Grappling With The Federal Reserve Logic

In light of the current low interest rate environment,’ began Ben Bernanke, ‘we are watching particularly closely for instances of ‘reaching for yield’ and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals.

Take a moment, dear reader.

This may be as close to an admission of guilt as the chairman gives us.

It was part of a speech he delivered to the Conference on Bank Structure and Competition in Chicago.

The Associated Press reports Bernanke saying that: ‘Too big to fail is partly a credibility issue on the part of the government. Will the markets believe the government will go through with its commitment to wind down an institution?’

Umm…last we checked, excessive risk-taking comes before bank failures. Either way, Bernanke’s remarks have caused speculation that the Federal Reserve could start reversing its QEfinity policy soon.

We’re inclined to say ‘fat chance’, but let’s give them a fair shake…

Over the weekend, the Financial Times wrote:

The dollar climbed against the euro and the yen after the European Central Bank cut interest rates last week and Japanese investors became net buyers of foreign bonds for the first time since the Bank of Japan launched a drastic campaign of monetary easing…

The moves suggest that investors once again see the U.S. as a bright spot in the global economy, with traders betting a healthier jobs market and concerns about excessive risk-taking could lead the Fed to slow down its third quantitative easing program, under which it is buying $85 billion of assets every month.

‘With Japan stepping up and possibly the eurozone, it opens the door for the U.S. to taper QE,’ said Richard Gilhooly, strategist at TD Securities. ‘Even if this is six months away, we will see people get out of the U.S. Treasury market, and the next leg of the rotation is out of cash and bonds into equities’…

Mr. Bernanke stopped short of former Fed chairman Alan Greenspan’s famous 1996 warning of ‘irrational exuberance’ in the stock market, but it comes at a time when equities are hitting new highs before adjusting for inflation and high-yield bonds no longer carry high yields.

He said that risk-taking alone would not concern the Fed. It would only be dangerous if the risk-taking involved illiquid assets or it was backed by large amounts of short-term debt.

Heh. So ‘excessive risk-taking’ isn’t enough for the Federal Reserve to tap the brake, it has to be ‘dangerous excessive risk-taking’. We guess the distinction will buy them some time before they have to decide whether to tank the dollar or tank the economy.

For instance, when The Wall Street Journal pressed Dallas Fed Chairman Richard Fisher about stepping on the brake last Friday, he replied,‘I don’t want to go from wild turkey to cold turkey. I think we ought to dial it back.

‘Dial it back’ seems pretty tame to us, yet according to the Journal, ‘Mr. Fisher is part of a contingent of Fed hawks who are wary of the central bank’s easy-money policies.’

Alas, this is what counts as dissention at the Federal Reserve: calls to print a little instead of a lot.

And so the crack up boom continues.

Regards,

Addison Wiggin
for Markets and Money

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From the Archives…

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Watch Out For When Australia’s Terms of Trade Goes Back to ‘Normal’
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