Another Fed meeting, another chance to set up expectations for an eventual move higher in interest rates. On an exclusive basis, Macro Man is pleased to be able to provide readers with a photo of today's FOMC deliberations. If you look closely, you can see the agenda for the September meeting being established to the left, with one FOMC member already preparing to slap down any expectations arising from today's announcement at the first sign of trouble (or what the committee defines as trouble, which may not fit your own definition.)
Leaving aside the dreary will they/won't they farce that has dominated Fed rhetoric for the past eighteen months or so, another questions arises: why doesn't the Fed just sell some bonds? After all, the original exit plan established early in the decade envisaged selling bonds as a precursor to raising rates, though that was eventually scrapped after the Fed snaffled another trillion or two of securities.
From Macro Man's perch, shifting the policy focus to selling bonds could offer a few benefits, including the following:
* By reducing the level of excess reserves, it would accelerate the timetable for a normalization of the level of reserves, potentially allowing the Fed to regain greater control of money market conditions using conventional (and less politically sensitive) tools
* By the same token, the extremely high level of current excess reserves should prevent an undesired tightening of conditions in the front end. Yes, repo rates would likely rise, but a modest increase there should not incur undue concern
* It would increase the amount of high quality collateral on the street. The monetary policy focus of many central banks since the crisis, including each of the G3, has been to purchase enormous amounts of government debt, effectively removing it from circulation. In a post Lehman world, this type of high quality debt is the collateral that greases the rails for global financial transactions, all the more so because most intermediaries can no longer rehypothecate this collateral. Providing more collateral to the world market (thereby offsetting that taken away by the ESCB and BOJ) can only be a good thing
* At the same time, providing more
* However, a modest rise in longer term rates may convey benefits beyond those to yield-starved savers. A modest steepening of the yield curve should be good for financial earning power. While this may be anathema to the likes of Elizabeth Warren, perhaps she should ask Europe how they're getting along with a banking sector that makes no money
* Just as importantly, higher long term rates actively helps pension funds via reducing ALM burdens and increasing the returns available from fixed income portfolios
* While it is true that higher mortgage rates are not good for housing, Macro Man's analysis suggests that changes is home sales are somewhat less responsive to changes in mortgage rates than they were before the crisis.
* Perhaps most importantly of all, implementing a regular auction program will enable the Fed to reap the benefits of more "free easing" simply by reducing or even stopping the program. Who needs the dots when you can just reduce a bond auction?