Have you ever lit a fire in a fireplace or at camp, and then stopped fanning the flames too soon, only to have the fire quickly die out? The next time you attempt it, you are most likely going to spend more time, care, and attention to ensure the fire can sustain itself before you leave it.
Well now you know how the U.S. Federal Reserve feels. For some 13 years now, since the end of the '90s boom in 2000, the Fed has been continually engaged trying to light a fire under the U.S. economy, trying to breathe some self-sustaining life into it that it might take care of itself without requiring further assistance or nurturing from the Fed.
Several times throughout these last 13 years, the flames of the American economy did indeed seem to rage strongly enough to be left alone. So the Fed backed off its nurturing—and what do you think soon happened each time? The flames would all too soon be smothered out by one unforeseen crisis or another.
As the New York Times described it:
“Each time in recent years that the Federal Reserve has paused in its efforts to stimulate the economy, it has come to regret the decision as premature. Its leading officials say the recovery has been slower as a consequence of those pauses. It is a mistake they do not want to repeat.”
This time, the Federal Reserve wants to do it differently. It is bull-doggedly fixated on labor, and it won’t stop fanning the flames until its unemployment targets are reached.
In a note to clients last week, as cited by the NYT, chief United States economist at Deutsche Bank, Joseph LaVorgna, stressed how Fed Chairman Bernanke and Vice Chairwoman Janet L. Yellen “have been abundantly clear in recent commentary that the improvement in the labor market to date falls far short of what they will need to see before reducing monetary policy accommodation.”
And the accommodation referenced is quite accommodating indeed, with interest rates still near zero and some 85 billion dollars’ worth of purchases of Treasuries and mortgage-backed securities each month.
These fire-stoking measures are intended to help businesses expand—or in many cases to simply keep them open for business—and help lower the unemployment rate to the targeted 6.5%. Given the current 7.7% unemployment rate, you can bet the Fed will not be announcing any policy changes at the end of their two-day meeting this afternoon.
So quotes the NYT:
“’The Fed will not take overt steps to scale back its asset purchases any time soon,’ Lou Crandall, chief economist at Wrightson ICAP, a New York-based financial research firm, wrote last week. ‘The Fed is not going to take any chances until it is sure that we have avoided another spring/summer swoon.’”
What serves as even greater assurance that Fed policy will not change today or anytime soon is the strong cold wind blowing out of the Mediterranean Sea—from Cyprus, to be more precise.
This wind could quickly grow into a tempest, given the precarious positions of several EU countries on the precipice of default, including Italy, Spain, Portugal, and both Greece and Ireland which have been close to that for quite some time. Even France was hit with a credit downgrade five months ago to the day.
Since Monday’s Cypriot shockwave jolted global stock markets, U.S. markets continue to be quite agitated, bobbing up and down over the last two trading sessions, posting lower lows below even Monday’s initial dip.
Notice how the CBOE Volatility Index (VIX) above had been stable and on the decline—up until the news out of Cyprus broke early Monday morning, which caused the index to rise sharply higher (red arrow).
Since then, market volatility has increased even more, meaning we can expect more turbulence ahead. As CNBC explains,
“That has put pressure on stocks and may prompt a pullback of up to 5 percent to 10 percent, said Jeff Kleintop, chief market strategist for LPL Financial.
“‘After all, it's time for March Madness,’ he said. ‘March has been maddening for investors in the past few years as the S&P 500 raced higher in March only to reverse all of those gains in a pullback of about 10 percent that began in late March or April.’”
Others, like Elliot Spar, market strategist at Stifel Nicolaus, also expect some degree of a corrective pull-back, but from a purely technical standpoint. “I continue to believe it will come from the technical side in the form of an increasing number of negative divergences, an increasing number of consecutive days of lagging NYSE breadth or a key reversal day in the major averages,” he told CNBC.
Whatever the cause of market instability going forward—be it technical sell signals from a prolonged market rise, or dramatic changes in macro-economic fundamentals—the flames under the U.S. economy are still flickering in the wind. We can therefore expect the Federal Reserve to draw the same conclusion this time around as it did the last time it met:
“In minutes from the last Federal Open Market Committee meeting,” CNBC recalls, “the Fed noted that ‘strains in global financial markets’ could be a downside risk to economic growth and possible reason to provide ongoing monetary stimulus.”
You will be hard-pressed to find anyone today who will not agree that if “strains in global financial markets” were present the last time the FOMC met, even greater strains are making their presence felt now.
Yet, although Fed Chairman Bernanke has continued to explain the Committee’s position clearly and consistently time and again, there has been of late a number of other voices speaking to his contrary.
“Fed officials who disagree with the policy,” informs the NYT, “including some who do not hold votes on the committee this year, have become increasingly vocal in their criticisms. And among officials who support the [stimulus] purchases, there is disagreement about how much longer the Fed should keep its foot on the gas.”
If these critics manage to reach audiences sooner than the Chairman himself can, the message reaching market traders and investors could be inaccurately skewed away from the Federal Reserve’s true position, unduly increasing market volatility.
So starting with today’s press conference, “The Fed chairman,” informs Bloomberg, “will cut the time between the release of post-meeting statements by the Federal Open Market Committee and his news briefings, giving investors less opportunity to misperceive the Fed’s intent.”
“Bernanke ‘felt he needed to take the wheel’ of communications to dispel any misperception that the Fed will end bond purchases too soon,” Bloomberg quotes Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore. “Bernanke rightly views it as imperative to get out in front of any movement to quickly pull away from stimulus, and to signal that to markets.”
So let the message ring clear. In view of the dark storm clouds still looming above stock exchanges around the world, including those of the U.S., the fire under the American economy must continue to be sheltered and nurtured.
Now is not the time to pull away and stop fanning the flames. Stimulus fuel is still required, and you can bet this message will ring out this afternoon yet again—and a few minutes sooner to boot.
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