Tuesday, October 09, 2007

Bernanke Shot First

The Fed minutes touched off a bear flattener, which tells me the market is decreasing the overall degree of easing and/or the time period the Fed will leave rates at the cycle low. This is emphasized by the 2-year, which sits at 4.14% after having fallen as low as 3.83% on 9/10. The current rate on the 2-year is only 60bps below the current target rate, suggesting that the total amount of Fed easing will probably only be another 75bps or so.

The minutes themselves had a little something for every one. There was upbeat news on the economy overall, but housing was viewed as a strong drag. I think the portions the market was focused on where statements like this:

With credit markets expected to largely recover over coming quarters, growth of real GDP was projected to firm in 2009 to a pace a bit above the rate of growth of its potential. Incoming data on consumer price inflation that were slightly to the low side of the previous forecast, in combination with the easing of pressures on resource utilization in the current forecast, led the staff to trim slightly its forecast for core PCE inflation. Headline PCE inflation, which was boosted by sizable increases in energy and food prices earlier in the year, was expected to slow in 2008 and 2009.

My take away is as follows:

  • The Fed isn't going to keep cutting just because we have a credit crunch. They seem to view that problem as short-term.
  • GDP growth is likely to be pretty slow in 2008, but accelerate in 2009. If that forecast remains in tact, the Fed isn't like to cut aggressively in 2008, less the 2009 bounce create inflation pressure.
  • It sounds like they think food and energy prices will moderate just based on mean reversion. I didn't see any stronger justification for this view. I think the Fed wants this to be the case, since higher food and energy prices are threatening to solidify consumer expectations for higher inflation rates in the future. So their statements on moderating food and energy prices may be more purposeful talk than analysis.
  • I think their view on housing continues to get worse. However, if you read between the lines here, I think there are people on the committee who don't want to cut rates so long as housing is an isolated area of economic weakness. I think the reasons for ignoring isolated weakness in housing is akin to reasons why they're ignoring isolated rising prices in food and energy.

My bearish view on intermediate term rates remains in tact. I still think the 10-year is rich at 4.65%. The 2-year is close to fair value if not slightly cheap.


Anonymous said...

It's all smoke and mirrors until he removes all of the 23A Tier Capital exemptions.

flow5 said...

fed funds/stop-out target

10/10 4.75
10/9 4.91 4.72
10/5 4.77
10/4 4.74 4.63
10/3 4.68 4.76
10/2 4.78
10/1 4.92
9/28 4.58
9/27 4.93 4.25
9/26 4.88 *
9/25 4.82 4.63
9/24 4.74 4.63
9/21 4.76 4.62
9/20 4.77 4.45
9/19 4.74 4.67
9/18 4.92 4.97 4.75
9/17 5.33 5.18 5.25
9/14 5.25 5.04
9/14 5.25 5.04
9/13 5.09 4.70
9/12 5.18 4.87 *
9/11 5.06 4.90
9/10 5.07 4.95
9/07 4.86 5.05
9/06 4.98 5.05
9/05 5.18 5.22
9/04 5.22 5.20
9/03 holiday
8/31 4.96 5.10
8/30 5.00 4.85
8/29 5.00 5.35 *
8/28 5.30
8/27 5.27 5.05
8/24 5.11
8/23 4.88 3.00
8/22 4.87
8/21 4.89
8/20 5.03 4.33
8/17 4.91
8/16 4.97 4.80
8/15 4.71*
8/14 4.54
8/13 4.81 5.11
8/10 4.68
8/09 5.41 5.15
8/08 5.27 5.18
8/07 5.26 5.17
8/06 5.26 5.17
8/03 5.24 5.17
8/02 5.24 5.14
8/01..5.30 5.13 *
7/31 5.28 5.14
7/30 5.29 5.17
7/27 5.25 5.19
7/26 5.28 5.16
7/25 5.32 5.14
7/24 5.25 5.15
7/23 5.26 5.15
7/20 5.25 5.14
7/19 5.25 5.12

The repurchase agreement rate (repo), or "stop-out" (lowest bid accepted for Treasury securities). This is the "true policy instrument".

The federal funds rate was below the target rate on 22 days before the Sept. 18th, 1/2 percentage point cut. Oct. 31st looks like a no-go.

Anonymous said...

@flow5 So whats your thinking about this $46bln maturing tomorrow in the Fed's TOMO?

thanks in advance

Anonymous said...

"I think their view on housing continues to get worse."

Does this mean

a) Housing in their view is getting worse.


b) Their view on housing (ie their grasp of the situation) is getting worse.


Anonymous said...

It is really impossible to read your post without thinking that their really was no reason to lower by 50 bp.


The stock market sure took off like a rocket afterwards...which might be another reason to believe the cut wasn't necessary.

Why? Simple. A 50 bp cut is a panic move in the face of panic conditions. Yet the stock market treats it like good news. Sheesh. It must not have been necessary.


I hope it was necessary. I really do.

flow5 said...

I don’t watch the volume of temporary open market operations, only their stop-out rates. Maybe if I was a primary securities dealer or a day trader I would pay more attention. The stop-out rate has been moving up, since roughly the 4th.

The NY Open market Desk sets the one-day repo rate on Treasuries, that is, the one-day cost-of-carry on government bonds. This is the true policy instrument -- and it affects huge amounts of money (essentially, the one-day return on all government securities), while fed funds transactions daily, in comparison, are a trivial amount. That is, the FOMC targets the federal funds rate (nominally the rate banks charge each other on overnight loans of deposits at the Fed), indirectly.

Today is Thursday (the beginning of the reserve maintenance period) & the “trading desk" (because of the 30 day lagged reserve requirements on bank liabilities) uses the data from this reserve computation period, to supply or absorb required reserves balances (hence the large 14 day open market purchases).

The focus on repurchase agreements (TOMO) ignores many factors that have had profound effects (sometimes even short-term) on the depository institutions capacity to create new money & credit. Some of these are variables are (1) currency held by the non-bank public (the principle drain on reserves), (2) bank capital accounts, the (3) Treasury's General Fund Account (quarterly tax collections), (4) float, (5) adjustments for reserve ratios, (5) 4% deficiency or excess carryover, (6) smoothing the 2 week maintenance period average level of reserves, etc.

flow5 said...
This comment has been removed by the author.
Anonymous said...

great post as usual

Accrued Interest said...

Anon @12:20: I think their grasp on the situation is coming around to a more negative view. I think they might have been a bit too sanguine on housing.

Anon @1:57: I think the only reason why their cut 50bps was to shock us. It wasn't necessary for pure macroeconomic reasons to cut 50. Now, I'd say there is a strong argument for cutting around 100bps in total. But I don't think a sudden 50bps would have happened without the liquidity crunch of August/September.