Thursday, January 7, 2010

Is the Fed contributing to instability?

In this fragile economy, one of the sources of stability should be the central bank. Paradoxically, mixed messages coming out of the Federal Reserve have contributed to the uncertainty.

Uncertainty about QE
The December 16, 2009 FOMC statement suggested that the Fed was prepared to ease off on quantitative easing [emphasis mine]:

In light of ongoing improvements in the functioning of financial markets, the Committee and the Board of Governors anticipate that most of the Federal Reserve’s special liquidity facilities will expire on February 1, 2010, consistent with the Federal Reserve’s announcement of June 25, 2009. These facilities include the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility. The Federal Reserve will also be working with its central bank counterparties to close its temporary liquidity swap arrangements by February 1. The Federal Reserve expects that amounts provided under the Term Auction Facility will continue to be scaled back in early 2010. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30, 2010, for loans backed by new-issue commercial mortgage-backed securities and March 31, 2010, for loans backed by all other types of collateral.
Now we get the news that they are prepared to re-enter the MBS market later in 2010? What’s going on? Did some earth shattering event occur between the December FOMC and today?

No clarity on the Plunge Protection Team question
In addition, consider my last post alluding to the presence of the Plunge Protection Team, or PPT. Over at Cunning Realist, he blogged about a question from Senator Jim Bunning to Ben Bernanke:

Before the financial crisis there was a widespread sense, especially on Wall Street trading desks, that the stock market was strangely resilient. This encouraged excessive risk-taking in various types of assets. Do you have direct or indirect knowledge of the Federal Reserve or any government entity or proxy ever intervening to support the stock market (or any individual stock) via futures or in any other way? If yes, who decides the timing of such intervention and with what criteria? How is it funded? Which Wall Street firm handles the orders, and who sees them before they are executed?

He went on to complain about the Fed Chairman’s non-answer, or incomplete answer:

The Federal Reserve has not intervened to provide support to the stock market or individual stocks by trading in futures or any other financial instrument. I have no knowledge of any other U.S. government entity providing such support.

Bernanke's answer was incomplete because he ignored the word "proxy," an important part of the question.

I have never been a big fan of conspiracy theories, largely because they generally don’t make sense. In the case of PPT, governments are known to intervene in a variety of markets, such as FX and the bond market. Why would they want to keep intervention in the stock market a secret?

If they were propping up the stock market (or the currency), wouldn’t they get a bigger bang for the buck if they let it be known that they were intervening?

The story of PPT intervention doesn’t make sense. Stock market leadership has been narrowing in the large caps. If the Fed or some other government agency was directly or indirectly buying S&P 500 futures, why is the Dow Jones Industrials outperforming the S&P 500?

Despite my reservations about the PPT story, it is nevertheless disturbing that Chairman Bernanke can’t give a straight answer to a question about government intervention in the equity market. He is experienced enough to know that the markets parse every nuance of his statement so his incomplete answer can’t be an accident.

All these actions point to either a Fed that is rudderless, indecisive, beset by internal bickering or plain doesn’t know what to do. In these uncertain times, any of these conditions at a major central bank is downright scary.


Patrick said...

"The policeman isn't there to create disorder, the policeman is there to preserve disorder."

- Richard J. Daley

keithpiccirillo said...

Nice quote Patrick, but as an ex-cop that particular paradox is only true part of the time. LOL.
TrimTabs CEO Biderman is perplexed and gives a few good reasons why it's possible.
What are possibilities divulging PPT information would create a consortium of hedge funds or foreign governments to play the other side? Most of the general public is not ready for daily news stories of yet more facets of government interference.
Thanks Mr. Hui.

Cam Hui, CFA said...

Keith -

What are possibilities divulging FX intervention information would create a consortium of hedge funds or foreign governments to play the other side?

keithpiccirillo said...

Yeah, I see your point, maybe I tried to say too much.
Foreign entities don't buy just bonds, and as Meb Faber pointed out, there are foreign listed hedge funds operating in the U.S that could become influential. Would not some be brazen enough to choose to "take on" disclosed government positions?
Men like Chanos have recently bet against China, and their are many who occasionally take contrarian trades. It doesn't seem to me that our pockets are deep enough to announce our intentions. LOL.