Fed Slows Printing Press….For Now

June 12, 2009 – 11:30 am

by Rolfe Winkler, CFA

Good news in money printing land.  The presses, for the moment, have slowed.  Despite the spike in Treasury rates (and consequently mortgages), the Fed has resisted the temptation to beef up asset purchases.  [Recall that the basic idea of quantitative easing is to print money to buy bonds in order to hold interest rates artificially low].

And Jon Hilsenrath reports in today’s WSJ that, for the moment, the Fed plans to Keep a Lid on Bond Buys

Federal Reserve officials are unlikely to significantly boost purchases of U.S. Treasurys and mortgage-backed securities when they meet in late June, but could make other adjustments in the face of rising bond yields and fresh signs of an improving economy.

Fed officials have become more confident recently that they have stabilized the economy and set the stage for recovery. But divisions are brewing within the Fed over whether it should do more to speed the healing, pause, or start pulling back to avoid an outbreak of inflation….

Interest rates on everything from business loans to home mortgages tend to move in tandem with Treasury rates [which have spiked in recent weeks]. If government-bond rates rise too much too fast, they could short-circuit a recovery by choking off consumer and business borrowing and spending.

Fed officials aren’t convinced that is happening yet, so they aren’t inclined to use their muscle to restrain bond yields any more than they have already set out to do. That could change if their views of markets and the economy change. Fed officials say much needs to be hashed out at the next meeting.

Last week we thought it was weird when NY Fed President Bill Dudley said rising interest rates were a sign of recovery.  We’ve long made the argument here on OA that any “recovery” would be short-circuited by higher rates, which would drive asset prices lower and decimate debtors’ balance sheets.

Whether he’s drinking the recovery kool-aid or just afraid of sparking inflation, Bernanke has slowed the Fed’s purchase of assets.  Take a look at its most recent balance sheet, published yesterday.

(Click chart to enlarge in new window)

Over the last two weeks, while purchases of Treasurys have continued ($16 billion this week, $9 billion last week), purchases of agency debt have been small ($4 billion total) and in MBS the Fed has been a seller (-$3.5 billion).

One reason asset purchases may have slowed is that the Fed doesn’t want to waste the $1.75 trillion worth of ammunition it has.  Besides $200 billion of Fan/Fred debt, they’ve committed to buying $1.25 trillion of MBS by the end of this year and $300 billion of Treasurys by August.  They’ve already bought $157 billion of Treasurys, according to WSJ, and $556 billion of mortgage securities.  There’s no reason the Fed needs to limit itself to $1.75 trillion, of course.  It can print as much cash as it wants.  But if central bankers spend too much too soon, they may have to increase their purchase commitments later.

Remember when Hank Paulson said his “bazooka” would save Fan and Fred?  Bondholders called his bluff and forced the government to take the two into conservatorship.

My point is that the bond market is bigger than the Fed.  If the Fed makes an open commitment to print money, inflation expectations may get out of hand quickly.  That’s unlikely to be sure.  Given the massive pile of debt under which we’re suffocating, deflation remains the biggest risk.  (As debtors default, “wealth” is destroyed hence “debt deflation.”)

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