Cold Water on QE3?

I am supposed to be working on a fifty-minute presentation on the global economy, but am struggling to wrap my mind around all the moving pieces at this time.  It would be easier if I had two or three hours.  So, in the meantime, I choose to procrastinate with a little Fed-watching.

It seems that market participants are looking for the Fed to ride to the rescue with another round of quantitative easing.  I doubt that conditions are dire enough to deliver that outcome at the next meeting, but could easily see a European-driven deterioration in financial markets driving such an outcome.  A lot could hinge on tomorrow’s ECB meeting – they really need to cut rates to at least sustain some expectation channel.  Consensus view, however, is no policy change. From the Wall Street Journal:

Although a rate cut this week can’t be ruled out entirely, the central bank is likely to hold off this time while potentially starting to prepare the ground for a rate cut at its next meeting in July or later.

Behind the curve, per usual.  I think no action is going to be a significant disappointment, so I am hoping to be surprised. Quite honestly, doing nothing is really almost impossible to imagine as it would represent complete and total failure on the part of the ECB.  Still, I don’t put it past them.

We have a couple of new comments in the wake of last week’s disappointing jobs report.  One from a credible policymaker, via the Wall Street Journal:

“I’d have to see a substantial change in my outlook” to be convinced the Fed should do more, Ms. Pianalto, 57 years old, said Friday, in the second of two exclusive interviews with The Wall Street Journal over consecutive days. “I don’t think this employment report, in and of itself, is likely to lead to a substantial change in my outlook. Consequently, it would not lead me, at this time, given what I know about my outlook, to change my position on policy.” It was her first interview with a national news outlet in her 10 years as a regional Fed chief.

Sounds like middle-ground contentment with current policy.  I don’t think Cleveland Federal Reserve Bank President Sandra Pianalto would say something that was not broadly consistent with the dominate view with in the Fed.  That said, there is some wiggle room here.  The current baseline is for Operation Twist to come to an end.  Arguably, not continuing the program could be seen as doing less, while continuing is just maintaining the status quo.  Indeed, extending Operation Twist is the path of least resistance for policymakers should they want to act.

Turning to less-credible policymakers, we also got comments from Dallas Federal Reserve President Richard Fisher.  Via Reuters:

Asked directly whether the May jobs report could prompt the central bank to embark on a third round of quantitative easing, or QE3, Fisher said the Fed must be careful not to overreact to economic data. “Short of an implosion, I cannot support further quantitative easing,” he said.

No surprise here, but I would say that Fisher’s confidence is waning.  He can’t support further easing, but doesn’t say it will not happen.  This is less certain than his comments earlier this year that QE3 is a “fantasy.”

More important guidance is still coming.  Pianalto’s message might be consistent with the last FOMC meeting, but we have frequently seen the regional presidents fall behind the thinking at the Board of Governors.  Tomorrow night we get some insight into the Board with a speech by Vice-Chair Janet Yellen, followed on Thursday with Senate testimony by the Chairman Ben Bernanke.  These are really the speeches to watch, and both will have to tread carefully. Considering the relative fragility of financial markets, they will not want to send mixed signals going into this next meeting.

Bottom Line:  Arguably, Pianalto and Fisher threw cold water on the idea of further action.  The former voice is credible, but could easily be behind the curve.  The latter voice is simply not credible.  More important signals should come latter this week.  If Yellen and/or Bernanke (I suspect they will coordinate) follow in Pianalto’s footsteps and downplays the jobs report, the expectation should be for steady policy later this month.  But if Yellen/Bernanke embrace the report, we should anticipate an extension of Operation Twist at a minimum.


I see St. Louis Federal Reserve President James Bullard also spoke today, and downplayed the employment report:

The recent nonfarm payrolls report was disappointing, but not enough to substantially alter the contours of the U.S. outlook.

He suggested seasonal distortions are at work – although, if they are at work, it means that the gains we saw earlier were outsized.  In other words, once again, expectations for high growth were excessive – which should suggest to Bullard that his earlier concerns that tightening would occur sooner than 2014 were misplaced.  He later makes this interesting comment after reviewing the path of Treasury yields:

One possible FOMC strategy is to simply pocket the lower yields and continue to wait-and-see on the U.S. economic outlook.

He doesn’t really appreciate the negative signal currently sent by global interest rates.  I don’t think the US needs lower rates at the moment, what it needs is policy that actually induces higher rates in response to an improving economic environment. I imagine that, since Bullard believes the economy is operating at potential output, he might think lower rates are helpful as they would be consistent with easing some resource constraint, but I interpret the lower rates as evidence of being well below potential output.

Moreover, Bullard continues to believe that monetary policy is easy:

Current policy is already very easy, as the policy rate remains near zero and the balance sheet remains large.

If policy was easy, market participants would expect the Fed to raise interest rates sooner, and thus longer term yields would rise.  If anything, the fall in rates implies that the Fed will need to keep interest rates low for a longer period.  Policy is not easy.

Bullard also dismisses financial market distress as an artifact of the European crisis:

The global problems are clearly being driven by continued turmoil in Europe.

China might be a bigger driver than we realize, but I digress.  Given that this is a European problem, the Fed is helpless:

 A change in U.S. monetary policy at this juncture will not alter the situation in Europe.

This is one of those things that makes you shake your head in the wonder of it all.  The point of further easing would not be to alter the situation in Europe – THE POINT IS TO PREVENT THE SITUATION IN EUROPE FROM WASHING UP ON US SHORES.  You know, offer a counterweight to softer demand  Moreover, if easier policy induces a weaker Dollar which then in turn prompts easier policy at the ECB (one can can dream), then the Fed is in fact altering the situation in Europe.  So US monetary policy might, just might, have an important role even if the proximate cause of the distress is in Europe.

Bottom Line:  Bullard downplayed the employment report and doesn’t sound like he wants additional easing.  Like the stance of his colleague Dallas Federal Reserve President Richard Fisher, not a surprise.  This kinds of comments keep me on edge that the pace of policy change will be slower than market participants believe.  But again, this is an issue of how far the regional bank presidents are behind the policy curve.  They could be close, they could be far.  We will get a better idea in the back half of this week.

This post originally appeared at Tim Duy’s Fed Watch and is posted with permission.