How easy is this Fed?

As we wait for the announcement from the FOMC, the markets has been seeing a number of mixed signals from the Fed lately. Josh Brown thinks that the Fed has no idea what happens next - and that's ok. I think that the Ben Bernanke has been incredibly activist and accommodative because of his academic study of the Great Depression and this Bernanke Fed isn't about to stop.

There are others who subscribe to my view of an easy Bernanke Fed. In a Barron's article (subscription required), former Fed insider Vincent Reinhart, of Morgan Stanley (and husband of Carmen Reinhart), believes that Bernanke may not have the political capital to undergo another QE cycle in 2H2012, so any accommodation needs to be brought forward:

But a long-time observer of Fed policy—from the inside and the outside—thinks another round of quantitative easing, or other measures, is likely later this year. Vincent Reinhart, Morgan Stanley's chief U.S. economist, formerly was director of the Fed's Division of Monetary Affairs and served as the FOMC's secretary and economist, so he has seen things from both sides.


In his latest report, Reinhart writes there is a 75% probability the Fed will take some "unconventional action by June" because of the "political calendar." The central bank is supposed to be above the political fray, but this former Fed insider thinks Ben Bernanke & Co. will want to keep a lower profile in the second half of the election campaign season.

Secondly, the economics also will justify a move, he continues. (I may be naïve but I still find it jarring to list economics after politics in determining Fed decisions, but I'm not an ex-insider.) Economic slack (read "unemployment") persists and inflation remains below the Fed's medium-term projections, Reinhart notes.

Moreover, he notes the Fed sees risks the economy could slow. "Here, too, at Morgan Stanley, we share the view that the fillip to economic growth associated with a restock of inventories is fading and that real [gross domestic product] growth will slow notably in current quarter. Anxiety-inducing headlines that the economy is losing steam will be conducive to Fed action."

If Vincent Reinhart is correct, then Bernanke may not have the political capital to undertake another round of QE. That's why we had the "leak" about the Fed considering "sterilized bond buying" as a way of appeasing the hawks inside and outside the Fed.

I have no idea how much Vincent's thinking is influenced by Carmen's and vice versa, but this thread of continued central bank accommodation is consistent with Carmen Reinhart's theme of "financial repression", which she believes is here to stay [emphasis added]:

As they have before in the aftermath of financial crises or wars, governments and central banks are increasingly resorting to a form of “taxation” that helps liquidate the huge overhang of public and private debt and eases the burden of servicing that debt.

Such policies, known as financial repression, usually involve a strong connection between the government, the central bank and the financial sector. In the U.S., as in Europe, at present, this means consistent negative real interest rates (yielding less than the rate of inflation) that are equivalent to a tax on bondholders and, more generally, savers.

In the past, other measures also included directed lending to the government by captive domestic entities (such as pension funds or banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter coordination between governments and banks, either explicitly through public ownership of some institutions or through heavy “moral suasion” by officials.

If I am right about this theme about the Fed getting to give the patient another shot of adrenaline, then it would be regarded as short-term bullish for risky assets (though it may not do much longer term).

That`s why my inner trader is carefully scrutinizing the FOMC statement to watch for any change in language.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

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