PREPPING FOR THE FED – IS AN EXIT STRATEGY COMING?
Earlier this month the ECB laid out the framework for their exit strategy from the extraordinary supportive measures they implemented over the course the last year. The Fed, however, has maintained that they will continue to support the markets for an extended period of time. I.e., they will continue to print money so as to avoid disrupting this so called “recovery” in markets. Will the Fed follow the ECB’s lead or will they continue to emphasize their continued support of financial markets? They will do both. We’ve seen a rather covert move away from the drastic measures implemented over the last year. The Fed is beginning to slowly unwind many of the credit facilities they made available last year. In addition, they have even hinted at backing away from quantitative easing a bit. Phil Flynn at PFGBEST elaborates:
At the last meeting the Fed was very clever. They tried to start backing away from quantitative easing without really doing so. The Fed said that they would continue with their plan to purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year and $300 billion of Treasury securities. Yet the Committee said that they had decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. Those purchases of course are made with freshly printed money. At this point the Fed has completed 94% of the purchases.
The Fed is now walking a tightrope. I believe Ben and Co. know the underlying economy is still very weak. If they were as confident about the economic recovery as they appear to be in their statements and their public appearances they would almost certainly be talking about or implementing their exit strategy. But Ben has a new problem on his hands – the dollar. The dollar has fallen 3% in just the last month. Bernanke knows the global economy can’t afford to go thru another massive commodity spike or a potential dollar collapse.
Will they begin to implement an exit strategy? Slowly, but surely. For now it is doubtful they will do anything drastic to disrupt the market. The Fed has shown no desire to support the dollar and the rising market and improving sentiment is exactly what the Fed wants to see right now. I doubt they will do anything to disrupt this.
Sept. 22 (Bloomberg) — “The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.”
http://www.bloomberg.com/apps/news?pid=20601087&sid=ax.FBWNLB5_o
Is this designed to prepare the market for substance of Fed announcement today? Any hint at withdrawing/exit will drive the dollar up. Seems to me this might be desirable on the part of the Obama admin. and the Fed as the weekend G-20 nears, in order to calm fears of a declining dollar. Also, pressure is building for the Obama admin. regarding deficits and for the Fed regarding its balance sheet. This pressure may be having consequences, and thus the need to demonstrated some resolve, at least to be expected in the future, to begin outlining what an exit strategy might look like.
On the other hand, no comment from the Fed in this regard today might further embolden dollar bears and send the stock market up.
Don,
I can’t imagine that they will disrupt the current sentiment. Any hint at a raise will certainly begin to crush market sentiment. The dollar will shoot up, commodities will crash and the still fragile market will roll over.
I just can’t imagine Bernanke is going to be proactive enough to do that….
so trash dollar, long equities trade should continue ?
i read somewhere else about FED doing repos in order to withdraw a liqudity:
From Art Cashin 9/23
It’s Great To Have Sharp-Eyed Friends – This morning, somewhat serendipitously, input from two friends seemed to complement each other to clear up a picture.
In this morning’s Marta on the Markets, the always savvy TJ Marta pondered some conversations he had learned of between the Fed’s trading desk and its primary dealer list. The topic was potential “reverse repos”, a strategy that would be used to drain money from the system. Noting the lingering fragility of the economy, TJ wondered why the Fed desk was exploring the climate for reverse repos, especially going into an FOMC meeting.
Then I picked up this morning’s edition of the always insightful and entertaining Gartman Letter. Here’s part of what my good friend, Dennis, wrote about today.
Which then brings us to a rather complicated open market operation that may catch everyone off guard in the next several days, perhaps suggesting to some that the Fed is beginning to tighten. Treasury is about to have a rather huge sum of “supplementary bills” maturing… $185 billion to be exact… and when they mature the money will find its way into the banking system. The Fed shall have no choice but to drain those reserves and when they do some will “see” this incorrectly as evidence of shifting policies. It will not be. This will merely be a technical operation, but the Fed has not been in draining reserves in a very long while, and the shout of “matched sales” resounding across the dealing desks of Wall Street will be mistaken. The dollar will spike on that news, but it will be short term in nature and solely technical. Do not be caught off guard. Forewarned is forearmed.
The two observations suddenly fit together perfectly.
If the Treasury pay-down floods the banking system with a sudden $150 billion surplus, the results could be dramatic. Naturally, the Fed would want to explore the “reverse repo” landscape to avoid or at least mute, any disruptive impact.
It’s great to have good friends. It’s even better when they are very, very smart.
Teomax,
Great comment. I love that long dollar trade, but I’ve been wrong about it for the last 3%….
TPC:
Agreed on the Fed not hinting at raising interest rates. Maybe around the middle of next year, at the very earliest. No, I was thinking more along the lines of slowing down the pace of GSE/MBS purchases, to ease their balance sheet. Or the rev. repo.
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