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What are the Central Banks Up To?

Interest-Rates / Central Banks Oct 09, 2009 - 04:59 PM GMT

By: Sy_Harding

Interest-Rates

Best Financial Markets Analysis ArticleAt its FOMC meeting last month the Fed said that while it is more confident that the economic recovery is underway, it expects to keep interest rates low for some time to come. Analysts took that to mean until sometime late in 2010.


So it raised eyebrows when a few days later Federal Reserve Governor Kevin M. Warsh said that “unwinding of the Fed’s unconventional policy tools will likely need to begin before it is obvious that it is necessary, and possibly with greater force than is customary.”

However, former Fed Vice-Chairman Alan Binder calmed the alarm, saying, “Nobody at the Fed thinks that now is the time to begin an exit strategy.”

When the G-20 nations met last month they agreed to keep their stimulus efforts, including low interest rates, in place for now to avoid derailing still fragile economies.

So central bank observers were surprised a few days ago when Australia, a G-20 member, raised interest rates by a quarter point, the first major central bank to openly begin reversing its stimulus efforts (which had interest rates in Australia at a 49 year low).

But there had also been indications in the Fed’s FOMC announcement that it is ready to unwind some of its stimulus efforts, saying it will begin slowing its program to buy almost $1.5 trillion of mortgage-backed securities, and end its program of buying $300 billion of U.S. Treasury bonds next month.

In a speech on Thursday of this week, the leader of the Conservative Party, and therefore “Leader of the Opposition” in England, called for an early end to quantitative easing in the United Kingdom, saying that “sometime soon the country will have to stop printing money if it wants to head off inflation”.

Meanwhile, it slipped out this week that the U.S. Fed is conducting small scale market tests of trades known as ‘reverse repos’ (reverse repurchase agreements).

In a reverse repo the Fed would sell assets on its balance sheet, like those it bought from major banks during the bank bailout efforts, to dealers, with an agreement to buy them back at a later date at a price that will give the dealer a small profit. The dealer pays cash, which goes into the Federal Reserve’s bank reserves, taking the assets of the Fed’s balance sheet, and the cash out of the financial system.

The market tests do not mean the Fed is on the verge of draining cash from the economy on a large scale, at least just yet. It is probably only testing various methods it might eventually use to reverse the massive stimulus efforts and easy money policies.

However, could all the leaks, the seemingly ‘off the reservation’ comments about the need to act now, and the preliminary rate hike by Australia’s central bank, be purposely designed to prepare global markets for an earlier withdrawal of the punch bowl than the official time-line, if it becomes advisable?

That approach would give them a broader range in which to work. If economies continue to improve more quickly than anticipated, raising the specter of rising inflation, they could act more decisively without potentially crashing markets, if the markets had been prepped for the potential of action being taken at any time. And if economies remain weak or threaten to slow again, they can stick with the official line that stimulus efforts will remain in place for some time to come.

However, some analysts believe the flurry of conflicting activity has another purpose.

An article in The Economist notes that “Fed governors aren’t singing the same tune in public comments on the likely path of monetary policy. It appears to be a deliberate attempt to introduce uncertainty into markets. Why would they want to do that?”

They quote an explanation by research and Fed-watcher firm Wrightson ICAP, that central bank officials are trying to lessen the irrational exuberance, “sending a warning shot across the bow of leveraged speculators, that with the trajectory of interest rates unclear, leveraged positions are no longer such safe bets as they have been.”

Either way, over the last couple of weeks central banks, and their individual members, do seem to be sending out conflicting messages regarding withdrawal of the punch bowl.

By the way, with the cost of the stimulus efforts estimated to be $3.2 trillion, this year’s federal budget deficit estimated to reach $1.4 trillion, total consumer debt reported to be $2.46 trillion, etc., a lot of areas have moved out of the categories of $billions and into $trillions.

If you have as much trouble as I do in grasping the difference, mathematician John Allen Paulos puts it this way; “A million seconds is 11.5 days. A billion seconds is about 32 years. A trillion seconds is 32,000 years.”

Nope. Still too difficult to visualize in terms of money.

Let’s wish the Fed and Treasury Department great good luck in getting their minds around the concept when they begin to unwind those kinds of dollars from the economy with just the right balance of timeliness, caution and aggressiveness.

Until next time.

Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily market blog at www.SyHardingblog.com.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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