Fed trapped in its current policy mix

With employment weak and consumer credit weaker, look for extended official measures to support the US economy. Recent data show despite emerging glimmers in manufacturing, de-stocking having reached its limit, and some strong showings globally, the US recovery is far from self-sustaining.

With Congress serving as an effective roadblock to a comprehensively expanding fiscal stimulus, the heavy lifting, if any is to be done, may fall on monetary policy and "off balance sheet" forms of stimulus.

The Christmas Eve move to suspend any cap, previously $400 billion (Dh1,462bn), on the bailouts of Fannie Mae and Freddie Mac is an example of the latter, while more mortgage buying and virtually zero interest rates from the Federal Reserve are probably in store.

"Markets are still thinking of monetary policy strictly as changes in interest rates – even though the Fed has been conducting successful policy this past year through quantitative easing," said St Louis Fed President James Bullard in Shanghai. "Markets should be focusing on quantitative monetary policy rather than interest-rate policy."

The big question is "how to adjust the asset purchase programme without generating inflation and still providing support to the economy while interest rates are near zero," said Bullard. "Interest rates may remain low for quite some time."

A recent run of very poor economic data illustrates the fact that, despite having underwritten the banking system and made progress on reflating asset markets, there really is no simple, elegant, low-cost solution to a balance-sheet recession.

The US economy lost 85,000 jobs in December, leaving just 58.2 per cent of the population employed, a figure not seen since the early 1980s. In terms of employment lost since the peak, this recession has been more savage than any in the post- Second World War period, and shows signs of being painfully slow to heal. When the annual revisions to the employment data are released next month they may well show a net loss of jobs across not just the year but the entire decade. There were some brighter spots in the jobs report; employers are using more temporary help, often a first step to adding permanent jobs.

Similarly sobering was data on US consumer credit, which fell for a record 10th straight month in November by $17.5bn, meaning it is contracting at an annual 8.5 per cent annual rate.

Credit card debt fell for a record 14th straight month. The contraction is almost certainly the result both of banks being unwilling to lend and consumers unwilling and unqualified to borrow. In the end the result is the same; for consumer spending to grow at a reasonable pace incomes and employment are going to have to grow to fund it. That does not seem likely.

The financial markets were quick to draw the conclusion that the Fed is a bit trapped in its current policy mix. Futures contracts are now pricing in only a 20 per cent chance that the Fed lifts rates to 0.5 per cent by June, down from about a third last week and 78 per cent at the end of December.

Of more interest possibly is what the Fed does about mortgages. By end-March, when its programme of buying is complete, it will have bought $1.25trn of them, keeping a lid on rates and supporting the housing market, and through it the banking system.

Boston Fed Chief Eric Rosengren said recently that he sees rates rising by as much as 75 basis points in coming months as the effect of official buying ebbs. That timing could be difficult for housing, which is benefiting through April from a tax credit for house buyers, but the programme may not end just yet.

Consumer credit and employment are not indicating a real recovery, nor is there fuel for inflation. It is true, too, that the effects of government stimulus will recede from the middle of this year, which is likely to further box the Fed into an easy policy mix, and very likely into buying more mortgages. The fight over a further stimulus package would be bloody and the political costs perhaps too high.

The stock market concluded the prospect of more easy policy is good news for it, and is perhaps right, though the logic holds up better perhaps for emerging markets than for the US. 


- James Saft is a Reuters columnist. The opinions expressed are his own

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