Could it be argued that the president of the Federal Reserve Bank of St. Louis, James Bullard, and his Japanese-style outcome comments (which came out just one week after the Fed Chairman Ben Bernanke’s allusion to “unusual uncertainty”) have unduly influenced expectations ahead of today’s FOMC meeting?
Certainly, in its last minutes, the FOMC stated the “need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably.”
We must admit that a majority of the committee members either harbor doubts that this criterion has been met or that a further expansion of the Fed’s balance sheet would prove beneficial.
These views were, after all, expressed with full knowledge of the “deteriorating backdrop” being discussed in the financial markets. At the risk of oversimplification, perhaps the question is therefore whether last week’s poor string of figures — which included a second consecutive drop in durable goods, a nine-year low in pending home sales and another disappointing payroll figure — will persuade the likes of Dudley and Hoenig that the “bumpy recovery” is now such that it is at risk of being derailed?
Interestingly, the San Francisco Fed published yesterday its economic letter, 2010-24: Future Recession Risks, in which it warns that the economic outlook “is likely to deteriorate progressively starting sometime next summer in 2011.”
To me, it would be unthinkable that this has not been read by Ben Bernanke himself, the architect of a postcrisis monetary policy that can only be described as a “deflation-avoidance strategy.”
Given that there are certainly those on the FOMC who will argue that deflation risks have returned, then it is reasonable to suspect that they may well have the ear of the Fed chairman.
This being the case, then Bernanke may need all his powers of persuasion if the committee isn’t to be split right down the middle.
So, all that said, and as an investor, I think it could be helpful to look back a few days and see what various Fed members have said lately.
• Ben Bernanke, Fed Chairman:
July 21 (The Associated Press): “The Fed is prepared to take further policy actions as needed … we are not prepared to take any specific steps in the near term because the Fed is still evaluating the economy.”
To Congress: “The economic outlook remains unusually uncertain.”
Aug. 1 (Businessweek): “If the recovery seems to be faltering, we have to at least review our options.”
Aug. 2 (MarketWatch): “The U.S. has a considerable way to go to achieve a full recovery in our economy, and many Americans are still grappling with unemployment, foreclosure and lost jobs.”
• William Dudley, New York Fed President:
July 22 (Reuters): “Economic activity in the city and state has expanded at a relatively brisk pace since the beginning of the year … however the recovery is likely to be a bit bumpy … We think the risk of double dip is quite low. The reason for that is quite straightforward: policy is quite stimulative.”
• James Bullard, St. Louis Fed President:
July 30 (CNBC): “The U.S. is closer to a Japanese style outcome today than at any time in recent history … A better policy response to a negative shock is to expand the quantitative easing program through the purchases of Treasury securities … I think everyone on the committee is completely on board with the idea that, you know, if things got really bad, we would try to take other action … at every meeting you should be saying, OK, here's how the data came in, here's how the forecast changed, so we're going to adjust a little in this direction, here's how we're going to react to events.”
• Elizabeth Duke, Board of Governors:
July 13: Duke comments that there are no plans to implement any further policy steps at the moment.
• Thomas Hoenig, Kansas City Fed President & Vice Chair nominee:
July 14 (Reuters): “I have not seen any recoveries that are perfectly straight lined … When you look at the long-run trend lines, I think the most likely outcome is for continued growth, and that's what we should act on … We have to finish the deleveraging. We have to get the fiscal side straightened out to where people have greater certainty and implement these new laws. If we do that, I think the economy could meet those goals, but monetary policy by itself can't do that.”
• Eric Rosengren, Boston Fed President:
July 13 (The Wall Street Journal): “There are several policy options if we think the economy is weaker than we would like … The risk of deflation has gone up and is more of a risk than I would like to see at this point.”
July 21: (The Boston Globe): “We’re having positive growth but it’s not the kind of growth that is going to have much effect on employment.” He added “I don’t expect us to go into deflation … but the risks are higher than I would like to see them.” Asked about fiscal austerity measures, he said: “We need to get closer to full employment before we do that … The economy is still fragile, and we need to have a few more positive quarters of growth.”
• Kevin Warsh, Board of Governors
Aug. 8 (The Financial Times): “I would want to be convinced that the incremental macroeconomic benefits of further balance sheet expansion outweighed any costs owing to erosion of market functioning, perceptions of monetizing indebtedness, crowding-out of private buyers, or loss of central bank credibility.”
• Richard Fisher, Dallas Fed President:
July 29 (The Economist): “Reasonable people can argue that there’s a risk of deflation, but we haven’t seen it in the numbers yet.”
(Reuters): “Businesses are calling timeouts and heading to the sidelines while they wait for the referees to settle on the rules of the game … If this is so, no amount of further monetary policy accommodation can offset the retarding effect of heightened uncertainty over the fiscal and regulatory direction of the country.” He added that “one could posit that further monetary accommodation might make the situation worse if private sector operators were to conclude that the Federal Reserve has become politically pliable and is prone to substituting such accommodation for fiscal discipline.”
• Charles Plosser, Philadelphia Fed President:
July 29 (The Economist): “I think the fear of deflation in and of itself is probably overblown, from my perspective.” He notes that inflation expectations are “well anchored” and of the $1 trillion in bank reserves sitting at the Fed, he added “It’s hard to imagine with that much money sitting around; you would have a prolonged period of deflation.”
We’ll see what comes out this afternoon.
Elsewhere, at the end of last week, I promised to let you know when I think it’s time to short the euro again.
Well, I think that after Friday's advance in the euro, and with Monday’s decline, the odds are increasing that the top in the euro I have been expecting has formed.
The Daily Sentiment Index (DSI) has risen to 86 percent bulls, which is the highest reading of the year and indicative of excessive optimism. Now we are up from 1.1876 on June 7, which represents a 45 percent retracement, which is a perfectly "normal" retracement.
Nevertheless, I still must have patience and wait to see in the short-term charts the confirmation of the turn. Anyway, any decline below the 1.3156 level would offer, at least in my opinion, good evidence that a top in the euro has indeed formed.
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