Thursday, June 27, 2013

More Thoughts On Fed Policy

Graph of 10-Year Treasury Constant Maturity Rate
Although interest rates have retraced some of the rise that occurred earlier this week, most commentators and observers think that rates are only going to move in one direction: higher.

Individual investors are listening to the financial press, and are leaving the bond market in record numbers:

U.S.-listed bond mutual funds and exchange-traded funds saw record monthly redemptions of $61.7 billion through June 24 amid signs the country’s central bank may scale back its unprecedented stimulus. 

The redemptions surpassed the previous monthly record of $41.8 billion, set in October 2008, according to an e-mailed statement by TrimTabs Investment Research in Sausalito, California. Investors withdrew $52.8 billion from bond mutual funds and $8.9 billion from ETFs during the period, said Richard Stern, a spokesman for TrimTabs.

 However, a number of economists are wondering how the Fed reached the decision that the economy was strong enough to start withdrawing its support.

Writing in yesterday's London Times, for example, Ambrose Evans-Pritchard was almost apoplectic in his anger towards the Fed.  Here's an excerpt:

The entire pivot by the Federal Open Market Committee is mystifying, almost amateurish, and risks repeating the errors made by the Bank of Japan a decade ago, and perhaps repeating a mini-1937 when the Fed lost its nerve and tipped the US economy into a second leg of the Great Depression. "It’s all about tighter policy," was the lonely lament by St Louis Fed chief James Bullard.

Evans-Pritchard notes that there is very little economic data to justify the Fed's apparent change of heart.  Instead, he argues, that the move is largely based on politics, and pressure from other sources such as the Bank for International Settlements (BIS) and the German government:

But if the Fed has erred again this time, it can't hold a candle to the Bank for International Settlements (BIS). This club of central bankers - now entirely in thrall to the Bundesbank, and the liquidationist doctrines of the Chicago Fed circa 1931 - demanded a halt to QE this week, as well as rate rises, yet more fiscal tightening, and an even faster pace of credit deleveraging for good measure...

One thing is certain, if such a nihilist cocktail of BIS contraction were imposed on the world in its current condition, it would kill recovery altogether, throw millions more out of work, and probably extinguish a few democracies along the way.

I am not an economist, but after reviewing some basic economic charts I can see some of the reasons for the ire of Evans-Pritchard, among others.

For example, while it is true that since 2008 the Fed has massively inflated the money stock of the United States, it is also true that the money velocity has also dropped dramatically.

It is hard to see any inflationary pressures in a period of deleveraging.

FRED Graph

 There are no inflationary pressures evident:

 FRED Graph

And employment is still below 2008 levels:

FRED Graph

As my earlier post on the Fed's actions stated:  I sure hope they know what they're doing.