Kicking the Can Down the Road For Nearly a Decade
The Federal Reserve has been very clever in focusing market participants on potential month to month Fed policy changes by citing oblique and constantly changing economic targets in their meeting minutes and in speeches by Fed officials in between meetings. This modus operandi has created the impression that the Federal Reserve is and has been conducting prudent monetary policy with objectives in mind and has obfuscated the reckless policies they have conducted over the past eight years.
Summary of Fed Monetary Policy 2008 – 2016
In November 2008, during the height of the financial crisis, the Federal Reserve began an “emergency measure” whereby they would purchase about $600 billion in mortgage backed securities and short and long term U.S. Treasury bonds. The dollars for the Fed to make the purchases were obtained by the Fed simply “printing” the necessary dollars. This program was called quantitative easing (QE) and its purpose was to provide liquidity to the markets and depress interest rates, that would stimulate the economy – or at least the stock and real estate markets.
In 2009, Federal Reserve Chairman Ben Bernanke told Scott Pelley in a “Sixty Minutes” interview that when the economy began to recover, the Fed could raise interest rates, unwind its Quantitative Easing program and reduce the money supply. The Fed and the U.S Treasury claimed that the U.S. economy had begun to recover during “Recovery Summer” in 2010, yet there was no raising of interest rates or reduction in the money supply. There was a temporary halt in QE in the summer of 2010.
In November 2010, a second round of QE was launched. Gold and silver soared during the periods of QEs one and two largely due to the perception that the Fed’s money printing policies would cause hyperinflation and ultimately destroy the dollar.
In September 2011, the Federal Reserve announced “Operation Twist” whereby they would exchange about $400 billion short term U.S. Treasuries that they had accumulated into U.S. Treasuries with longer term maturities.
In September 2012, QE III was launched, initialy consisting of $40 billion a month in purchases of mortgage backed securities and U.S. Treasury Bonds, then increased to $85 billion a month by December 2012. In the summer of 2013 talk of “tapering” QE began. Federal Reserve President Ben Bernanke indicated that monthly purchases would be cut provided that inflation headed towards the Fed’s target and unemployment reached 6.5%. (the Fed’s unemployment target fell below 6.5% in early 2014, without any rate hikes and now stands at 4.9%) He also mentioned that if these conditions were met, the Fed would most likely begin to raise interest rates.
“Taper talk” dominated Fed observers’ attention during the rest of 2013 as it appeared the Fed might become more “hawkish” and reduce it monthly purchases. The Fed talked for months about doing so and finally started to wind down the program in February 2014. As the Fed wound down QE III, they talked about raising interest rates. The tapering of QE III lasted through out 2014 and it finally ended on October 29, 2014. Two days later, The Bank of Japan announced a continuation of their own QE with another massive dose of stimulus (over $500 billion a year). Japan’s move made the Fed’s end of QE appear to be a fiscally prudent move in comparison.
The Fed spent all of 2015 talking about rate hikes, when they might come, how many there might be, all the while insisting that a rate hike was possible at the “next meeting’ that year. The Fed’s decision whether to raise rates, the markets were told, would be “data dependent”, a term the Fed never clearly defined. The Fed did not raise rates in 2015 until their last meeting in December. At that meeting the Fed raised interest rates 0.25%.
In early 2015, the European Central Bank (ECB) announced and began their own QE program that would consist of buying €60 billion worth of bonds a month. Interest rates in the Euro zone and Japan were also brought into negative territory during the past couple of years.
Following the Fed’s rate hike in December 2015 (its first in nearly a decade), the Fed led markets to believe that four more rate hikes would follow in 2016. In January 2016, the U.S. equity markets tumbled and had the worse January on record. The Dow fell over 2,000 points from December 29, 2015 to February 11, 2016.
In March 2016, after its open market committee meeting, the Fed changed their out look to two rate hikes in 2016 instead of four. The markets interpreted this announcement as dovish and a sign that the Fed was willing to conduct a more accommodative monetary policy. The Dollar Index immediately fell. The dollar had been rising the past two years on the taper talk, the ending of QE, and the talk of rate hikes. A cut back in the number of rate hikes caused the dollar to fall.
A week or so later after the Fed’s March 2016 meeting, no less than six Fed Presidents, sensing that the markets had interpreted the Fed annoucement as too “dovish”, hinted that a rate hike might be coming as soon as their next meeting in April.
Fed Conditioning of the Markets
Had the Fed outlined in 2008 that over the course of the next eight years they would print over $4.5 trillion dollars to buy mortgage backed securities and U.S. Treasuries and keep interest rates at zero, the dollar would have collapsed. Instead, by March 2016, the U.S. Dollar Index was higher than it was when the Fed began its series of multi trillion dollar QE programs in 2008. The U.S. Dollar Index was about 80 in January 2009 and in March 2016 it traded around 96.
It’s About the Dollar and Managing Perceptions
The Fed managed to print $4.5 trillion out of thin air, lower interest rates to zero and maintain and increase the dollar’s value vs. other major currencies. The Fed achieved this by keeping market expectations and focus on the short term. By focusing markets on the month to month decisions on whether they would “taper” QE, end QE or raise interest rates” the Fed was able to extend QE and its zero interest rate policy for years while actually strengthening the dollar and demand for U.S. Treasuries. The Fed and the dollar were also aided by subsequent Bank of Japan and European Central bank stimulus programs.
Having preserved and increased the value of the dollar the past few years by their “tightening” actions, especially in comparison to the looser monetary policies of Japan and the ECB, the Fed has room and credibility to return to another round of QE and or to lower interest rates back to zero should they decide such policies to be “necessary”.
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This article does not necessarily reflect the explicit views of BGASC, nor should it be construed as financial advice.