Sunday, October 27, 2013

The Fed’s predicament in three paragraphs (Be the Fed)

Summary:  The Fed has few options in driving mortgage rates back down when not tapering hasn't done enough.  Lowering the Fed Funds Rate is pointless when you're virtually at 0%, forward guidance has little effect on long term rates, false, negative forecast may bring rates down, but will also stall economic activity, false positive forecast could bring rates up, which is self-defeating.  Basically, the Fed is out of options.

St. Croix --(CreditWritedowns.com and The Center of the Universe)--


So imagine you are a moderate FOMC number.

Mortgage apps are down, new home sales marginal, and private sector job creation sagging. And you keep revising your GDP forecast lower at each meeting. Likewise inflation remains low, and you believe the risks are asymmetrical. That is, you know you can stop inflation and growth with rate hikes, but you’re not so sure about fighting deflation.

And so, as an FOMC member, you’d like to see mortgage rates back down. So how do you get them there? You might not like QE, and at least highly suspect it doesn’t have any first order effects, and you fear there are unknown costs, but you know tapering, for whatever reason- almost to the point the reason doesn't matter- causes rates to go higher. And you know not tapering brought them down some, but not enough. Fed funds are already close to 0% so there’s no room there. Forward guidance, etc. has kept the short end low but not the long end. You are afraid to simply peg long rates with an unlimited bid for securities at your target rate. You know a weaker economic forecast will bring long rates down but that it would be intellectually dishonest to manipulate a forecast.

And maybe worst of all, if you do something that causes markets to believe the economy will do a lot better, mortgage rates go higher, presuming Fed rate hikes will accompany growth, and thereby make things worse instead of better.


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