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Today's WSJ article, "Fed Gears Up for Stimulus", appears to be a Fed leak that discloses a QE2 program "worth a few hundred billion dollars over several months," far less than the Wall Street pundits were predicting as recently as yesterday.
Not surprisingly, the stock market was immediately disappointed, though it later recovered much of its losses on the day. The Treasury market took it on the chin—also not surprisingly—though it would appear that suspicions of a disappointing QE2 must have been at work for the past two weeks, since 10-yr yields bottomed Oct. 11th at 2.39% and ended today at 2.71%. Gold peaked at $1387 on Oct. 14th, and ended today at $1328. Most encouraging, I think, was the fact that the dollar bottomed Oct. 15th and closed today up 2.7% from that low. All in all, these moves were predictable, given a disappointing QE2 announcement. Despite the 30 bps rise in 10-yr yields in the past few weeks, stocks are roughly unchanged.
Maybe this was a trial balloon from the Fed. If so, the takeaway should be this: there is NO NEED for QE2 at all. Faced with the prospect that QE2 would be quite small and dribbled out over months, the stock market barely budged, while Treasuries and gold suffered a drubbing and the dollar rose nicely. This means the market viewed QE2 as only marginally—if at all—important to the economy, but very important to the dollar and Treasury bonds. Another injection of money from the Fed was unimportant insofar as the economy was concerned, but the prospect of fewer dollars being jammed into the system was a great relief for holders of dollars and it gave pause to those running to gold for protection.
I'm quite pleased with today's action, since to me it is a sign of a market that is operating rationally. The message from the market to the Fed should be clear: we don't need your stinkin' QE2—it would only muddy the waters.
Wednesday, October 27, 2010
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7 comments:
Mr. Grannis:
Since the Fed seems determined to bring inflation “back to trend” and simultaneously with a mandate of promoting full employment, well….inflation as a trade off for employment smells of The Phillips Curve.
As you suggest, the Fed still believes in the Phillips Curve. That's the main reason they have made mistake after mistake over the past 15 years.
Last fall The Federal Reserve of Richmond put out a special issue of Economic Quarterly regarding The Phillips Curve and in particular the New Phillips Curve promoted by new-Keynesians. The conclusions are not to rosy for The Phillips Curve (but we already know that). The content is as follows:
Introduction to the New Keynesian Phillips Curve by Andreas Hornstein
The Phillips Curve and U.S. Macroeconomic Policy: Snapshots, 1958-1996 by Robert G. King
The New Keynesian Phillips Curve: Lessons From Single-Equation Econometric Estimation by James M. Nason and Gregor W. Smith
DSGE Model-Based Estimation of the New Keynesian Phillips Curve by Frank Schorfheide
Policy Implications of the New Keynesian Phillips Curve by Stephanie Schmitt-Grohé and Martín Uribe
The link to the publication is:
http://www.richmondfed.org/press_room/press_releases/publications/2009/eq_fall2008.cfm?WT.si_n=Search&WT.si_x=3
I would say "quantitative easing" by the Fed will probably be light -- in other words, those hoping for a "shock and awe" campaign by the Federal Reserve are delusional. On the other hand, it does sound as if the Fed is moving toward monetary contraction either, so the status quo is likely to guide US monetary policy in the coming months.
Nevertheless, the problem of jobs is still ahead of us. For example, what is California going to do to deal with its unemployment problems? I maintain that the Main Street Depression is still consuming America, albeit while the largest firms in America begin to thrive. We need good ideas on how to work through what is increasingly looking like a tiered recovery in the US. How to rectify California's battered unemployed is perhaps the proper case study to consider. While a am totally against a Federal "bailout" of California, I fear that the populist backwash from California Democrats is only beginning to gain traction, and a status quo monetary policy by the Fed is unlikely to provide grounding for a California recovery anytime soon. How to fix California while sustaining status quo monetary policies is the question of the hour. The simple answer is for California to engage in across the board cuts in public spending, but who knows if that can happen. Thank you for the opportunity to comment and think aloud about where we are going as a nation...
Why is it when the equity market pulls back from rallies you call it expected, necessary, and that a rise in the face of fear is always bumpy yet when gold pulls back from its meteoric rise (in the face of fiat fear I might add), it takes a drubbing?
There is nothing in the way of drubbing in this chart of the GLD Trust.
http://www.google.com/finance?client=ig&q=GLD
The longer your vantage point, the more bullish it looks...
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