Chugging Ahead or Are We?
Posted by Doug Rice on Tue, Mar 16, 2010 @ 05:23 PM
The Federal Reserve Open Market Committee (FOMC) left interest rates unchanged and released a statement that updated their position on the economy just a bit. A comparison of this statement vs. the previous one in January can be found HERE.
Notable changes were changing the words "Deterioration in the labor market was abating" to "The labor market is stabilizing." While that's little consolation if you are out of a job, it's clearly a minor improvement.
Also, the addition of "business spending has risen significantly" is a positive sign as is the removal of the special liquidity they put in place during the crisis.
Could this be a return to normalcy? Are we going to just go chugging ahead?
Maybe.
But before we go to our cabin and take a nap feeling all is well, it should be noted that what they didn't change may be more telling.
They continue with language that "bank lending continues to contract" which means that banks are doing something other than lending with their money.
The one dissenting vote, from Thomas Hoenig, President of the Federal Reserve Bank of Kansas City, continued his stance that things have "improved enough that the expectation of low rates for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability."
What can you learn from this?
The economy is still in need of help because otherwise they would be moving interest rates up to more normal levels.
The rear view mirror shows some positive signs that we are headed on the right path, but the windshield is still foggy and there are still some icebergs out there.
So full steam ahead is very risky.
The reduction in the special liquidity is the first step in normalizing monetary policy and before they move interest rates, the Fed will have to see how the market reacts to the reduction this action.
The potential for another bubble is already forming. (or worse, one has already formed!) This is the concern of Fed President Hoenig.
Me too.
The banks are able to borrow money at basically zero percent. Anything they do with it is a positive return. They could lend this money to consumers or businesses, but consumers aren't interested in excessive borrowing and small businesses are risky. So banks take that interest free money and invest it in stocks and other assets that they can sell quickly should an iceberg appear. Also, they are still using leverage, perhaps high leverage, which exacerbates the problem and increases their desire to pull back quickly at any sign of real trouble.
That desire to pull back the sign of trouble wouldn't be there if asset prices were fairly valued. But the markets are priced at levels that anticipate a solid future expansion. If that's not what happens, all that money put into the markets will disappear, probably fairly quickly. The potential for a quick pull back combines with plenty of potential reasons to have a pull back to provide clear concern about the foggy future.
Icebergs...I hate icebergs.