While the Federal Reserve is going full steam ahead with its money printing, a rule that applies to all central banks says it should be doing the exact opposite. Apparently the Fed plans to keep its collective head buried deep in the sand until everything blows up.
- The Chart the Federal Reserve Doesn't Want You to See
- Why’s There So Much Dissension Inside the Fed?
- FOMC Meeting: What the Fed Policy Changes Mean For You
- Today's FOMC Meeting Ends with Major Change
- This Week's FOMC Meeting: Why to Expect More Stimulus
- FOMC Meeting Minutes: Will We Ever See QE3?
- Today's FOMC Meeting: Fed Votes Operation Twist to Continue
- Today's FOMC Meeting: Here's What the Fed Could Do
- What's Different About this Week's FOMC Meeting
There's considerable dissension within the ranks at the Federal Reserve, with many of Chairman Ben Bernanke's colleagues saying the Fed's monthly purchase of $85 billion in bonds should end by late this year.
"About half" of 19 Fed members "indicated that it likely would be appropriate to end asset purchases later this year," according to minutes of the June Fed policy-making committee meeting, released Wednesday.
Ending QE3 could have enormous implications for the stock market - whose four-plus-year bull market has been buoyed by the central bank's stimulus - and for the economy as a whole.
But while there's growing sentiment inside the Fed to end QE, a majority of the 12 voting members of the policy-making Federal Open Market Committee hope to extend the bond-buying into next year.
Still, the Fed's June 18-19 meeting could prove to be a turning point, given the amount of discord at the meeting.
The minutes add some context to Bernanke's comments at a press conference immediately after the meeting in which he said the Fed could begin scaling back QE3 this year and end it altogether by mid-2014.
The markets dipped immediately after Bernanke's comments but then recovered some.
"They're Making It Up As They Go Along"
"To me, the real news is that you've got dissension inside the Fed now," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "My initial read is there's a lot more dissension than usual.
"And," Fitz-Gerald said, showing his longtime disdain for the Fed, "the level of dissension reinforces the notion that they don't know what they're doing and they're making it up as they go along."
Money Morning Capital Wave Strategist Shah Gilani, meanwhile, said the June FOMC showed legitimate concerns among members.
First, the central bank said it would increase the amount of quantitative easing by replacing Operation Twist, which ends Dec. 31, with outright purchases of long-dated Treasury bonds.
Under Operation Twist, every month the Fed sold $45 billion in short-term Treasury bonds and notes and bought $45 billion of long-term Treasury bonds in an effort to keep long-term interest rates low.
Because the Fed funded its purchase of long-term bonds with the sale of short-term bonds and notes, no new money was created.
However, outright purchases of long-term bonds will create new money-$45 billion every month-and, by concentrating its buying at the long end of the yield curve, the Fed should be able to keep long-term interest rates low.
The Fed also said it will continue to purchase $40 billion of mortgage-backed securities each month, creating a total of $85 billion in new money from these operations monthly.
That means QE4 is here.
Starting in January, the Fed will be more than doubling the amount of money it is pumping into the economy. Happy New Year!
Second, the Fed set unemployment and inflation "thresholds," instead of setting a date for when the central bank expects to be able to raise interest rates. What this means is that the Fed will not raise interest rates unless unemployment is 6.5% or less or inflation is more than 2.5%.
By setting thresholds where monetary policy might change, the Fed is attempting to improve its communications with the public.
And in an additional unprecedented move from the central bank, interest rate decisions will now be tied to the unemployment rate and inflation.
About a half hour into the release, the Dow Jones Industrial Average staged a near 65-point rally - but then lost that gain and ended down nearly 3 points at 13,245.45.
Here's a breakdown of the FOMC meeting outcome.
Today's FOMC Meeting: QE4As expected, the FOMC meeting ended with a replacement for Operation Twist, the expiring program introduced in 2011 of swapping short-term Treasuries for longer dated ones. The goal of Operation Twist was to lower long-term interest rates to stimulate the U.S. economy.
The new asset purchase program is an extended arm of the Fed's familiar quantitative easing programs, and has thus been dubbed QE4.
Now with QE3 and QE4 together, the Fed will purchase a whopping $85 billion a month of Treasury securities, stacking the Fed's portfolio with government-backed investments for an extended period.
The buying spree will remain intact until the unemployment rate falls below 6.5% and inflation projections remain no more than half a percentage point above 2% for two years out.
The Fed also left interest rates at rock-bottom historic lows near zero, as was also expected.
While these moves were widely expected, what wasn't expected was the Fed's forward-looking guidance.
As central bankers gathered Tuesday for the last policy meeting of the year, expectations were high that Fed Chief Ben Bernanke and his cohorts will announce a large scale asset purchase plan to replace the soon-to-end Operation Twist, introduced in September 2011.
The Fed hopes additional stimulus will finally boost growth and the employment level. With the current unemployment level at an elevated 7.7% -- a number that economists say will be revised higher in the coming weeks - the weak labor market remains a grave concern.
At recent meetings, the Fed indicated that it will continue QE3, the policy of buying $45 billion in mortgage-backed securities each month until it sees a significant and sustained improvement in the employment scene - which is unlikely to come anytime soon.
Together with Operation Twist, the two programs added some $85 billion in long-term bonds to the Fed's balance sheet each month.
The aim, the Fed said in a statement, "should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
The central bank has also stressed it would employ its other policy tools "if the labor market does not improve substantially."
While the Fed did not elaborate on what those tools are, it maintains it still has plenty of ammo left and stands ready to pull the trigger when and if necessary.
It looks like now is the time.
But no such clues were shared.
Last month the Federal Reserve decided to extend Operation Twist, a bond maturity extension program. But many investors wanted a third round of asset buying, or QE3, instead of more twisting.
Immediately following details of the June FOMC meeting, the Dow Jones Industrial Average, which had been choppy all day, was little changed. Then came the negative reaction and all three major indexes ticked lower, and the VIX, the "fear index," edged higher. The Dow fell as much as 90.14 points, or 0.7%, to 12,562.98 in afternoon trading.
Though QE3 is not completely out of the question, things need to deteriorate further for the Fed to even consider more bond purchasing as a means of stoking the economy, according to the FOMC meeting minutes.
Just four Fed officials referred to more quantitative easing in their individual forecasts, with two in favor and two considering another round.
Had that FOMC meeting been held today, maybe more officials would have supported a heavier stimulus measure. Since that meeting, fresh data have shown manufacturing is weak and unemployment levels are still elevated - and look to move higher.
In addition, economists have drastically reduced second-quarter growth estimates amid the weaker-than-expected numbers.
This has left scores scratching their heads asking how much worse things need to get before the Fed makes a move.
The minutes also show that several Fed officials want to create "new tools" to ease financial conditions. With little left in their cache to give the economy a much needed boost, "new tools" are warranted, but scarce at best.
The Fed announced it will extend Operation Twist, which was set to expire at month's end, until the end of 2012, in an effort to keep interest rates low.
The Fed will expand Operation Twist, which replaces short-term bonds with longer-term debt, by $267 billion.
In a statement, the FOMC said the prolongation of Operation Twist "should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative."
The Fed pointed to the U.S. economy's poor recovery as reason for more "twist."
"Growth in employment has slowed in recent months and the unemployment rate remains elevated," the Fed reported. "Household spending appears to be rising at a slower pace than earlier in the year."
The lack of more intense stimulus, namely a third round of quantitative easing, sent the Dow Jones, which had been flat all day, plummeting some 50 points in just seconds. All three major indexes treaded lower following the report. Gold, hoping for QE3, sold off some $25 an ounce.
The yield on the 10-year Treasury note rose to 1.67% just after 1 p.m. in New York from 1.62% late yesterday.
After more than three years of trying to rouse the economy, hiring remains weak, unemployment is still elevated, and economic growth has ebbed.
As the Fed concludes its two-day policy meeting today, it needs to act sooner rather than later - and may be ready to do so.
"I think Fed officials will send a pretty decisive signal that they are prepared to provide more support to boost economic growth and lower unemployment," Brian Bethune, economics professor at Gordon College in Massachusetts, told the Associated Press.
Here is a trio of scenarios Team Bernanke could present.
What Could Happen at Today's FOMC Meeting
#1: The Fed Continues Operation Twist
There's a good chance the Fed will decide to continue its previous monetary stimulus method, "Operation Twist."
Under this strategy, the Fed traded $400 billion in short-term bonds for those with longer maturities. The goal of the twist is to drive down long-term interest rates.
This creates an environment that makes it cheaper for businesses to obtain loans and for consumers to get a hold of mortgages and other forms of credit.
Goldman Sachs Group Inc.'s (NYSE: GS) chief economist Jan Hatzius said in an e-mail to clients he expects the Fed to start a new asset purchase program.
"A decision not to ease is tantamount to a tightening. At this point we'd be quite surprised if we saw no easing," said Hatzius.