLANTA FED CHIEF CALLS FOR RATE HIKE (THE PRAGMATIC CAPITALIST, 3/16/10)
Dodd And Bernanke Need To Get A Room (LOLFed, 3/15/10)
Read more on Federal Reserve at Wikinvest
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