Will They? Won't They? - Reading the FOMC Tea Leaves
Wednesday, April 25, 2012
Since the collapse of the mortgage bubble in 2008, the Fed has gone a long way into uncharted territory. The Federal Reserve's balance sheet has swelled from under $1 trillion to over $3 trillion as "normal" monetary measures such as reducing the Fed Funds rate and Discount rate were insufficient to keep the U.S. economy aloft. Like Japan, the U.S. has taken the unorthodox step of purchasing U.S. government securities in enormous quantities to push interest rates across the yield curve lower.
Today the Fed concludes its latest monetary policy meeting and the market awaits any indication that the Fed will continue on its monetary inflation push. Economic data globally has been weak, driven by falling real estate prices in China, and austerity measures across Europe. Given the clear and present danger to the U.S. economic recovery, highlighted by the dramatic 4.2% drop in March durable goods orders, a move by the Fed would appear to have justification save two uncomfortable facts - high oil prices, and equity market strength.
The last time the Fed embarked on quantitative easing in November of 2010, WTI crude oil was priced in the mid-$70s per barrel. Today, WTI crude futures are over $100, currently at just under $105 per barrel. With the average price of gasoline in the U.S. just under $4.00 per gallon, any indication by the Fed that it is to ease policy would likely cause gas prices to surge, undermining its oft-stated claim that inflation was contained, and offsetting any benefit from lower rates.
Equity markets leading up to QE2 were nearly 15% below current levels. The equity market is hardly suggesting any dire economic downturns, and the equity markets are traditionally considered a forward economic indicator.
Precious metals would generally benefit from more monetary policy easing on rising inflation expectations. The Fed is currently terrified of the prospect of deflation since the overall level of indebtedness among local, state, and federal governments, as well as individuals who have been deleveraging since 2008 would become an intractable problem in a deflationary environment. Falling income and earnings would make rising debt levels more difficult to service. The solution is to assure an inflationary environment.
As a final note, readers should remember that Fed Chairman Ben Bernanke is a "man of action." Even a mild downturn in the U.S. economy would be hard to reverse, and this could shape his thinking towards being proactive sooner. The obvious question however is with the benchmark 10-year yield already at a near historical low of 2%, what exactly will more monetary easing accomplish. Regardless, all eyes will remain fixated on today's Fed announcement and policy statement.
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