Does Wall Street Have Fed 'On the Hook' For More Easing?
Even as doubts escalate over whether further easing measures will do any good, the Federal Reserve appears set to push forward out of obligation as much as anything else.
After all, the stock market has rallied more than 12 percent over the past seven weeks in part over the anticipation that the central bank will provide some form of stimulusto get the economy out of its malaise.
While the Fed has not openly acknowledged that it is ready to enact any new measures, the market is expecting it. Those expectations, will form the impetus for the Fed to start buying assets—probably Treasurys—as part of a program known as quantitative easing, experts say.
"The Fed has become less independent than the law permits," says noted Fed historian Allan Meltzer of Carnegie Mellon's Tepper School of Business in Pittsburgh. "The administration has...run out its string of fiscal expansion so it presses the Fed to do what it's doing. The Fed is doing what the Treasury wants."
Despite its obligation not to swayed by politics, the Fed instead has become a tool for the markets and Washington to get their way, says Meltzer, who testified before Congress in September and implored the lawmakers to institute a three-year moratorium on new business regulations.
"Political pressures, market pressures—the bond holders have had a nice ride on the rumors, and now that the rumors seem to be pretty strongly formed, the bond market has been moving the other way," Meltzer says. "I'm sure some people have made a lot of money betting on the Fed's actions."
Statements by Fed presidents and Chairman Ben Bernankehave indicated that while the bank is in disagreement over how effective another round of easing would be, some sort of action is likely to come at the November meeting.
Respondents to a recent CNBC survey said they expect a $500 billion program to buy Treasurys in the central bank's latest efforts to drive down interest rates and encourage economic activity.
In the interim, stocks and commodities have rallied sharply, while bond prices have slipped a bit and yields have come off what in some cases have been historic lows.
"They're on the hook to do something because they've massaged expectations," says Kevin Ferry, president of Cronus Futures Management in Chicago. "It's hard for me to say there were negative consequences for them bringing this up with the S&P at 1,180 and the 10-year note on a steady climb. Bet against them? I tried it. It sucks."
Indeed, one of the Fed's chief goals since it began intervening with the capital markets has been to push investors toward risk—away from the safety of government bonds and money markets and out into stocks and high-yield bonds.
Consequently the stock market has grown in spurts while bonds have been unrelenting. Real yields have fallen and loan rates, particularly for mortgages, have plunged.
Yet amid those successes the Fed has managed to generate only modest economic activity, a dilemma it has acknowledged in recent statements bemoaning the inability to achieve a healthy inflation rate. The lack of economic success has some analysts questioning the wisdom of printing more money and running the risk of intractable inflation.
"They're on the hook to do something because they've massaged expectations."
"Count us as skeptical if not on the likelihood of QE2 then certainly on its effectiveness and its impact on risky assets," Jeffrey Rosenberg, head of global credit strategy research at Bank of America Merrill Lynch, wrote in a research note. "Our arguments stand in line with the few skeptics at the Fed that liquidity is no longer the problem hence cannot be the solution. Moreover, too much liquidity now is itself becoming a problem."
So what if the Fed surprises everyone and decides not to act?
Some market pros have suggested the Fed announcement will be a classic sell-the-news moment—when traders bid up the market on rumors of a big event then sell and take profits once the event occurs.
But another school of thought suggests inaction could have the opposite effect, in which the Fed says it does not need to act yet because the economy is showing enough signs of strength to recover on its own.
In a best-case scenario, the Fed accomplishes the goal of increasing investor risk through jawboning more quantitative easing, while not actually having to implement the buying program and further bloat its $2.3 trillion balance sheet.
"Does it really matter either way?" asks Art Hogan, managing director of Boston-based Jefferies. "The larger issue is what if Nov. 3 comes and goes and the Fed doesn't deem it necessary to increase their balance sheet. You would think that would be more cause for celebration in the marketplace."
Hogan sees the Fed's actions as only one part of a triad of factors that could lift the market, the other two being a change of political power after the November election and the exhaustion of the bond and commodity rally.
"The third leg of this is really equities have become the asset class of last resort. Clearly commodities have ramped up more than equities have. All classes of fixed-income assets have certainly gotten more sponsorship than appropriate right now," Hogan says. "Stocks are the best-looking horse in the glue factory."