Tuesday, April 26, 2011
What Happens When the Fed Leaves The Party?
There was a time when the Federal Reserve, and the Fed's policy decisions, received as much media attention as my beloved New England Revolution soccer team.
Back in the Carter administration, for example, then-chairman G. William Miller joked that when he was first appointed head of the Federal Reserve, his relatives thought he was going to head up a bourbon company.
(Mr. Miller was famous for insisting that Fed meetings should be over as quickly as possible, and he often succeeded: it was not unusual for a Miller-led meeting to conclude in 10 minutes.)
No more. The Fed, and Fed actions, are scrutinized and discussed as much as any government actions.
And so last weekend, right next to the stories of the wars in Libya and elsewhere, there was a front page story in last Sunday's New York Times discussing whether the Fed's second round of quantitative easing (so-called QE2) had any positive effect on the economy other than causing stock prices to move sharply higher.
The consensus in the article was essentially that QE2 was a flop, a zephyr in the economic breeze.
I'm not really sure this is true, and the news magazine The Economist begs to differ as well:
So what happened after Mr Bernanke made it clear to markets that the Fed would act again? Growth accelerated, from a 1.7% annualised pace in the second quarter to 2.6% in the third quarter and 3.1% in the fourth quarter. Inflation expectations ceased falling and began rising back to normal levels. Confidence rose. And the pace of hiring improved meaningfully. In both February and March, private firms added over 200,000 jobs. Since the Fed's policy began, the unemployment rate has fallen a full percentage point.
My point in mentioning all of this today is that there seem to be unmistakable signs that economic growth is beginning to slow again - just when the Fed is ending its QE2 program.
Some economists are pointing towards higher oil prices, which certainly is playing a large role in changing consumer behavior. Housing continues to sputter along, and unemployment rates are far higher than they typically would be in a normal economic recovery.
First quarter GDP will be reported later this week, and it will probably be around +1.5%, down considerably from the fourth quarter of 2010, when GDP came in at +3.1%.
Then there's my favorite barometer, the bond market. Bond yields have fallen 21 basis points over the last 9 trading days, and the 10-year Treasury now yields 3.36%. Apparently there are lots of investors who think locking in returns just north of 3% is better than any alternative.
I remain positive on the stock market for the time being, but diligence remains important in this environment.