New Fed Words

Pushing on a String

by John Mauldin
September 24, 2010

 

This week the Fed altered their end-of-meeting statement by just a few words, but those words have a lot of meaning. It seems they are paving the way to a new round of quantitative easing (QE2), if in their opinion the situation warrants it. A trillion dollars of new money could soon be injected into the system. …

 

Measures of inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.

The next (and only other real) change was:

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. (Mauldin’s emphasis) …

I agree with David Greenlaw from Morgan Stanley. He writes:

Growth data still take precedence. … To be sure, the inflation data do matter, but the growth indicators matter more .. from the Fed’s perspective …

The key driver for whether the Fed enters into another round of quantitative easing, likely to be in the trillions, is the growth in the US economy. If we are above 1.5-2%, I think they will hesitate, for reasons I go into below. If we drop below 1% and it looks like we are getting weaker, then they are likely to act. …

The Fed purchased $1.25 trillion in mortgage assets last year, (and) we could (still) look at total residential mortgages (down); credit card debt (down); and commercial mortgages (down). The list goes on. …

So, what happened to the trillion-plus dollars? It doesn’t look like it went into bank lending. … Banks put it back into the Fed.  … If banks are not lending now, with what seems like lots of reserves, then what is to make us think that another $2 trillion in QE will make them feel like they have too much money in their vaults? …

How much of an impact would $2 trillion in QE give us? Not much, according to former Fed governor Larry Meyer, who, according to Morgan Stanley … Moreover, a model such as Meyer’s is based on normal historical relationships and therefore assumes that the typical transmission mechanisms are working (and) the transmission mechanism is at least partially broken …

(Also,) if QE were attempted on that scale, it would not be good for the dollar. …