Pulling a rabbit out of a hat

Last night several more Fed boffins were on the hustings giving dovish speeches. The first is Dennis Lockhart. Here is the executive summary:

  • While acknowledging that downside risks to the recovery have increased, Lockhart expects a modest cyclical recovery to proceed. In his view, a number of necessary structural adjustments are holding back economic growth in this recovery. One of the major adjustments is deleveraging.
  • In Lockhart’s opinion, it is necessary that the process of deleveraging plays itself out, which may take several more years. While the private sector has made progress in lowering its debt burden over the past two and a half years, government debt has surged. So for the economy as a whole, debt relative to GDP has barely changed over the period.
  • Lockhart believes that policy must continue to help the economy achieve a healthy enough cyclical recovery, while at the same time recognizing the long-term need for directionally opposite structural adjustment, including deleveraging. The test policymakers must step up to is balancing short- and longer-term needs.
  • Lockhart is comfortable with the current stance of monetary policy. However, given the recent weak data and considering the rising concern about chronic slow growth or worse, he does not think any policy option can be ruled out at the moment. But in his view it is important that monetary policy not be seen as a panacea. Structural adjustments take time, and Lockhart is acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.

According to Zero Hedge, during the Q&A Lockhart also said that:

“slow growth is now a bigger problem than inflation”

Another dovish Fed governor, Charles Evans, was also quoted extensively in an interview with the WSJ. Also from Zero Hedge:

Mr. Evans, who stirred markets with similar comments earlier in the day on CNBC, said he felt the Fed needed to make an even stronger commitment to keep interest rates low. He worries the public has tended to be too quick to assume the Fed will raise interest rates whenever the economy perks up a little and says that view is undermining the recovery.

“I would want to nail down expectations about accommodation,” he said. “By itself that would be very helpful.”

Mr. Evans doesn’t think the Fed should raise interest rates until the unemployment rate gets to 7% or 7.5%, or unless inflation threatens to move up to 3% in the medium-run. The Fed has a 2% long- run goal for inflation, but just as it undershot that by roughly a percentage point during the recession, he thinks it is OK to temporarily overshoot it, too.

…Running a little bit above 2% is far from a catastrophe,” he said, adding that the 2% goal is what inflation should average over time and it shouldn’t be seen as an absolute ceiling.

Without stronger commitments to keep money easy or other efforts by the Fed to boost growth, there is a “tangible risk” the economy won’t be any stronger two years from now than it is today, “and I think that would be a huge problem,” he said.

I’m not sure what these various Fed speeches achieve. These two obviously appear to be a softening up of expectations for QE3. But as I’ve observed countless times, all that does is price in QE3, making QE3 less likely. Maybe the Fed governors should keep quiet, let the business cycle unfold and the market tank, then stimulate.

That, however, is not the point of today’s post. Rather, the Fed’s Lockhart has me wondering if the Fed can pull another rabbit out of the hat. The Fed actually has a very strong history of doing so in this crisis. If I recall the dark days of 2008 and 2009, the Fed’s preparedness to innovate was extraordinary and exemplary. Although I most certainly agree that the Fed under Greenspan did just about more than anyone else to precipitate the crisis, under Bernanke it was swift and bold and played a significant role in averting a banking calamity.

During the crisis, the Fed guaranteed loans for Bear Stearns and adopted a swath of its crappy assets into a special purpose vehicle. From The Great Crash of 2008, the Fed then:

Before the month was out, American Insurance Group (AIG) and Citigroup were both saved using a similar combination of gigantic Federal Reserve loans, off-balance-sheet vehicles, fiscal guarantees and insurance wraps. Again, regulators probably had little choice. The companies at risk were so vast and interconnected, and the markets so gripped by panic, that their failures would have caused a meltdown of global proportions.

Any pretence of a division between shadow and deposit-taking banks was dropped when the remaining investment banks, Morgan Stanley and Goldman Sachs, were permitted to transform themselves into bank holding companies. This designation had formerly been reserved for deposit-taking institutions. The melange was baked by December, when the pure shadow bank financing arm of General Motors, GMAC, was permitted to become a bank holding company.

The Federal Reserve now extended its lending facilities in the form of non-recourse loans to the money- market funds, so that they could resume purchases of short-term corporate debt. It also purchased short- term corporate debt directly through a Special Purpose Vehicle. The Federal Reserve was now the lender and buyer of last resort for the shadow banking conveyor belt…

Of course, since, it has also embarked on QEs 1 and 2.

Given this record, it will perhaps be a surprise if the Fed actually doesn’t produce some new and exciting innovation in monetary policy management. Having given markets a sense that a surprise is in the offing by extending the September meeting to two days, they had better not disappoint.

Houses and Holes
Latest posts by Houses and Holes (see all)


  1. Every time a rabbit is produced we are one rabbit closer to the time when there are no more rabbits left.

    • Yeah..and with respect,Sherlock..and it doesn’t really compare to ’93…back then American illusionists were pulling Supermodels out of their hats..these days seems ..no Schiffer’s ,Just rabbits..
      cheers JR

  2. I don’t know why they need QE3. I read Adam Carr this morning, and the global economy is booming again.

    91,000 jobs were created in America during August, and again after US factory orders rebounded 2.4 per cent in July (+13.4 per cent year-on-year with shipments up 1.6 per cent month-on-month and 11.8 per cent year-on-year – strong data).

    German unemployment fell 8,000 in August, while the unemployment rate was steady at 7 per cent. Retail sales were unchanged in July after a 4.5 per cent gain the month prior.

    And on Australia…

    today’s [retail] survey has been understating retail spending for well over a year

    In the March quarter, investment was pretty good across the board with mining investment up 21 per cent year-on-year, as you’d expect, but I guess the real surprise has been the strength in non-mining investment, especially the ‘other’ component (reflecting investment in transport, rental and real estate services, construction, wholesale and other services), which is up 4.7 per cent over the year but has risen on average by 4.7 per cent per quarter over the last three quarters (which annualises to almost 20 per cent).

    So its all good. Hardly any bad data around. Nothing to support the ‘recession hysterics’ anyway.

    Anyone care to comment?

    • Hi Lorax,
      Maybe you need to become more selective as to what you read 😉 Or at least how much weight you give it!

      • My tongue is firmly planted in my cheek, mind you, Capex and retail sales were better than expected apparently, which has put a rocket under the ASX and AUD.

        The boom is back baby, the boom is back.