The Fed is on hold

I have consistently warned for the past few months that the Fed would pause before rushing into QE3. I reiterated this yesterday. Yet, somehow people came away from Ben Bernanke’s testimony before Congress yesterday thinking the Fed was going to crank up the QE3 keyboard strokes. It’s not going to happen.

Look at Bernanke’s prepared remarks:

On the one hand, the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support. Even with the federal funds rate close to zero, we have a number of ways in which we could act to ease financial conditions further. One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels. Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally. Of course, our experience with these policies remains relatively limited, and employing them would entail potential risks and costs. However, prudent planning requires that we evaluate the efficacy of these and other potential alternatives for deploying additional stimulus if conditions warrant.

On the other hand, the economy could evolve in a way that would warrant a move toward less-accommodative policy. Accordingly, the Committee has been giving careful consideration to the elements of its exit strategy, and, as reported in the minutes of the June FOMC meeting, it has reached a broad consensus about the sequence of steps that it expects to follow when the normalization of policy becomes appropriate. In brief, when economic conditions warrant, the Committee would begin the normalization process by ceasing the reinvestment of principal payments on its securities, thereby allowing the Federal Reserve’s balance sheet to begin shrinking. At the same time or sometime thereafter, the Committee would modify the forward guidance in its statement. Subsequent steps would include the initiation of temporary reserve-draining operations and, when conditions warrant, increases in the federal funds rate target. From that point on, changing the level or range of the federal funds rate target would be our primary means of adjusting the stance of monetary policy in response to economic developments.

Translation: the Fed will pause to assess the economy before doing anything else. If economic growth in the U.S. does not falter in the second half of 2011, the Fed will look to drain excess reserves from the system as preparation for an interest rate hike at some unforeseeable future date.

There is immense pressure on the Fed from within as well as politically to refrain from more unconventional policy. The economy will weaken significantly before the Fed moves against it – and only then because of vocal outcries for more policy stimulus.

Tim Duy sees this as well – and he wants more from the Fed. Bottom line: there will be no stimulus unless the economy and/or asset markets deteriorate further.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Dan Duncan

    EH writes: Bottom line: there will be no stimulus unless the economy and/or asset markets deteriorate further.

    There is no bottom, which, of course, means there’s also no top. Only a circle. Which brings us from:

    There will be no stimulus unless the economy and/or asset markets deteriorate further.


    Asset markets will deteriorate further unless there is more stimulus.

    And round and round we go…

    1. gruntled

      If the asset markets deteriorate, even the rich will feel poor. Then where would we be, with everyone feeling down and out? It would be, like, a depression.

      1. Jim A

        It’s remarkable how little it takes before the rich start to feel poor. The creshendo of whining from the Hamptons and the toney parts of Manhattan is overwhelming if the possibility of allowing taxes to return to their 2000 level is even mentioned.

        1. YankeeFrank

          You are so right my friend. Imagine if they ever really felt the bite of poverty? They would wilt like paper in a rainstorm. Sad fearful creatures scurry after wealth above love, creation and connection.

    2. Thor's Hammer

      What does QE3 have to do with stimulus? Funding Goldman’s reserves to pay off derivatives bets to European banks stimulates the US economy? Easy money for global corporations to set up new plants in China or Brazil revives the US job market and holds back the wave of home foreclosures? Give me a break. The WPA was a stimulus program: Bonuses for banksters is class warfare.

      1. monday1929

        Bernake explicitly stated that stimulus results were measured by the level of the Russell 2000. He who lives by the sword…….

        but the rest of us will live in a van…..down by the river!

    3. propertius

      There will be no stimulus unless the economy and/or asset markets deteriorate further.


      Asset markets will deteriorate further unless there is more stimulus.

      The beatings will continue until morale improves.

  2. alex

    Is no QE3 (at least for now) so bad?

    There are limits to what you can do w/ monetary policy. It surprises me that people like Krugman, who claims liquidity traps as one of his signature issues, is so big on monetary stimulus. You can’t push on a string and all.

    Nor is QE without costs. Commodity inflation, the need to soak up the money in the future, etc.

    As much as I despise the Fed for being in cahoots with the banks, I will say that they’ve done more than anyone else to fight the Great Recession. Yes, they helped create it, but at least they played firefighter after they played arsonist. Our actual elected federal government just played arsonist and then satisfied itself with a quick piss on the flames. Now they’re talking austerity. At least the Fed did something, but there are limits to monetary policy.

  3. robert in london

    Honestly, with all the angst and hand wringing and musings about further economic ‘stimulus’ one could be excused for thinking the market(s) were down 15 to 20% from the May highs. For shitsakes we are down 2%! So what exactly constitutes significant market deterioration from here? A retest of the June lows? What a total catastrophe that would be! Just forget the real economy which has been roasted and toasted for years and completely relegated to a sideshow by the plutocrats who pull the strings of our dear leaders and their msm shills. The whole shebang is a ponzi/shell game/fraud of the highest order yet we continue to be absorbed by the carnival barker and his clowns. Pathetic.

  4. Amit Chokshi

    I actually think the Fed will be ready to hit QE3 much faster this time. I own long dated Ts as a hedge and the Ts did not buy the market, interesting to see both the market rally albeit fade hard and Ts rally hard too, market def is confused. Econ sux but we all know that, I am sitting on some cos that still are doing well and off low valuation. Look at MASC for example, ~$100MM market cap, about a $70MM EV, on track for $21MM EBITDA this year, solid EPS. and they are a US auto components provider. Basically trading at <4x ev/ebitda, as EV shows, it has no net debt, cash flow positive, and improving margins.

    Then there's stuff like say IMN. Dying business overall but about $8 in net cash per share trading at $9-10, these guys are chugging along, nothing great but the valaution is so low, even at the current pace they are cash flow positive. So yes markets can get clobbered but I'm inclined to think we're in a bit of a churning market where like 2001-2002 there were long only guys that could make money by not crapping their pants and going for legit value opportunities.

    But back to the Fed, you have QE3 potential if the economy sux, so where does the market correct for them to rev up QE3? Another 5% hit, i mean one thing that is "good" is how quickly skittish "investors" get, they are willing to bail fast. So then you sort of have a strong effort to create a bottom range or what not for stocks.

    Secondly, I think the market has priced in <2% GDP for Q2 based on the latest updates by the big banks. If we get some continued relief at the pump I think that puts in the potential for some upside surprises in H2. It doesn't have to be meaningful for a huge move given how much operating elverage companies have now given they basically have serfs as labor.

    I would also note that yesterday it seemed the Bernanke was a bit more forceful and pushing back to Congress re fiscal options.

  5. bmk

    The more important takeaway is that prior to Ben’s remarks most of the street was absolutely convinced QE3 was off the table, eg the Fed would not consider it at all. Even though conditions dont warrant it now, the fact that he cleary spelled out that he’d be willing if conditions deteriorated caught alot of the market by surprise. In addition, Bernanke isnt blind to expectations – he talks about inflation exp ALL the time – so he’s also making a soft bet that by stating they arent opposed to doing more might be enough to keep delfationary forces from building. This is all part of the ongoing message about making sure the market knows the Fed will REMAIN accomodative for as long as necessary. Ben talks about this communication technique whenever & wherever possible.

  6. Susan the other

    Further asset deterioration? Like all of southern Europe defaulting? Or commercial real estate in the US? Or a muni crisis so overwhelming society breaks down? What will these huge but unrecognized defaults emerge as next? When the hedge funds bottom out will they be the last to crash?

    First came all the victims of the capitalist ponzi extravaganza and they were crushed (citizens of the US and the EU). Next the still optimistic speculators – we can always find something to trade for profit and fun – lose their ass in a flash crash because there is no underlying economic growth. And finally the big investment funds will liquidate their assets and take their bonuses.

    And all this happens while the TBTF banks remain completely insolvent in spite of quarterly reports showing profit. I guess the Fed can always accelerate real time money circulation. If they hand the money back and forth fast enough the debt can’t catch up with them, right?
    Glasnost anyone?

    1. Cedric Regula

      File: What We Have Here Is A Failure To Communicate

      Global Village goes on Big Party for 6 years.

      Passes out and wakes up with huge hangover and splitting headache.

      Central banks unsure if this is a liquidity or solvency problem. (At this point, it is both)

      They do QE1 and all those other things to solve liquidity problem.

      They find out it’s a solvency problem.

      They do “extend and pretend” + QE2 for solvency problem.

      Wash, Rinse, Repeat for as long as they deem neccesary.

      Interchange terms like economy/markets and asset prices/employment to make sure we know they are executing their charter.

  7. TC

    The Fed, like Zed, is dead. The moment of revelation that, it is powerless to sustain a mountain of illegitimate debt — a mountain built on King Ponzi’s watch (Greenspan) — is arrived. Mr. Madoff, I’d like you to meet your new cell mates: the shriveled one, his name is “Magoo” and the bearded one, call him “Benito.”

    1. bmk

      TC – With all do respect, that is so insanely stupid i dont even know if i can respond. Despite the fact that the US has high deficits & a weak economy, our T-bonds are in very high demand – people are loaning the US 10-yr money for 30%!

      1. psychohistorian

        I think that the music of faith based animal spirits is going to stop….. soon.

      2. monday1929

        You will be stunned by how fast things can change. Actually, those rates may go lower as the Dow dips below 2,000.


  8. Johnny Clamboat

    “Bottom line: there will be no stimulus unless the economy and/or asset markets deteriorate further.”

    If those are the metrics then I’ll put up 100 fiatskis to donuts on QE3 (and QE4… and QE5….). Where are the drivers for growth? I see plenty of risks out there.

    If you go back to the stated goals for QE2, The Bernank is batting .000.

    1. psychohistorian

      Where are the frigging JOBS?

      Just like regulation of industry is needed to temper their excesses, regulation of money is needed to clarify between the provision of the utility aspects and the “at risk” portions and when one becomes the other. The key here is to stop having the tail of financial risk taking wagging the utility dog of medium of exchange.

      1. hermanas

        “Where are the frigging JOBS?”
        Exacto, I get the feeling we’re talking past each other.
        If everyone is sitting out, there is no economy.
        Good luck with that paper, or metal or whatever.

    2. hermanas

      “Bottom line: there will be no stimulus unless the economy and/or asset markets deteriorate further.”
      Ever consider that the equation changes faster by reducing the denominator,”per person”?

  9. scraping_by

    “Bottom line: there will be no stimulus unless the economy and/or asset markets deteriorate further.”

    However, hyperinflated assets tend to lower job growth, with the obvious example of oil and other raw materials. While asset inflation helps to grow jobs in that category’s production, it’s a drag on all the others. And when the asset is capital, as in stocks, it directs the economics away from productivity to speculation.

    So, wouldn’t it be wiser to let capital assets drift down to their reasonable, demand-from-use-not-speculation, level, and make employment the only basis and goal of stimulus? Just asking…

  10. Blurtman

    I think what Obama should do is champion the belief that everyone should have the ability to earn millions per year, and that the niggardly folks who are already multi-illionaires and got there when tax rates were so much higher on the wealthy are cutting off the next generation through their philosiphy of greed – that is, “I got mine, screw you.”

    He’s got to become pro-wealth, i.e., next generation wealth, through higher taxes on the already wealthy. He’s got to turn the current multi-millionaires into the enemies of economic growth and wealth accumulation for everyone else.

  11. Justicia

    The Washington Follies increasingly look like Grand Guignol:

    “These plays often explored the altered states, like insanity, hypnosis, panic, under which uncontrolled horror could happen.”

    The power players (and the pundit chorus)are acting out scenes of financial horror, driving the U.S. government and the economy to the cliff and dangling the terrified middle class over the edge until we agree to give up the social security net and accept “structural unemployment” as the new normal.

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