Even though market players know the monetary transmission channel from lower rates to household credit expansion is broken - and there are indications that the Fed now gets this too - markets were still left disappointed by the Federal Reserve''s timidity yesterday.
The Federal Reserve''s decision not to engage in aggressive stimulus and instead to extend Operation Twist has ignited a debate about the policy tools left at the Fed''s disposal amid fears that a fiscal cliff next year will add to the US economy''s woes.
Société Générale doesn''t see the Feds decision as in any way unexpected though they do call it timid. Effects on Treasury yields should be fairly minimal the Feds commitments are smaller than those seen with the launch of Operation Twist, and SocGen figures a lot of the yield reduction is already being priced in.
The FOMC delivered precisely what the market expected, no more, no less. Over the next 6 months, the Fed will sell or redeem $269bn of 0y-3y paper and reinvest the proceeds in the 6y-30y segment of the curve. This will entirely deplete the Feds holdings of short term paper, and by the end of the year the SOMA portfolio will have almost no securities maturing through January 2016. The overall amount implies a monthly run rate of $45bn, which is in-line with Operation Twist 1. ...
While helpful at the margin, todays action will provide a very modest amount of stimulus to the economy. By the Feds own estimates, OT1 compressed the yield on the 10year Treasury by about 20bps. Extrapolating from that and allowing for some diminishing returns, todays announcement is probably worth about 10bps, much of it already being priced in.
Echoing SocGens concerns of timidity, Monument Securities'' Stephen Lewis sees the decision as falling short of what the market was hoping for. He sees some solace in Ben Bernankes dovish tone in explaining the decision Bernanke hasnt yet closed the door to further monetary stimulus if it becomes more obviously necessary.
The committees decision to continue its maturity extension programme, previously due to expire this month, up to the end of the year fell short of meeting the markets best expectations for a resumption of Federal Reserve outright purchases of US Treasuries. The FOMCs indication that the Fed would no longer reinvest the proceeds from maturing Treasuries reinforced the markets view that the US central bank was doing less than it might to underpin economic demand. However, Mr Bernanke adopted a fairly dovish tone in explaining the FOMCs policy, making clear that the FOMC was monitoring the situation closely and could take further action if it were deemed necessary ... The Fed Chairman declared that the central bank was ready to cushion the US economy and financial system from the effects of an adverse turn in the European situation. He was at pains to assure his audience that the Fed was not in danger of exhausting its means of countering downward pressures on economic demand. At the same time, he drew attention to various costs and risks associated with non-standard measures. In view of these, he did not think such measures should be taken lightly. It sounded rather as if he were rationing the ammunition. As for the fiscal cliff, he said it was a bit early to worry about it, though he expected that the uncertainty associated with it might have some effects later. His strategy seems to be to face one challenge at a time. For now, Europes woes present a serious enough problem, without worrying about a fiscal cliff.
The extended accommodation policy action was likely insufficient to propel the economy beyond the fiscal cliff danger in 2013. Congress will still have to put an honest effort to resolve this problem. As Bernanke noted during the follow-up press conference, the effects of the impending fiscal cliff will likely be felt more strongly as we approach yearend, as businesses will have to make next year''s spending and hiring plans in a very uncertain environment. He continues to believe, as do we, that any fiscal resolution should avoid inflicting harm on the weak recovery but should ensure long-term fiscal sustainability.