Getting Inside the Fed's Head
By now, you've read the myriad of reports on the Federal Reserve's FOMC meeting minutes released Wednesday. I've been resolute in my view that the Fed was going to extend its low-rate pledge into 2015, even as others backed off after a "strong" July jobs number. So I feel somewhat redeemed in that call by the relatively dovish FOMC minutes. But there is definitely more at play than just the minutes indicating additional support. Here are some quick hits on all the relevant issues:Don't expect a third round of quantitative easing in September, although I'm 50/50 that Fed chief Ben Bernanke may talk it up at Jackson Hole. I do expect the Fed to extend its short-term rate pledge in September with QE likely at some point later, maybe January. Both QE3 and the low rate pledge may take a very different form, such as holding those rates low indefinitely until certain economic statistics improve or inflation picks up. Similarly, I could see the Fed supplying billions of dollars of QE per month indefinitely until growth improves. I think both would have more impact than specified amounts or time frames. St. Louis Fed President James Bullard called the FOMC minutes dated, as some economic figures have improved since. I believe that he's alone in that view, and further, he was clearly not supportive of new monetary easing measures in the first place. I agree with Bullard's prior reasoning for objecting to QE3, but his claim that the new data indicate improved growth doesn't make sense. We added 99,000 extra jobs in July vs. June. That's 0.06% of the working population -- 0.06%. No one can tell me the Fed was all for a massive new monetary policy action before that jobs number but changed its mind. That implies that its model of the economy is accurate down to 0.06%. No way. Also worth noting: Bullard is not currently a voting member. Flying very much under the radar was a critical discussion during this meeting of "simple rules" for monetary policy. These likely included the Taylor Rule, which is a simple model of what the Fed's rate target should be given inflation and either unemployment or growth, depending on the version of the model. They may have also discussed some cutting-edge ideas that have been emerging out of academia, such as nominal GDP targeting, which Chicago Fed President Charles Evans has publically endorsed. The idea behind such rules is that it takes some of the discretion away from the Fed and encourages it to react to data in a consistent and predictable way. I'm very much a fan of "simple rules," which have the advantage of telegraphing to the market what the Fed is likely to do ahead of events. That should reduce volatility in monetary velocity and, therefore, make monetary policy more effective. Former Fed chief Alan Greenspan always quashed such ideas because he insisted he needed flexibility to react to events. But we saw from the mistakes he made in 2002-2004 that discretion isn't always a positive. Developments in this area will be important to watch. Finally, Republican presidential hopeful Mitt Romney said Thursday that he would replace Bernanke as chairman of the Federal Reserve Board if he wins in November. Bernanke's term ends in January 2014 and he has said that he doesn't want an additional term, so in one sense this is irrelevant. But the fact that the Fed's top spot has become a campaign issue is worrisome. It implies that Romney wants someone who thinks very differently from current members of the Federal Reserve Board. While I've had many issues with those on the board, I'd don't want to see the position become political. The last time that was the case, we got the mass inflation of the 1970s. I suspect a President Romney would nominate Glenn Hubbard, who is one of his economic advisors and, by most accounts, was runner-up when George W. Bush nominated Bernanke. And Hubbard is a perfectly reasonable economist who I suspect would have done most of the same things Bernanke would have done. But would he be overly influenced by the president? Concerning to say the least.
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