The Federal Reserve released the minutes of the December 14 FOMC meeting this week. The FOMC’s meeting minutes provide an expanded discussion of the Fed’s views on the economy, financial markets, and future monetary policy. This is required reading for investment managers.
The minutes from the December 14 meeting are particularly important because that was the first meeting since the Fed started its second round of money printing, aka Quantitative Easing 2.0 (QE 2).
At the FOMC’s November 3 meeting, Bernanke & Co. decided to print an additional $600 billion to buy Treasury securities. The following day, the Fed chairman wrote an article in The Washington Post explaining the Fed’s decision to inject more monetary stimulus into the economy. He wrote:
The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.
Then, about a month later, Bernanke appeared on 60 Minutes, where he said the following:
What we’re doing is lowing interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that’s what we’re gonna do.
So on two occasions, the Fed Chairman told the public that buying another $600 billion in Treasury securities would lower long-term interest rates and that these lower rates would stimulate growth. Based on Bernanke’s statements, a reasonable person would have to assume that to be deemed successful, QE 2 would have to decrease, or at least not increase, interest rates.
What have interest rates done since the Fed restarted the printing press? Exactly the opposite of what Chairman Bernanke told us they would do. Yields on 10-year Treasury notes have spiked up a full percentage point from their October lows, and they are up about 80 basis points since the November Fed meeting. Based on Bernanke’s own benchmark of success (low long-term interest rates), a reasonable person would have to deem QE 2 a failure.
How does the Fed view QE 2 in light of the recent run-up in interest rates? The December meeting minutes offered the first glimpse into the FOMC’s thinking on the matter. Here is an excerpt from the December meeting minutes:
A number of participants indicated that, because the backup in rates appeared to importantly reflect changes in investors’ expectations about the size of Federal Reserve asset purchases, the backup was consistent with purchases helping to keep longer-term yields lower than would otherwise be the case.
Wow. Talk about lowering the bar. Rates are lower than they otherwise would be. What would they otherwise be? This sounds like the Obama administration’s contention that the $862-billion stimulus plan saved or created three million jobs. Imagine if businesses were run this way. Can you see a CEO saying to his board, “Well, if I weren’t in charge, the company would have missed sales and earnings goals by even more.” I have a hunch this wouldn’t go over well.
The Fed is in denial. Rates are up, but they were supposed to fall. The program has failed. The meeting minutes cast a light on the disturbing truth that there is no accountability at the Fed. The benchmark for QE 2’s success has been redefined. The meeting minutes should confirm to all that despite the potentially devastating long-term economic consequences, the Fed is going to print every last dime of the $600 billion that has been authorized. On that joyous note—happy investing!
Jeremy Jones, CFA
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