Wednesday, September 22, 2010

Monetary policy: Fed next | The Economist

The Big News yesterday in the markets was the release of the Fed's policy statement.

As you have no doubt read in the papers, the Fed indicated that while it is not yet ready to act, it is closer to aggressively increasing its current monetary stimulus stance to try to spur economic growth.

To many, the question is not whether the Fed should act, but why is the Fed taking so long. Here's an excerpt from The Economist blog:

At this point, it seems silly to speculate about what's going on inside the FOMC. We've all looked into our crystal balls and wondered why the Fed hasn't yet acted, and there's little more to be said on this front. The bottom line is that the Fed could and should do more and most observers—including those drafting the Fed statements—seem to acknowledge this. It's a shame that we'll have to wait two more months, at least, to see something done at last.

I think the real reason that the Fed is hesitating is the current political mood in Washington. Any Fed chairman - and Bernanke is no exception - has to be sensitive to the political winds (recall his renomination was hardly a unanimous approval) and so caution seems to be the word of the day.

Monetary policy: Fed next | The Economist

And, to be fair, the markets don't seem to be able to make up their minds.

Gold and silver continue to rocket higher, which would seem to indicate a lack of confidence in paper money and a fear of inflation.

At the same time, U.S. Treasury bond yields moved sharply lower in the aftermath of the Fed statement. Two year Treasury notes now yield 0.43%- the lowest level in at least 40 years.

Someone buying a bond yielding less than 1/2 percent must be pretty confident that inflation isn't going to be a problem for at least a couple of years.

Municipal bond yields, by the way, have generally moved in the same direction as government bonds, with the exception of lower quality municipalities. This the one area of the credit markets that seems to be consistent in its fear of default.

And, finally, speaking of defaults, this morning's Wall Street Journal indicates the corporate bond default rates are now at lows not seen for at least a couple of years:

Corporate debt-default rates are expected to fall to the same levels that preceded the financial crisis of September 2008, marking a swift turnaround for the fate of the most troubled U.S. companies.

The U.S. default rate should fall below 3% by year's end, according to Moody's Investors Service, a stunning drop from the 14.6% peak of November 2009 and even below the default rate of 3.1% from August 2008.

This trend seems to be consistent with the jobless recovery that we seem to be experiencing: Corporate America is getting healthier, stocks are moving higher (the S&P 500 is now up over +11% in the third quarter), but unemployment rates remain depressingly high.