MacroScope

More Fed QE: done deal or Pavlovian response?

“Will he or won’t he?” That’s what investors, traders and policy-watchers in the financial markets are pondering, frozen at their terminals waiting to find out if Federal Reserve Chairman Ben Bernanke will persuade his colleagues to print more money this week.

Among economists who work for primary bond dealers, the firms who sell government bonds directly to the Fed, there’s a striking conviction rate that he will, 68 percent, according to the latest Reuters Poll of probabilities.

The wider forecasting community isn’t far behind, at 65 percent.

While that kind of probability is more than enough to make people paid handsomely to take huge bets with other people’s money to confidently say something is a done deal, the real policy decision is probably a lot closer.

Indeed, just a few weeks ago, after Bernanke gave a speech at the Fed’s annual conference in Jackson Hole, Wyoming that failed to give a clear signal for the timing of more QE or indeed whether or not he would print more money, the broad consensus among economists and global asset managers was a mere 45 percent chance it would do so at the meeting this week.

That’s about as split down the middle as these unscientific debates through analyst polls can go.

U.S. bond bulls ready to charge after payrolls report, survey says

(Corrects to show CRT is not a primary dealer)

Bond bulls are ready to charge after Friday’s July U.S. employment data, according to a survey by Ian Lyngen, senior government bond strategist at primary dealer CRT Capital Group.

Says Lyngen:

Despite the vacation season and the multitude of ‘out of office’ responses we got, participation in this month’s survey was above-average and consistent with a market that’s engaged for the big policy/data events of the summer. As for the results of the survey, in a word: BULLISH.

Lyngen argued the survey results were the most bullish since November 2010, a point that was followed by a selloff that brought 10-year yields from 2.55 percent to 3.75 percent over the following four months.

Like over-hyped Olympian, Fed set to disappoint

Pity the Federal Reserve. Like an over-hyped Olympian, the U.S. central bank enters this week’s policy meeting with sky-high expectations and a high probability of disappointment.

Markets are salivating at the prospect of a decisive easing move when Fed policymakers emerge from their meeting on Wednesday. The S&P 500 is up 3.6 percent in the last four sessions as traders hold out hope the Fed will launch a third round of quantitative easing, or QE3, to blast the U.S. economy out of its funk. Stumbling job creation, manufacturing and spending, as well as a measly 1.5 percent GDP growth in the second quarter and serious spillover threats ahead from Europe’s debt crisis, all feed this thesis. Fed policymakers from Chairman Ben Bernanke on down the line to Cleveland Fed President Sandra Pianalto and James Bullard of St. Louis have also stoked the market with a more dovish tone the last little while. And yet, this is probably not the time for a big policy move.

Topping the list of reasons to disappoint – and to knock the market down to size – the Fed probably doesn’t want to front-run the July employment report that’s due on Friday, and which will give a fresh sense whether the spring-summer slump in the labor market is temporary or more permanent. Waiting until the Fed’s next scheduled meeting, Sept. 12-13, would give policymakers the added benefit of the August jobs report. And speaking of front-running, the U.S. central bank may not want to get out just ahead of the European Central Bank’s policy decision on Thursday. If, down the line, things get really ugly in Europe – or if the U.S. Congress sends the country off the so-called fiscal cliff – the Fed will probably want to have the QE3 bazooka ready in its arsenal.

Repo market big, but maybe not *that* big

Maybe the massive U.S. repo market isn’t as massive as we thought. That’s the conclusion of a study by researchers at the Federal Reserve Bank of New York that suggests transactions in the repurchase agreement (repo) market total about $5.48 trillion. The figure, though impressive, is a far cry from a previous and oft-cited $10 trillion estimate made in 2010 by two Yale professors, Gary Gorton and Andrew Metrick. The Fed researchers, acknowledging the “spotty data” that complicates such tasks, argue the previous $10-trillion estimate is based on repo activity in 2008 when the market was far larger, and is inflated by double-counting.

Repos are a key source of collateralized funding for dealers and others in financial markets, and represent a main pillar of the “shadow” banking system. The market was central to the downfalls of Lehman Brothers and Bear Stearns in the 2008 crisis, and now regulators from Fed Chairman Ben Bernanke on down are looking for a fix. Earlier this year, the New York Fed itself said it might restrict the types of collateral in so-called tri-party repos, after being dissatisfied with progress by an industry committee.

The study published by the New York Fed on Monday slices the complex market into five segments, mapping the flow of cash and securities among dealers, funds and other players. Because dealers represent about 90 percent of the tri-party market, the Fed study extrapolates that onto the broader repo market, to arrive at its estimates. Bottom lines: U.S. repo transactions total $3.04 trillion; U.S. reverse repo transactions total $2.45 trillion.

Fed’s Tarullo not making any promises

We’re pretty sure that Daniel Tarullo, the Federal Reserve’s point person on regulation, expects the United States will finally understand exactly what financial reforms are coming “some time next year.” But the Fed governor made doubly sure to qualify that statement lest anyone – especially any press “in the back” – take it as gospel.

At a conference in New York Wednesday morning, Tarullo was asked how long it would take for the various regulatory agencies to give final details on the raft of financial crisis-inspired reforms, everything from Basel III capital standards to the Volcker ban on proprietary trading. Here’s what he said:

“I know it’s frustrating for people not to have the proposed rules out. On the other hand, doing them simultaneously does allow us to see whether something in one of the proposed capital rules will affect something in another proposed capital rule, so that we end up, when we publish the final rules, with fewer anomalies, questions and the like, which will undermine the ability of a firm or academic or just anyone in the public to see and understand how these things are going to function. I hesitate to give a time line on exactly when we’ll get there. But I think…it seems to be reasonable to expect that some time next year the basic outlines – and I don’t just mean the ideas, I mean the details associated with the major reform elements – should be reasonably clear to people even though questions will inevitably rise in implementation. (You) don’t want to take that as a promise. But as I think about these various streams, that is my expectation… To have gotten it done this year would have meant the sheer magnitude of the task would have lead to a lot of inconsistencies or open questions, which then would have just produced another round of change. So you’ve got me on the record saying some time next year, but I tried to qualify it as much as possible – that’s for all you people in the back…”

from Mike Dolan:

Sparring with central banks

Just one look at the whoosh higher in global markets in January and you'd be forgiven smug faith in the hoary old market adage of "Don't fight the Fed" -- or to update the phrase less pithily for the modern, globalised marketplace: "Don't fight the world's central banks". (or "Don't Battle the Banks", maybe?)

In tandem with this month's Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that's a lot of additional central bank support behind the market rebound.  So is betting against this firepower a mug's game? Well, some investors caution against the chance that the Banks are firing duds.

According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What's more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.

Love, dissent and transparency at the Fed

All four Federal Reserve policymakers who dissented on U.S. central bank policy this year will lose their votes next year. That could make the New Year full of love, but not necessary free from dissent, Dallas Fed President Richard Fisher joked on Friday.

Fisher, like Minneapolis Fed President Narayana Kocherlakota and Philadelphia Fed President Charles Plosser, lobbied and lost against Fed easing earlier this year; all three dissented twice. Chicago Fed President Charles Evans dissented twice from the other side of the aisle, arguing for further easing at the most recent two meetings against the majority’s decision to stand pat.

None will have votes next year. Not, of course, because they voiced their opposition to the majority, but simply because votes rotate among regional Fed presidents according to a set schedule, and it just so happened that all four regional Fed presidents with votes this year used those votes to dissent.

from Christopher Whalen:

Are U.S. regulators worsening E.U. credit squeeze?

"Our purpose is to lean against the winds of deflation or inflation, whichever way they are blowing." -William McChesney Martin Jr., Chairman, Board of Governors of the Federal Reserve System

During his tenure as Chairman of the Fed from 1951 through 1970, William McChesney Martin Jr. saw the transition from America at war, with the government controlling much of the economy, to a peace time economy where wider financial ebbs and flows were possible.  His experience in confronting both inflation and deflation during his term is instructive today.

The carefully managed, low-interest rate policy which the Fed maintained during WWII ended under Martin’s predecessors, Mariner Eccles and Thomas McCabe.  These two Fed Chairmen defied President Harry Truman and raised interest rates to forestall inflation.  Even when the Chinese Red Army attacked American military forces in Korea, the Fed under Chairman McCabe stood its ground and eventually won its independence from the Treasury in 1951.

Bernanke testifies before Congress

Live video coverage of this event has concluded. A video report on Federal Reserve Chairman Ben Bernanke’s semi-annual Congressional testimony on monetary policy is below and here is our story on highlights of Bernanke’s testimony.

from Reuters Investigates:

Club Fed: the ties that bind at the Fed

USA-FED/BERNANKE We're getting a lot of good feedback on our special report on cozy ties between Wall Street and the Fed. As one Wall Street economist put it: "I've never seen the 'Fed Alumni Association' used more extensively for back-channel communications with the Street than has been the case since June."

The story pulls back the veil on the privileged access that Federal Reserve officials give to big investors, former Fed officials, money market advisers and hedge funds.

Another economist from a European bank thanked us for the report, saying: "I hate the idea that monetary policy is communicated through non-official channels, be it old friends or newsprint."